Chapter 7 - Paper 3.4 (Advanced Taxation)

CHAPTER 7

TAXATION OF MINING OPERATIONS

7.1 – BRIEF HISTORY OF ZAMBIAN MINING

The Mining and refining of copper constitutes by far the largest industry in the country and is concentrated in the cities of the Copperbelt. Cobalt, Zinc, Lead, Gold, Silver, Gemstones, and Coal are also mined. Copper accounts for over 80% of foreign exchange. Copper mineralization was first discovered at the turn of the century but large scale production only commenced in the 1930’s with the start-up of Roan Antelope Mine in 1931, followed rapidly by Nkana Mine opened in 1932, Mufulira Mine opened in 1933 and then Nchanga Mine opened in 1939. Copper production exceeded 400,000 tons per annum in the late 1950’s and reached a peak of 700,000 tons per annum in the period 1969-1976 before beginning a progressive decline and sinking to a 1995 low of 307,000 tons per annum. However, the privatization of Zambia Consolidated Copper Mines (ZCCM) is anticipated to activate the remaining industry and halt this decline. With a total mineral resource of at least two billion tones on the Copperbelt alone, there is no doubt that copper and cobalt production will soon begin a significant upward trend.

While the privatization of Zambia’s copper Mines may not have been as successful as originally hoped, the process has at least resulted in the long downward spiral in copper production being

L.3 – Advanced Taxation Amendment Act 2006/07

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LEARNING OBJECTIVES:After studying this Chapter you should be able to understand the following:

The History of Zambian Mining The Zambian Government’s Mining Policy Why Mining Companies are Taxed Differently Rights to Minerals in Zambia Types of Mineral Rights Large Scale Mining operations Retention Licences Small Scale Mining Operations Mineral Royalty Tax Income tax Deductions for Mining Investments Tax Concessions for the Mining Industry Tax Treatment of Expenditure on Community Services,

Infrastructure and Compound or Mine Township Roads. International Aspects of Mining Taxation Carry forward of Mining Losses in United States Dollars Indexation of Mining losses and capital allowances

decisively reversed. Annual production of copper, around 700 000 tones 30 years ago, dropped to 270 000 tones in 1999 and 249 000 tones in 2000, the year when the privatization process was completed. It has now once again moved up above the 300 000 tone mark, with Konkola Copper Mines (KCM), the dominant player on the Copperbelt, producing 222 000 tones in 2002 and Mopani Copper Mines (MCM), the second biggest producer, just over 100 000 tones.

Despite the production increases, profitability has proved to be an elusive goal. Many of the Copperbelt Mines are old and deep and really need a copper price much higher than the present US$1 600/tonne or so to be comfortable. KCM and MCM have both reported losses in recent years and so have the other operations in the sector. But there are signs that production costs are coming down and both KCM and MCM are predicting a return to profitability.

Zambia has a history of gold mining on a relatively small scale, with the twenty larger deposits having produced a total of slightly more than 2 tones of gold since modern mining began in 1902. The largest past producers are Dunrobin (990kg gold), Jessie (390kg), Sasare (390kg), and Matala (225kg); Dunrobin has recently been re-opened by Reunion Mining and is scheduled to produce 500-600kg gold per annum. More than 300 gold occurrences have been reported throughout the country.

Copper production could reach 600 000 tons per annum

It is interesting to speculate on where total Zambian copper production might be three to four years hence. A “best case” figure is easily worked out. KCM is targeting 250 000 tones a year, MCM at least 175 000 tones, Bwana Mkubwa / Lonshi 30 000 tones and Metorex about 12 000 tones. Add in 100 000 tones from Kansanshi (although the figure will likely be higher in the early years of the mine) and another 40 000 tones from NFC Africa Mining and the total is just above 600 000 tones (and could even be higher depending on what happens at Baluba and Lumwana). This is an impressive level of production and more than double the figure of 2000. None of the figures seem inherently improbable, although much will depend on developments at KCM.

Mining & the Economy

For the past sixty years the Zambian economy has been heavily reliant on the mining of copper and cobalt and despite the positive steps taken to diversify the industrial and manufacturing base, the reliance remains. The mining sector contributed US$822 million to the total export.


