The recent publication of the draft Taxation Laws Amendment Bill (TLAB) makes it clear that the proposed amendments to the Mineral and Petroleum Resources Royalty Act are aimed at increasing the mineral royalty contributions made by coal mining companies to the National Revenue Fund.

This is the view of law firm ENSafrica associate André Vermeulen, who highlights that, as a result of “some companies incorrectly interpreting the legislation or the legislation not being sufficiently clear”, the National Treasury is proposing amendments to the Second Schedule of the Royalty Act, which pertains to unrefined minerals, of which coal is one, as well as Section 6A of the Royalty Act, which deals with the application of the Second Schedule.

He says to appreciate the impact of the proposed amendments in respect of coal, it is necessary to understand the current methodology applied in determining the mineral royalties payable.

Section 2 of the Royalty Act states that the mineral royalty amount to be levied is determined by multiplying the gross sales (as defined in the Royalty Act) of the extractor for the year of assessment (‘the tax base’), with a percentage (‘the royalty rate’) determined in terms of Section 5 of the Royalty Act.

The royalty rate is, however, also determined with reference to the gross sales of the extractor for the year of assessment.

“Any impact on the gross sales of the extractor will have a substantial influence on the mineral royalty that is to be paid, as the tax base, as well as the royalty rate to be used, will be affected,” notes Vermeulen.

The gross sales amount for unrefined mineral resources is determined in terms of Section 6(2) of the Royalty Act. In this regard, the Royalty Act determines that where a mineral resource is transferred “in the condition specified” in the Second Schedule, the gross sales amount will be the “total amount received or accrued during the year of assessment in respect of the transfer of that mineral resource”.

Where the mineral resource is transferred in a condition other than the condition specified in the Second Schedule, the gross sales amount will be “the amount that would have been received or accrued during the year of assessment . . . had that mineral resource been transferred in the condition specified in Schedule 2 for that mineral resource in terms of a transaction entered into at arm’s length”.

The “condition specified” for coal, in terms of the Second Schedule, is currently set at a minimum calorific value (CV) of 19 MJ/kg, which refers to the energy potential per kilogram of coal.
When reading Section 6 of the Royalty Act in isolation, mineral royalties will be payable when an extractor transfers coal at a CV of 19 MJ/kg or higher.

This would thus be an unlimited range in which coal can be trans-ferred. Where coal is transferred above the minimum condition specified, the extractor should determine the gross sales, at an arm’s- length price, that it would have or did receive for the coal at that higher CV.

Vermeulen says this interpretation of Section 6 ignores the provisions of Section 6A, which deals with the application of the Second Schedule.

In this regard, Section 6A(1) provides that “if any unrefined mineral resource is transferred below the minimum condition specified in Schedule 2 for that mineral resource, the mineral resource must be treated as having been brought to the minimum condition specified for that mineral resource; or is transferred at a condition beyond the minimum condition specified in Schedule 2 for that mineral resource, the mineral resource must be treated as having been transferred at the higher of the minimum conditions specified for that mineral resource or the condition in which that mineral resource was extracted”.

“Section 6A thus specifically provides for the situation where an unrefined mineral resource (that is, coal) is transferred in a condition other than the minimum condition specified in the Second Schedule. Where an extractor transfers coal below the minimum CV of 19 MJ/kg, that extractor, for purposes of determining its mineral royalty liability, will be deemed to have transferred the coal at the minimum CV of 19 MJ/kg and, as such, will be deemed to have received consideration equal to an arm’s length price for the coal at a CV of 19 MJ/kg, irrespective of the actual consideration received,” explains Vermeulen.

Similarly, where an extractor transfers coal at a CV over and above the minimum condition specified, that extractor will be deemed to have transferred the coal at the higher of the minimum condition specified or the condition in which the coal was extracted.

Should the coal be extracted below the minimum CV of 19 MJ/kg, but beneficiated to a CV higher than 19 MJ/kg, the gross sales will be determined as if the coal was transferred at a CV of 19 MJ/kg.

In the event that coal is extracted at a CV higher than the minimum condition specified and transferred immediately thereafter, or beneficiated and then transferred, the gross sales amount will be determined as if the coal was transferred at the point of extraction.

“This means that the extractor’s gross sales will be determined on a deemed consideration amount, that is, an arm’s-length price for coal with a CV as at extraction, but before beneficiation,” says Vermeulen.
He maintains that the above interpretation appears to be in line with the statement made by the National Treasury in the Draft Explanatory Memorandum to the Royalty Act, where it states: “The purpose of these alternative deviations is twofold. Firstly, the Schedule 1 and 2 conditions are intended to act as minimum bases. This minimum base ensures that extractors do not structure their affairs so as to undermine the royalty (that is, by adding little or no value to the mineral from its mine mouth condition so as to artificially reduce the gross sales value below general industry practices).

“Secondly, it also prevents the royalty from acting as a hidden penalty for beneficiating mineral resources. The Schedule 1 and 2 conditions effectively act as maximum bases upon which the royalty can be applied (so that further addition by way of further beneficiation does not increase the gross sales base for the royalty).”

Vermeulen says, in most instances, the price used by extractors to determine their gross sales is the price at which they sell coal to State-owned power utility Eskom or an adjusted amount derived from the Eskom price.

The proposed amendments to the Royalty Act could, however, result in a substantial increase in mineral royalty liability, where an extractor beneficiates its coal. The TLAB proposes amending the Second Schedule so as to no longer provide for a minimum condition in which coal is to be transferred, but instead creates a CV range of 19 MJ/kg to 27 MJ/kg within which coal is to be transferred.

Accordingly, to the extent that coal is transferred below the minimum of the range of conditions specified (below a CV of 19 MJ/kg), the determination of an extractor’s gross sales remains unchanged, as the mineral royalty will continue to be determined on a deemed arm’s- length price, as if the coal was transferred at the minimum of the range. Where coal is extracted within the specified range and transferred at that extraction CV, the extractor’s gross sales will be determined on the actual consideration received for the coal at that extraction CV.

However, the proposed amendments could result in an increase in an extractor’s gross sales where it beneficiates its coal. This is because the implementation of a CV range and the insertion of Section 6A(1A) of the Royalty Act will result in the extractor’s gross sales no longer being determined at a deemed arm’s length price, but at the actual consideration it received for the transfer of its beneficiated coal.

While an extractor’s gross sales would previously have been determined at a deemed arm’s-length price for coal transferred at the minimum condition specified, where it extracted coal below the minimum condition of 19 MJ/kg and beneficiated it, its gross sales will now be determined on the actual consideration received for the coal transferred at that beneficiated CV.

Similarly, where the coal is extracted within the specified range (above a CV of 19 MJ/kg) and then beneficiated, the gross sales will no longer be determined on a deemed arm’s-length price for that coal at the extraction CV, but on the actual consideration received for the beneficiated coal.

Vermeulen notes that as the bulk of local coal sales consist of sales to Eskom, which buys coal within a relatively low CV range of 19 MJ/kg to 21 MJ/kg, the proposed amend-ments should have a limited impact on extractors operating in the local market, as this coal requires little or no beneficiation. Those targeting the export market, where the coal quality ranges between 24 MJ/kg and 27 MJ/kg and the sales price is considerably higher than the price paid by Eskom, will be hardest hit.

The proposed amendments will, essentially, levy a mineral royalty not only on the value of the coal extracted, but also on the value added to the coal through beneficiation, he highlights.