By PWC Tax Synopsis
In Armgold/Harmony Freegold Joint Venture v CSARS  ZASCA 152, a decision handed down on 1 October 2012, the Supreme Court of Appeal has brought welcome clarity regarding the taxation of a mining company that owns and operates more than one mine, not all of which are operating profitably, where the company also derives income from non-mining activities.
This matter came before the court as an appeal from the decision of the Tax Court in ITC 1854 (2012) 74 SATC 42 and involved the interpretation of sections section 36(7C), (7E), (7F) and (7G) of the Income Tax Act 58 of 1962.
The central issue confronting the court in this case was to determine the correct method by which deductions for capital expenditure (for brevity, ‘capex’) and assessed losses are to be applied in calculating the taxable income of a mining company.
The facts of the case
In this particular case, the taxpayer company (a joint venture company established by the Armgold and Harmony mining groups) derived income from its three gold mines, known as Freegold, Joel and St Helena, respectively. Of the three mines, St Helena operated at a loss whileFreegold and Joel produced a taxable income.
However, the capital expenditure incurred in respect of Freegold and Joel, if deducted from their taxable income, would reduce that taxable income to nil. Neither Freegold nor Joel had a balance of assessed loss brought forward from previous years. The taxpayer also derived a taxable income from non-mining activities in an amount that exceeded the operating loss of St Helena in each year.
The contrasting arguments
The taxpayer argued that its overall taxable income for the year should be assessed at R105 million, being its taxable income (R156 million) from non-mining activities less the R51 million loss made by the St Helena mine.
SARS did not agree with this methodology, and argued that the St Helena loss for the year inquestion (namely its gross income minus operating expenses in terms of section 11(a)) should be deducted from the taxable income before capital expenditure of the two other mines, after apportioning the loss between them. This would have the effect of reducing the taxable income before capital expenditure of each profitable mine while at the same time reducing their capital expenditure deductions.
The taxpayer argued that, in the assessment of its taxable income, each of its mines should be treated as a separate trade, and that the loss incurred by its St Helena mines should constitute an assessed loss as envisaged in section 20(1)(b); moreover, that in calculating the taxpayer’s overall taxable income, the assessed loss of the St Helena mine should be deducted only after the taxable income of the other mines (being separate trades) had been determined.
The taxpayer argued further that it was impermissible to allow the St Helena loss (that is to say, its gross income less its operating expenses) to be deducted from the taxable income of the Joel and Freegold mines because this would, in effect, mean that St Helena’s operating expenses would be set off against the other two mine’s incomes to determine their respective taxable incomes before making their capex deductions.
The decision of the Supreme Court of Appeal
The issue before the Court was how to reconcile the apparent conflict between sections 36(7E) and 36(7F) of the Income Tax Act.
Leach JA (who delivered the unanimous judgment of the Court) pointed out (paragraph ) that the purpose of section 36(7F) was to prevent the use of capex of one mine from being allowed as a deduction against the income derived by another mine. It therefore "ring-fences” mining capex on a "per mine” basis.
The operation of the "per mine ring-fence” is straightforward as long as all of the mines are generating a taxable income. However, difficulties emerge where one of the mines generates a loss. Here, the litigants were at odds. The appellant asserted that the provisions of section 36(7F) of the Act effectively required each mine to be taxed as a separate trade, and this is what it (the appellant) had done in preparing its return of income. Reliance was placed on the requirements of section 36(10) of the Act which requires that the capex in respect of each mine is to be computed separately and paragraph (2)(d) of the Schedule of Rates of Tax which provides that rate of tax in relation to a person who mines for gold may vary from mine to mine.
On this issue, after generally identifying what constitutes a "trade” for income tax purposes, Leach JA rejected the argument (at ):
"Had the legislature intended each mine’s operations to be regarded as a separate trade, it could easily have said so. Not only did it not, but the provisions of s 36(7E) in which reference is made to the ‘aggregate of the amounts of capital expenditure . . . in relation to any mine or mines’ clearly exclude different mining operations being regarded as different trades. The appellant’s argument based upon the necessity to regard its operations at its different mines as different trades must therefore fail.”
Having so determined, the Court then turned to the appellant’s argument that it is impermissible to set off the losses derived on one mine against the income of another mine. Leach JA found merit in the appellant’s argument that the basis applied by SARS was unacceptable in principle (at ):
"Section 36(7F) envisages the capex deduction of each mine to be determined by having regard to the taxable income derived from that mine, an objective that will be defeated if the operating expenses incurred of one mine are to be taken into account in respect of another.”
After examining the available precedent and the apparent purpose behind the enactment of section 36(7F), the learned Justice of Appeal concluded:
"...s 36(7C) provides for the amount to be deducted under s 15(a) to be the capital expenditure on a particular mine, determined by the income derived from working that mine. Violence would be done to this if the operating expenses of one mine were set-off against the income of another, and I have therefore concluded that it is impermissible to do so.”
However, the appellant was not yet out of the woods. The Court then had to determine how the capex deduction should be applied. This, Leach JA pointed out (at ), required that he analyse the appellant’s argument that the capex deduction is subject to both section 36(7E) and section 36(7F).
It fell to the Court to reconcile the provisions of the two subsections and direct how the capex deduction should have been calculated. This, Leach JA explained (at ), should be achieved by apportionment:
"Although s 36(7F) provides for a maximum (or particular cap) that may be deducted for capital expenditure in respect of each of the Freegold and Joel mines, it does not necessarily entitle the appellant to deduct the full amount of each such cap. Thus, the answer seems to me to be for the individual capex caps of the Freegold and Joel mines to be reduced so that their total does not exceed the general cap imposed by s 36(7E). In this way the two sub-sections will work in tandem, setting a maximum total deduction and reducing the Freegold and Joel mines maximum caps proportionally (an exercise similar to that adopted by the respondent in prorating the St Helena loss of R51 million between the Freegold and Joel mines).”
In the result, the effect of apportionment of the capital expenditure in the manner determined by the Court resulted in the same taxable income as assessed by SARS, and the appeal was dismissed and the assessment made by SARS was confirmed.