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7.2 – MINING POLICY

The Government has adopted a pragmatic mineral policy which is designed to enhance investment in the Mining industry and to ensure the development of a self-sustaining minerals-based industry. The privatization of many state-owned companies and especially the Copper Mining industry, formally managed under the parastatal umbrella of Zambia Consolidated Copper Mines Ltd (ZCCM), is a clear demonstration of this intent. Enactment of this policy is being promoted by the Ministry of Mines and Minerals Development through the technical support available from its three constituent departments - Geological Survey, Mines Development and Mines Safety.

The Zambian Mining Policy

Key objectives of the government's Mining Policy:

To make the private sector the principle producer and exporter of mineral products through putting in place a private sector initiative in the development of new Mines in order to increase and diversify mineral and mineral based products and exports. This will maximize long term economic benefits to the Country.

To promote the development of the Small scale mining industry which has the potential to significantly contribute to the economy.

To promote the development of gemstone Mining and facilitate liberalized marketing arrangements in order to realise the industry's potential to contribute to the development of the economy.

To promote the exploration and exploitation of industrial minerals and to encourage the establishment of a ferrous industry.

To reduce the danger of ecological damage arising from Mining operations as well as damage to the health of workers and inhabitants of the neighborhood through water, air and land.

To promote the local processing of mineral raw materials into finished products for added value.

To promote private participation the Government of Zambia has developed a new mining policy which brought in a Mines and Minerals Act in 1995. The new policy aims to encourage foreign investment in exploration and new large-scale developments, and to encourage private investment in medium and small-scale mining. This is achieved by enshrining in the legislation the following basic assurances that the foreign investor expects:

Secure title to mining rights Stability of the fiscal regime Foreign exchange retention Right to market mine products


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Right to assign (right to trade the mining right) Stability in environmental management International arbitration Freedom of commercial operation

The Government policy is not to participate in exploration or other mining activities or any shareholding other than regulatory and promotional role.

Mining Legislation

The Mine and Mineral Act (1995) - which greatly simplified licensing procedures, places minimum reasonable constraints on prospecting and mining activities, and creates a very favourable investment environment, whilst allowing for International arbitration to be written into development agreements, should this be deemed necessary.

A framework for responsible development has also been created through publication of the Environmental Protection and Pollution Control Regulations.

Export Procedures

In all cases a Customs and Excise Declaration form has to be completed, usually accompanied by a letter of authorization from the Mines Development Department. Additional procedures have to be followed for different commodities

Gemstones - Valuation Certificate required from Government Recognized Valuer.

Precious Metals - provision of a sample for analysis. Base Metals - a one year letter of authority is issued by the mines

Development Department, rather than for individual shipments. Rock and Soil samples of no commercial value - the samples to be physically

checked before export

7.3 – WHY MINING COMPANIES ARE TAXED DIFFERENTLY?

As we have noted in 7.1 above, the Mining Industry is one of the largest and most important in Zambia. Revenues earned by the Industry have over the years contributed significantly to the National Economy. This is more the reason why the Government of the Republic of Zambia has adopted Mining policies aimed at encouraging acceptable exploitation of the Country’s Mineral Wealth.

The special character of the Mining Sector and the dual nature of the role of the government lead to the dilemma, whether taxation of the Mining Sector should be different from the general taxation system in terms of Rate structure and even administration. Taxes of general application may not always be suitable for Mining Companies involving high capital intensity and long gestation periods. At


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the same time, exempting Mining Companies from general taxation is administratively inconvenient and also against equity principles.

GRZ Motivations for Mining TaxationIt is a well known fact that Tax policy is an important instrument of government intervention in any sector, including Mining. While taxing the Mining Sector, the government has three objectives to consider.

The first emanates from the Role of government as an agent responsible for achieving economic and social development. Here the Government has the responsibility to ensure that the Mineral extraction is socially optimal and equitable, and at the same time, the sector makes due contribution to public revenues in the same way as other Sectors of the Economy to promote sustainable development. To fulfill these goals, the system of Mineral Taxation should be characterized by the generally acclaimed principles of certainty, fiscal stability and administrative convenience apart from neutrality.

