Miner or manufacturer? The plot thickens
10 October 2014
Posted by: Author: PwC South Africa
Author: PwC South Africa
A recent decision in the
Johannesburg Tax Court (Case No 13410 – judgment delivered on 4 August 2014)
has served to add to the confusion that surrounds the question of whether a
person is carrying on mining activities or manufacturing activities.
In this matter, the taxpayer (a
company) carried on mining operations on property which it did not own. It
extracted mineral ore from the earth and transported this to its concentrator
plant on the property. At the concentrator plant, the ore was smelted, which
separated the mineral content from the rock, after which the minerals were
recovered by means of a flotation process.
contract for the sale of mineral concentrates provided that payment for
concentrate delivered would only be determined some four months after delivery,
due to various factors related to market prices and rates of exchange. The
contract provided further that the moisture content of the concentrate should
not exceed a specified level, and if it exceeded such level, the taxpayer would
be liable for the costs of drying the concentrate.
In its returns of income for the
2007, 2008 and 2009 years of assessment, the taxpayer excluded the value of
sales of product made in the last four months of the year of assessment from
the current year’s income. In terms of
section 24M of the Income Tax Act (the Act), where a person disposes of an
asset during a year of assessment and the amount of the consideration cannot be
fully quantified in that year of assessment, so much
of the amount as cannot be quantified is deemed not to have accrued to that
person in that year of assessment.
The taxpayer’s filing position in
respect of its income was accepted by the South African Revenue Service (SARS).
However, SARS disallowed a portion of the operating expenditure incurred by the
taxpayer in the relevant year of assessment, in terms of section 23F(2) of the
Act. This section provides that a deduction for expenditure incurred during a
year of assessment in the acquisition of trading stock is to be disregarded to
the extent that it
exceeds the proceeds for the sale of such trading stock that has accrued to the
The taxpayer objected to the assessments
disallowing the expenditure, and, its objection having been disallowed, appealed the matter to the Tax Court.
The taxpayer raised two principal
arguments against the disallowance of expenditure. First, it argued that the
mineral-bearing ore mined by it did not constitute trading stock. Second, it
contended that there was no acquisition of the mineral-bearing ore. For these
reasons, the provisions of section 23F(2) of the Act do not apply.
on the other hand, contended that the mineral-bearing ore was trading stock and
that it had been acquired by the taxpayer. It argued that the purpose of
section 23F(2) was to achieve a matching of taxable income and deduction, such
that, where the accrual of income is deferred, the deduction of expenditure
related to that deferred income should also be deferred and allowed as a
deduction in the year in which the income accrues.
The judgment of Victor J is difficult to follow
and to reconcile to other decided judgments. That said, the judgment
seeks to deal with the two principal issues.
trading stock argument
The taxpayer’s argument was based
on the fact that section 15A of the Act was not in force in the relevant years
of assessment. This section provides
that mineral-bearing ore constitutes trading stock. It therefore argued that
the mineral-bearing ore was not trading stock. Further, it was argued, the ore
was not acquired for purposes of manufacture, sale or exchange, and, as such,
did not fall within the
scope of the definition of ‘trading stock’ in the Act. The concentrate was
trading stock, and therefore the costs of acquisition of the trading stock must
be limited to the costs attendant upon acquiring the concentrate from the ore.
elegant argument severed the continuum of the mining activity into two separate
processes, namely the mining of the ore and the extraction of the concentrate.
By dividing the process into discrete elements, the impression is created that
no trading stock arises in the first
element, because what is severed from the earth is not yet trading stock, and
only the second element gives rise to trading stock. Victor J appears to have
accepted this argument.
That Victor J was persuaded by
this argument is not altogether surprising,
given that there are judgments of the Supreme Court of Appeal which have
seriously blurred the law in relation to trading stock, in particular insofar
as the distinction (if any) between mining and manufacturing is concerned.
Victor J concluded that
the ore could not be trading stock by reason that it was not stockpiled at any
time, relying on the decision in CIR v Foskor Ltd 72 SATC 174
(SCA), whichheld that mineral ore stockpiles were trading stock which
must be taken into account for purposes of section 22 of the Act, as authority
for this conclusion. Further, she found that the decision in Richards BayIron and Titanium (Pty) Ltd & Another v CIR 1996 (1) SA 311(A) dealt with mineral stockpiles
in the context of manufacturing rather than mining.
These two decisions in the
Supreme Court of Appeal have been severely criticised for ignoring the
difference between mining and manufacturing, and it is unfortunate that our
courts of lesser jurisdiction are compelled to apply and reconcile the
J concluded that only the concentrate met the requirements for the application
of section 23F(2) of the Act, because it was trading stock, whereas the
mineral-bearing ore was not trading stock.
