JOHANNESBURG (miningweekly.com) – The recommendations of the Davis Committee on Tax bring the prospect of new mining development to a screeching halt and sound the death knell for new gold mining development in particular, commentators warn.

The South African mining industry has until October 31 to comment on the first round of the Davis proposals, which commentators condemn for riding roughshod over the committee’s terms of reference of ensuring economic growth and job creation.

“Gold mining’s an industry on a knife-edge and ill-thought tax policy may be the push it doesn’t need. The same probably applies to half the platinum miners,” Imara Asset Management investment manager Bruce Williamson warns in a comprehensive and thoughtful written response to Creamer Media’s Mining Weekly Online.

The tax review, under Judge Dennis Davis, was announced in the 2013 Budget as an initiative to assess South Africa’s tax policy framework as well as its role in supporting the objectives of inclusive growth, employment, development and fiscal sustainability. But the recommendations ignore the need for mining to remain a competitive investment proposition.

On the Davis chopping block is the 100% capital investment deduction, which is a fundamental shift away from the established principle of mining being very distinguishable from manufacturing.

Then specifically for gold mining companies, the committee recommends the scrapping of the gold tax formula for new mines and the discontinuation of the special indexation allowances that compensate for the cost of capital, which increases the risk of borrowers being in breach of their debt covenant ratios in an industry already starved of liquidity, equity and debt capital.

“So you’ve got three very important pillars recommended for removal,” says KPMG corporate tax head Muhammad Saloojee, who earlier this month sounded a call to action.

Williamson points out that the gold tax formula takes the view that gold mining taxation should not discourage the mining of marginal ore and particularly ore at depth.

The gist of the system is to reduce the tax burden on mines with a low profit to revenue ratio and the quid pro is that mines with high profit to revenue ratios pay higher tax rates.

This progressive formula tax has ensured that the State is able to level peg with investors in receiving returns from gold mining. South African gold mining data from 1951 to 2011 shows that the government received the same percentage of gold mining revenue in tax as investors received in dividends. (Also watch attached Creamer Media video.)

But Davis wants a neutral tax system that equates the ups and downs of the cyclical price-taking mining industry with the steady upward slope of price-making manufacturing, which is likely to result in the 30 000 t to 40 000 t of gold still in the ground in South Africa being sterilised for all time.

This flies in the face of the plea made earlier this month by Business Leadership South Africa chairperson and former AngloGold Ashanti CEO Bobby Godsell, who called on South Africans to see as a patriotic challenge the turning to positive account of the huge volume of gold still available for mining.

Taking the gold mining industry as a single entity, in a period of 60 years just over 7% of revenue was returned to shareholders as dividends and virtually the exact same percentage was paid to the government in direct taxation.

However, taking into account the indirect taxes paid by mine employees and mine suppliers, the government received far more than shareholders.

Moreover, the substantial forward and backward capital expenditure and working cost linkages gave rise to the creation of large self-sustaining cities such as Johannesburg itself.

Williamson enthuses about the mechanisms that have been built into the tax formula that take into account the long-term nature of mining investment and the risks that variable orebodies present.

The idea of introducing a neutral tax system is to enhance the allocation of capital and financing, reduce wasteful tax avoidance expenditures and enhance stability and productivity within an economy.

“This may well be the case in highly developed and competitive economies, but I am not convinced it’s the right way to go in South Africa, especially as it would greatly impact the mining sector, which is still an important cog in the South African economy,” Williamson said in his response to Mining Weekly Online. 

In his view the ‘one tax fits all’ approach is not a sensible approach to mining’s vastly varying mineral deposits, volatile commodity pricing and erratic exchange rates, which the variable-tax rated gold tax formula caters for in an efficient and sustainable way.

Moreover, he believes that the gold tax formula is so appropriate that it should also be extended to platinum mines.

“Mining is still vital and I am not sure that the extent of its multiplier effect is fully appreciated by all,” says Williamson, whose charts show that since 1990, gold costs in rand per kilogramme terms have soared as a result of narrow-seam gold and platinum mining being “caught in a time warp” of migrant labour, male-only hostels, low wages and low skills.

While promising alternative technologies are being trialled by major mining  companies, mine modernisation is proving to be a race against time, which makes it all the more important for the tax committee to understand fully the complex point at which mining finds itself. 

For example, the travelling time to the rock face of today’s deep gold operations takes two to three hours out of the working shift, leaving only five to six hours at the face.

With the addition of falling grades, greater heat and more support costs, even the gold tax formula with its tax-tunnel will soon not help.

The formula’s tax tunnel caters for differing orebody sizes and grades by charging no tax when a mine’s profit-to-revenue ratio is less than 5%.

As the mine’s profit-to-revenue ratio exceeds 18%, the formula then increases the tax to a level greater than the flat-line corporate tax rate.

Ultimately, as the mine moves into the so-called super profit level, it pays 50% more than the flat-line corporate tax rate.

With zero profit, there will be zero tax and no space to pay mineworkers the higher wages they so deserve, especially when compared to the 1.3-million civil servants, who average 25% more than South Africa’s nine-million private sector employees at R20 250 a month.

Moreover, to March 2015, the average net employee benefit cost to State power utility Eskom was more than R50 000 a month per employee for 42 500 employees.
 
The Davis line of a tax neutral policy is thus a long-term dream whereas it should first be dealing with the current nightmare.

The situation is already so poor that many believe a point is being reached where urgent action may be needed to protect South Africa’s gold and platinum mining infrastructure and orebodies, with coal, manganese, chrome and iron-ore probably also coming into contention.

“It doesn’t make sense to turn our backs on these mines with their huge shaft and processing complexes and attendant services like power, water, roads and rail – and a large labour force.”

Just as the State Aid formula supported lossmaking gold mining companies between 1973 and 1988 to the tune of a non-inflation adjusted R318-million, a radical, short-term solution may be for the government to declare old, deep gold and platinum mines and their orebodies national assets, which would exempt them from tax – which they are unlikely to be paying soon anyway – and declare a moratorium on pay-as-you-earn tax for the mineworkers employed at these national assets.

This is about the only way South Africa may be able to effect wage increases for mineworkers at deep-level mines without endangering this country’s gold and platinum national patrimony still further, Williamson adds to Mining Weekly Online.

The Chamber of Mines of South Africa has made five voluminous submissions to the Davis Committee on Tax, in which it stated that while it was reasonably comfortable with the findings and recommendations in its initial reading of the first interim report on mining, there were some areas which would needed careful examination.

The chamber agreed with the assessment that the partially profit-based royalty system ensured fair benefit to the State during boom times, making any additional windfall tax unnecessary.

But the chamber said it would need to look closely at the proposal that the existing capital expenditure write-off system be replaced by a depreciation regime similar to that applying to the manufacturing sector.

It was not convinced by the committee's arguments of tax neutrality between mining and other sectors, given the comparatively long lead time between the initial investment of a new operation and the beginning of revenue flows.

"We look forward to further engagement with the National Treasury and the committee on these and other matters," added the chamber, which expressed strong belief in the right of all role-players to raise any concerns they might have with the proposed changes in tax policy.

The chamber has engaged directly with the Davis committee and has made it clear that it intends to continue to do so.