The Second arises from the Role of GRZ as Owner of Minerals that requires the GRZ to secure an appropriate share in the Mineral Rent. If a valuable mineral is extracted, the GRZ should receive not only the Regular Tax but also a separate payment over and above it.

The Third aims at minimizing the damage to the environment and ecological balance likely to be caused by Mining Companies if not properly put under check.

Mines are wasting assets. When exhausted they have very little residual value. To set up a Mining Venture involves the establishment of a costly infrastructure with a long pre production period in most cases. It also involves the taking of great risks, as even though the research and exploration work might have been done, the success of the venture depends on numerous factors, among others, the timely set up of the Mine infrastructure, the Mining of the expected quantities and grades of ore, the containing of working costs and the commodity prices which can vary quite significantly.

The high Risk and considerable expenditure is undertaken in the first years of a Mine’s life. The Income is only received after a considerably long time span and is minimal until the Mining operation is in full production. The payback period therefore also lengthens. International markets are volatile and even when the Mine is in full production, profitability cannot be guaranteed. As a result the Mining Industry in Zambia and elsewhere in the World has historically received different tax treatment compared to other industries. This is especially so in relation to its Capital Expenditure.

In many Countries, there exists a range of Mineral levies, each with a plethora of components, along with other methods such as equity sharing. These Taxes and non taxes impinge on the Mineral Sector at various stages of prospecting, exploration, trade and final consumption. The high Risk, high capital intensity characteristics coupled with long gestation lags involved in Mineral activity call for special tax treatment of the sector. And as may be expected there are unavoidable trade-offs between Revenue, Risk and Timing of revenue receipts. Thus use of multiple fiscal instruments in maximizing Tax Revenue from the Mining Sector is unavoidable.


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7.4 Rights to Minerals vested in the President

Section 3(1) of the Mines and Minerals Act states that all rights of ownership in, searching for, and mining and disposing of, minerals are vested in the Republican President on behalf of all the Zambian people.

It follows, therefore, that rights of prospecting for, mining and disposing of, minerals may be acquired under the provisions of the mines and minerals Act, that is to say that no one is allowed to under take mining activities without obtaining a mining right granted under the mines and minerals Act.

Types of Mining RightsThe following mining Rights may be granted under the Mines and Minerals Act::

A prospecting License A retention License A Large –scale mining License A prospecting permit A small scale mining License A gemstone License An artisan’s mining right.

Persons Disqualified from holding Mining Rights

A mining right shall not be granted to or held by:(a) An individual who:

Is under the age of eighteen years Is or becomes an undischarged bankrupt, having been adjudged

or declared bankrupt.(b) A company, which is in Liquidation, other than Liquidation, which

forms part of a scheme for the reconstruction of the company or for its amalgamation with another company.

An Artisan’s mining right shall not be granted to a person who is not a citizen of Zambia.


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7.5 – LARGE SCALE MINING OPERATIONS

Prospecting Licenses

A prospecting License confers on the holder of the License exclusive rights to carry on prospecting operations in the prospecting area for the minerals specified in the License and to do all such other acts and things as are necessary for or reasonably incidental to the carrying on of those operations.

A retention Licenses

Retention License confers on the holder exclusive rights to apply for a Large- scale mining License within the area for which the retention License has been granted.

Large – scale mining License

Such a License confers on the holder exclusive rights to carry on mining and prospecting operations in the mining area, and to do all such other acts and things as necessary for or incidental to the carrying on of those operations.

7.6 – SMALL SCALE MINING OPERATIONS

Prospecting permits A prospecting permit confers on the holder exclusive rights to carry on prospecting operations in the prospecting area for the minerals (except gemstones) specified in the License.

Small – scale mining License

This License confers on the holder exclusive rights to carry on mining operations in the mining area for minerals other than gemstones.

Gemstone Licenses

A gemstone License confers on the holder the same exclusive rights as a prospecting permit and a small –scale mining License, but only in relation to gemstone.


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Artisan's mining Right

An Artisan’s mining right shall confer on the person to whom it is granted exclusive rights to mine according to its terms in respect of the minerals specified in the permit.

Any citizen of Zambia who has identified a mineral deposit may apply for an artisan’s mining right.