This line of reasoning, it is
submitted, is questionable. A mining operation is undertaken to win a mineral
from the soil or a constituent thereof. The mineral that is finally available
for sale is the only item of trading stock that is acquired and disposed of.
The process by which it is acquired is a continuum that commences when the
ore is severed from the earth and ends when the mineral is recovered in
saleable form. All costs attendant upon winning the ore and extracting the
mineral are arguably costs in respect of the acquisition of the trading stock.
To simply ignore part of the continuous process by an artificial division into
separate stages leads to a conclusion that is questionable.
Victor J was urged by the taxpayer
to find that the taxpayer had actually acquired the minerals at the point that
the mineral-bearing ore was severed from the earth. All other costs incurred in
respect of the various mining processes leading to recovery of the concentrate
in saleable form, it was urged, were incurred after the acquisition, and
therefore did not fall within the scope of section 23F(2) of the Act. This
argument was rejected.
Victor J took the view that, since the mineral-bearing ore was not trading
stock, the costs attendant on its acquisition fell outside the scope of section
23F(2). She was therefore concerned only with the expenditure incurred in
respect of the acquisition of the concentrate. In this regard she ruled further
that any costs incurred in reducing the moisture content to meet the
requirements for sale were incurred after the acquisition of the concentrate
and were not incurred in respect of the
acquisition of the concentrate.
There is apparent conflict in the
reasoning behind the decision, in the sense that it was stated at paragraph
my view there are similarities between the Foskor and Appellant’s case. Some
form of transforming low value raw materials occurred, resulting in high value
finished goods. The only difference is that the Appellant was involved in the
entire process, from mining, to manufacturing and trading. The purpose of the
taxpayer in both cases is similar, and hence their treatment should actually be
the same as the raw material was acquired. The difference will be in the
taxation formula applied in manufacturing versus mining. (Emphasis added)
However, the final statement of the decision at paragraph  reads:
This begs the question: If the
Court has stated that the Appellant was involved in the entire process, from
mining to manufacturing to trading, how could the Court later conclude that the
second phase was not a manufacturing process?
second phase process of producing concentrate remains a mining process and not
a manufacturing process. Accordingly the taxation formula to be applied to the
second phase shall be that of mining.
judgment dealt also with the amount that was required to be disregarded. In
this respect, there is also evidence of a lack
Section 23F(2) of the Act states:
a taxpayer has during any year of assessment disposed of any trading stock in
the ordinary course of his or her trade for any consideration the full amount
of which will not accrue to him or her during that year of assessment and any
expenditure incurred in respect of the acquisition of that trading stock was
allowed as a deduction under the provisions of section 11(a) during that year
or any previous year of assessment, any amount which would otherwise be
deducted must, to the extent that it exceeds any amount received or accrued
from the disposal of that trading stock be disregarded during that year of
The elements are:
- Trading stock must have been disposed
of and the income not
yet accrued; and
- Expenditure must have been incurred
in respect of the acquisition
of that trading stock,
which is deductible in terms
of section 11(a) of the Act.
these elements are present, the amounts incurred in respect of the expenditure
incurred under section 11(a) which would have been deductible but for the
application of section 23F(2) shall be disregarded. This, it is submitted, is
the interpretation to be applied to the word ‘otherwise’ in this
The judgment deals with arguments
advanced but does not appear to conclude on the proper application of section
23F(2) of the Act.
proper interpretation, it is submitted, the costs incurred in the acquisition
of the trading stock need to be identified by reference to the manner in which
a deduction is claimed in respect of such costs. To the extent that the costs
rank for deduction in terms of section 11(a) of the Act (whether in the current
or a prior year of assessment), they should be taken into account for purposes
of section 23F(2) of the Act. However, any amounts allowed as a deduction that
fall outside the
provisions of section 11(a) (e.g. mining capital expenditure and prospecting
expenditure) cannot be disregarded.
This argument appears not to have
been advanced or considered in the course of the judgment (we stress, however,
that we do not have access to the case record and make this supposition on the
basis that it was not addressed expressly in the judgment). However, it points
to the exclusion of infrastructural overheads, such as depreciation, that may
have been absorbed as part of the cost of trading stock.
One is left with the inescapable impression that this matter
will proceed on appeal to the Supreme Court of Appeal. The amount of tax
involved is significant, and the principles deserve clarification.
In the event that the matter does
proceed on appeal it is to be hoped that the Supreme Court of Appeal will
examine its earlier decisions on trading stock in the context of the mining
industry critically. It is imperative that we understand what is mining and
what is manufacturing, as the formula applicable to the taxation of each of
these activities is different.
In addition, a clear explanation of the application of section
23F(2) of the Act would be most welcome.
This article first appeared on pwc.co.za.