Mining companies generally make financial provision for rehabilitation by virtue of rehabilitation trusts or financial guarantees through a financial institution or lately, insurance policies. Although a deduction can be claimed for contributions to a rehabilitation trust and the income derived by such rehabilitation trust is exempt from tax, cash strapped mining companies in the current economic environment are finding it tough to contribute the required amount of cash to the rehabilitation trusts. Insurance policies therefore became a more lucrative option as it enables mining companies to spread the premiums, and therefore payment burden, over a longer period of time and even lead to some mining companies transferring the funds in rehabilitation trusts into the insurance policies. The potential pitfalls of these methods are firstly, the adverse penalties in excess of 200% of the value of the funds in the rehabilitation trust which could be imposed by the South African Revenue Service (SARS) upon the transfer out of rehabilitation trusts and the potential non-deductibility of the premiums paid towards the insurance policies.
Mining companies in South Africa are required to make financial provision in terms of the Mineral and Petroleum Resources Development Act No. 28 of 2002 (the MPRDA), read with the National Environmental Management Act No. 107 of 1998 (NEMA), for the rehabilitation of the mining areas on which mining activities are conducted (this will in future solely be governed by NEMA). From an administrative and practical perspective, mining companies are required to re-evaluate their rehabilitation liabilities and ensure that they sufficiently cater for any shortfall in the provision for such rehabilitation liabilities. In this regard, the Department of Mineral Resources (the DMR) insists that mining companies must be able to provide for any shortfall in the provision for rehabilitation liabilities upfront. For companies which merely provide for rehabilitation through a rehabilitation trust, this would imply that a cash contribution of the entire shortfall amount would need to be contributed towards the rehabilitation trust. Commercially, many mining companies (especially junior mining companies) are not in a position to make such contributions as this would lead to cash flow constraints for the already cash strapped mining companies.
As alluded to earlier, section 37A of the Income Tax Act No. 58 of 1962 (the Act) provides for the deduction for income tax purposes of contributions made to a qualifying rehabilitation trust. This deduction would not necessarily benefit mining companies which are not in a tax paying position. Instead, additional funding would need to be obtained to firstly fund the operations and secondly fund the rehabilitation trust. As a result, mining companies have opted to provide for rehabilitation expenses through the various insurance products which are currently in the market (and have been for quite some time) as this is regarded by the mining companies as a more effective method to manage the cash flow constraints and provide the DMR with the required guarantee(s) for the future rehabilitation liabilities. The benefit of these insurance products is that although the guarantee is received upfront, the mining companies have a longer period during which the actual premiums can be paid as the insurance policies typically extend over 3 years (which could be extended further), thereby easing the cash flow constraints.
Due to the funds contributed to a rehabilitation trust being restricted and can only be withdrawn for rehabilitation purposes (or used for purposes set out in section 37A), many mining companies have opted to rather solely provide for rehabilitation through insurance policies than to establish rehabilitation trusts (i.e. mining companies regard the insurance products to be a more effective method to provide for future rehabilitation expenditure). In some instances, mining companies have gone so far as to transfer funds out of already established rehabilitation trusts into the aforementioned insurance policies. SARS does not favour such transfers and has indicated that the application of the penalty provisions provided for in section 37A (which would lead to a penalty in excess of 200% of the value of the funds in the rehabilitation trust) would be strictly applied to any transfer which contravenes the provisions of section 37A.
From an insurance policy perspective, National Treasury has inserted section 23L into the Act which came into effect on 31 March 2014. In essence, the purpose of section 23L is to disallow the deduction of any premiums incurred by a taxpayer with regard to short-term insurance policies, unless the required criteria are met. The required criteria include, inter alia, recognising the insurance premiums as an expense in the financial statements (and not capitalise the expense as many mining companies would typically do). In this regard, the question which should be considered by taxpayers is whether the specific insurance policy which has been entered into to provide for future rehabilitation expenditure would be regarded as a short-term insurance policy as envisaged in section 23L of the Act and, if so, would the criteria to not fall within the ambit of section 23L be met.
It is recommended that careful consideration be given and advice sought from tax advisors who also understand and are knowledgeable of the requirements of the MPRDA and NEMA before a taxpayer opts to transfer any funds out of an established rehabilitation trust into any other fund or policy not specifically mentioned in section 37A. This is to ensure that the adverse (and arguably draconian) penalty provisions contained in section 37A are not triggered. It is further advisable that tax advice be sought before any mining rehabilitation insurance policy is entered into by a mining company in order to ascertain whether there is not a more efficient manner in which the policy could be structured, thereby not falling within the ambit of section 23L.
It would be worthwhile to note how the newly established Davis Committee will approach the current tax incentives for mining rehabilitation and whether, going forward, insurance policies of the nature discussed above would be recognised by the Davis Committee and adequate provision be made in the Act for the treatment of insurance premiums paid on such insurance policies.