Interpretation of terms

MiningMeaning the extraction of mineral, whether solid, Liquid or gaseous from Land or from beneath the surface of the earth in order to win minerals…

MineralMeans any material substance, whether in solid, Liquid, or gaseous form, that occurs naturally in or beneath the surface of the earth, but does not include water, petroleum or any substance prescribed by the minister by regulation.

ProspectMeans to search for any mineral by means and to carry out such works, and remove such samples, as be necessary to test the mineral –bearing qualities of any land.

GemstonesMeans amethyst, aquamarine, beryl, corundum, diamond, emerald, garnet, ruby, sapphite, topaz, tourmaline and any other non – metallic mineral substance, being a substance used in the manufacture of jewelry…

Industrial mineralMeans barites, dolomite, fluorspar, coal, graphite, guano, gypsum, ironstone, kyanite, Limestone, phyllite, magnesite, mica, nitrate, phosphate, parophyllite, sands, clay and talc.

7.7 - MINERAL ROYALTY TAX

The Commissioner – General is responsible for the assessment and collection of mineral Royalty. Mineral Royalty is payable by holders of large scale mining License such as the Konkola Copper Mines, Chambishi Metals and Mopani Copper Mines to mention but a few. But with effect from 1 April 2003, even Small and Medium Scale Mining companies are now required to pay the Mineral Royalty since these companies are also benefiting from natural resources. This measure has been taken to broaden the tax base and maximize revenue collection.


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Mineral Royalty is calculated on the Gross value of minerals produced. The rate, which has been in force until 31 march 2002, is 2%. With effect from 1 April 2002, Mineral Royalty has been reduced from 2% to 0.6% for any mining company holding a large scale mining licence and carrying on the mining of base metals.

Base metal means a non-precious metal that is either common or more chemically active, or both common and chemically active and includes iron, copper, nickel, aluminium, lead, zinc, tin, magnesium, cobalt, manganese, titanium, scandium, vanadium and chromium.

The meaning of gross value

For the purpose of the calculation of mineral Royalty, for ‘Gross ’Value is defined to mean the realizable value for a sale free on board, at the point of export from Zambia or point of delivery within Zambia.

The meaning of Net Amount

Net Amount means Gross sale amount Less: The cost of transport, including insurance and handling charges,

from the mining area to the point of export or delivery; and The cost of smelting and refining or other processing costs,

unless such other proceeds costs relate to the processing normally carried out in Zambia in the mining area.

Prior to 1 April 1999, Mineral Royalty was calculated on the Net amount under section 66 of the Mines and Minerals Act CAP 213 of the Laws of


Category Mineral royalty rate

Holder of a large scale mining licence and carrying on mining of base metals

0.6%

Holder of a gemstone licence or small scale mining licence or an artisan mining right to mine gemstones, base metals or precious metals

5%

Holder of any other Mining Licence

2%

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Zambia. This form of Taxation however raises some concerns at to its neutrality.

Due Date

Section 66 (2) of the Mines and Minerals Act stipulates that mineral royalty is due and payable 14 days after the end of the month in which the sale of minerals is done. A penalty of 5% per month or part thereof is charged on late payments of mineral royalty as provided in Section 78 of the Income Tax Act. Further, interest is charged at the rate of 2% above the Bank of Zambia.

Mineral royalty Returns

Monthly mineral royalty returns are due within 14 days after the end of the month. A penalty of K180,000 for individuals or K360,000 for companies is charged per month or part thereof for failure to submit a monthly mineral royalty return.

Meaning of Neutrality

A tax is simply a transfer payment by the private sector to the government. There is no direct productive activity on the government's part in obtaining the tax revenue. In economics, applying a tax can have two effects, namely the income effect and the substitution effect. The income effect purports that real income and hence real consumption has fallen, causing the agent to feel poorer and thereby increase its effort. The substitution effect purports that, leisure has become relatively cheaper to consume, and hence there is an incentive to reduce effort. In order for the agent not to change production or consumption behavior the income and substitution effects must cancel each other out.

In an open economy with no government sector, and under conditions of perfect competition, there should exist perfect productive and allocative efficiency. Neutrality of a tax implies that when it is applied, the productive and allocative efficient outcomes without a government sector should continue. This is essentially the ‘economists' perspective.

