By Johan Kotze, Tax Executive in the Tax team

The Mineral and Petroleum Resources Royalty Act, No. 28 of 2008 (as amended), (the Royalty Act) imposes the obligation on a person to 'pay a royalty for the benefit of the National Revenue Fund in respect of the transfer of a mineral resource extracted within the Republic'.

The rate at which the royalty is to be imposed is dependent on the determination of gross sales and earnings before interest and taxes (EBIT), per the following formulae:
• In the case of refined mineral resources: 0,5 + [EBIT / (gross sales x 12,5)] x 100
• In the case of unrefined mineral resources: 0,5 + [EBIT / (gross sales x 9)] x 100

Gross sales of a refined and unrefined mineral must be determined without any regard to any expenditure incurred in respect of transport, insurance and handling (the TIH costs):
• after that mineral was brought to the relevant condition; or
• to effect the disposal of that mineral resource.

SARS has issued a draft Binding General Ruling (on 10 February 2017) and in relation to the TIH costs says the following:

'Expenditure incurred in respect of transport, insurance and handling to bring the mineral resource to the condition specified in Schedule 1 or 2 (whichever is applicable) must be taken into account in the determination of gross sales and EBIT.

All expenditure in respect of transport, insurance and handling incurred after the mineral resource is brought to the condition specified in Schedule 1 or 2 must not be taken into consideration when calculating gross sales and EBIT.

Only transport, insurance and handling expenditure incurred in order to bring the mineral resource to the condition specified in Schedule 1 or 2 can be taken into account when determining gross sales and EBIT.'

The draft Binding General Ruling then goes on to rule that:

'The ordinary dictionary meaning of the phrase “without regard to”, as contained in sections 5(3) and 6(3) respectively, means that the expenditure incurred in respect of transport, insurance and handling –
• after the mineral resource is brought to the condition specified in Schedule 1 or 2; or
• to effect the transfer of that mineral resource,
must not be taken into account when determining gross sales and EBIT for purposes of calculating the royalty percentage. Such costs will not qualify as a deduction in the determination of gross sales or EBIT.

In the event that such costs are on charged and included in the price of the mineral resource sold, the sales price may be adjusted to disregard such amounts from the calculation of gross sales and EBIT. The onus of proof rests with the extractor to prove that such amounts were taken into account and included in the price of the mineral resource.'

At the time it was the writer's view that the draft ruling seems to have strained the manner by which gross sales and EBIT should be determined. SARS does not fully appreciate the stages performed to bring a mineral resource to the relevant condition and then the stages performed after the mineral resource is brought to the relevant condition.

SARS seems to follow a rather literal approach to the meaning of 'without regard to' and applies this approach equally to gross sales and EBIT; ignoring the context in each instance. The reality is that these expenses will always be taken into account in the cost of sales and be recovered by gross sales, which should then be excluded or deducted in order to be ‘without regard to’ these expenses.

The gross sales is the amount received or accrued during the year of assessment in respect of the transfer of the mineral resources and, it is submitted, that it should not even include these expenses, so recovered, incurred before the mineral is brought to the relevant condition, whereas the cost of sales should include these expenses incurred before the mineral is brought to the relevant condition.

This aspect was considered in a recent judgment of Meyer J in the case of United Manganese of Kalahari (Pty) Ltd v C:SARS (Gauteng Provincial Division of the High Court) – a declaratory sought by the taxpayer. After thorough reasoning the judge ordered that the taxpayer is entitled to calculate the gross sales in respect of manganese transferred by it, by deducting:
• the TIH costs incurred by the taxpayer in respect of the manganese, after the manganese had been brought to the condition specified in Schedule 2 of the Royalty Act, and
• any TIH costs incurred to effect the disposal of the manganese,
irrespective whether the TIH costs were specifically and / or consciously considered in the determination of the taxpayer's gross sales, and irrespective whether the TIH costs are of a capital nature.

The draft Binding Ruling is consequently obsolete.

There is no doubt SARS will appeal against this decision.