Neutrality can also be described in more practical terms. When a tax is levied, there is less disposable income left for the private sector. A neutral tax would reduce disposable income, but not affect decisions on consumption, trade or production. It is clear therefore that the concept of neutrality is directed at the decisions of the private sector.


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Economic rent & Quasi - Rent

In economics, four factors of production are recognized: land, labor, capital and enterprise. Each of these factors requires compensation for its services. These can be classed as rent, wages, interest and profit respectively. When entering into a project, one can calculate a return. Economic rent is that return that is present after all costs to the relevant factors have been met. Economic rent may thus be seen as a bonus, "a financial return not required to motivate desired economic behavior.

An important point needs to be mentioned here. Neutrality is concerned with allocation. Economic rent is a surplus. It has no allocative consequences. The essential point about economic rent is the way in which it is distributed. Hence a tax is neutral if the revenue obtained by levying it is completely from economic rent. Moreover, a neutral tax is concerned with the distribution of surplus rent and not how the resources are allocated.

Quasi-rents can be seen as part of economic rent, but they only occur in the short run, due to some change in the market. There could be a shift in demand, for example, which temporarily increases the rent accruing to the firm. The point is that quasi-rents are transitory. Therefore, if an attempt to tax these is made, then long term production decisions may be affected, implying non-neutrality. Therefore one can say that economic rent consists of pure rent plus quasi-rent. For a tax to be completely neutral it must only take income from pure rent. Kay and King describe as being neutral, a tax, which fell on pure, rent.

In practical terms, one could then suggest that taxes should be aimed at taxing positive net present values (NPV). The reason being that, NPV discounts all future cash flows, and incorporates all the relevant rewards to the factors of production. Hence a positive NPV could be likened to economic rent, a surplus above what is necessary.

An Economic Depiction of Neutrality

This section will now show neutrality formally from the perspective of economics and outline some of its implications. Consider the following diagram:


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MC represents the aggregate marginal cost curve of production for the mines. Each mine has a different cost of extraction. The marginal cost curve is upward sloping reflecting the fact that the most profitable mine is exploited first. From this diagram economic rent is depicted as the difference between the price available for the product and its cost of production. Therefore the triangle PTS represents the economic rent present for these mines.

PTS is the total amount that the Government could tax away without affecting allocative efficiency. However, in order to do this successfully, it has to apply different taxes to different mines in proportion to the economic rent they command. A quasi-rent could be depicted as a temporary shift in price upwards, which would increase the size of the triangle PTS.

Examples of Neutral & Non-Neutral Taxes

The classic non-neutral tax is the royalty tax, which is a production tax. It is levied on the physical quantity produced, or its value. It completely ignores costs and profits associated with the project.

Income tax is an example of a neutral tax. Tax is calculated on taxable income, which includes certain deductions and allowances.

The distinction is that whereas royalty does not take any account of the level of economic rent that is actually present, income tax focuses predominantly on surplus profits. If profits are zero, then income tax revenues are zero. With royalty, even if profits are zero, the tax revenue will be positive, assuming there is still considerable production.


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Importance of Neutrality to Government

Neutrality as an objective

The main theme of this chapter is whether the Government should hold neutrality as its prime objective. The Government will want to maximize the level of revenue it obtains, and also give incentives to foreign companies to participate in its resource sector. Neutrality for the Government implies that it earns tax revenues when the company earns positive profits, and it will earn nothing when the firm earns nothing. A study has been conducted, which shows that if a Government switches from an ad valorem royalty to a Resource Rent Tax (RRT), its tax revenue can be increased without affecting the optimal level of investment. The RRT is seen as a much more neutral tax.

Advantages of Neutrality

First and foremost is the fact that a neutral taxation regime captures pure economic rents. As mentioned earlier, this has the implication that it should not hinder investment by firms to develop fields. This implies that it is consistent with the economist's criteria for productive and allocative efficiency. This in turn implies the socially optimal level of production. Increased foreign investment has the added benefit of being a foreign inflow of currency and a positive factor for the balance of payments account.

A major problem of resources industries is high grading. This occurs when companies exploit the most profitable fields first, and then leave marginal fields because the tax regime makes it un-economical to produce them. A neutral tax regime will only take tax from a company once it has made a surplus profit. This means that, ignoring the tax regime, the company is encouraged to develop the field if it is profitable. This implies there is the potential of many more fields being developed and hence likely increases in total tax revenue to the Government.

A neutral tax regime shifts risk away from the investor. At first sight, this may seem to be a disadvantage to the Government. However, when the investor considers a project, risk will be calculated. The required return is a component of a risk free rate plus a risk premium. The lower this risk premium, then the lower will be the required return from a project, as perceived by the company. This implies a bigger surplus leftover for the Government.

Alternative Objectives

Zambia has continued to rely on ad valorem royalties as a means of resource taxation in the Mining Sector. If the investment-neutrality claims of the academic literature are accepted, it would seem that the reluctance of the Zambian governments to switch to a purely resource tax regimes in the Mining Sector must be due to some other factor than their concern over its impact on investment levels. Moreover, RRT's unlike royalties do not act regressively to changes in the Mining commodity price, which can have a negative impact on marginally profitable mines. Hence there may be other factors which


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Governments holds in higher esteem, than a neutral tax regime. From the economist's perspective, there are four other objectives of a tax. These are efficiency, equity, clarity and stability. In the following paragraphs, these objectives and others are outlined.

Efficiency simply refers to resource allocation. The problem however is that there may be a difference between the socially optimal and the private optimal levels of efficiency. Therefore, although a neutral tax regime would bring about a private optimal level of efficiency, this does not necessarily correspond to the socially optimal level. For example, there may be negative externalities present, which the Government may feel it has a priority to alleviate.

A policy of equitable tax incidence and distribution is also important. The Government may hold in high esteem a policy of spreading the tax burden over a number of concessions with different firms operating them. The problem with economic rent is that it shows a surplus, but how to collect and distribute this surplus equitably is a debatable point. In particular, where production usually takes place there is great social unrest from the indigenous people of that community. With neutral taxes, revenues may not occur for years or ever, even though the company will be operating and costs are being met. It may be politically unfeasible not to have some revenues generated early on in the life of the project.

One major problem and disadvantage with neutral taxes is their administration and monitoring. The marginal costs associated with different Mining Companies vary. A Government faced with this situation has to calculate the different levels of rent, discount rates and expected yields to actually value each Mining Company properly. This problem is specifically applicable to developing countries, where administration and monitoring costs may be difficult to meet. Therefore, another objective of the Government may be clarity and simplicity in the tax regime.

Another destabilizing factor for Governments is the volatile price fluctuations especially in commodities such as Copper. Zambia relies on mineral rents for most of its foreign earnings. Fluctuations in prices affect spending plans. There may also be short term problems for the exchange rate and external accounts which have a whole host of macro-economic implications. In short, price fluctuations dent the economic development of a country. A non-neutral tax regime based on production volume could help mitigate this. Hence, stability in the tax revenues may also be an important objective of Governments.

Revenue protection is another valid objective to consider. When a company develops a field, it extracts a resource that can never be replaced again. Therefore, regardless of what it is sold for, it is a piece of property being removed from someone's land. Zambia has a royalty policy, which is based on this very presumption. Many people see as senseless, a resource being extracted from a Country without charge. It is for this reason that Zambia has a royalty policy on Minerals.


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Importance of Neutrality for the Firm

The attractions of a neutral tax regime are obvious. The Company only pays tax when it has recovered all its exploratory and development costs. Thereafter, it pays tax out of its surplus profits. Since the company only pays tax once it makes a profit, the pay-back period of the investment will be shorter than, if a royalty was applied. However, the rules on capital allowances and depreciation should also be favorable.

A neutral tax responds to the cyclical nature of the resources industries. For example, if the price of the resource decreases substantially, the tax incidence also responds correspondingly. Reserve replacement and value replacement are equally important to companies. If a company is tied to a PSC, then its estimate of recoverable reserves will vary more with the oil price. With a neutral tax regime, the value of reserves to the firm is not as volatile. The reason for this is that the Government actually participates in the price risk. This encourages the company to lower its discount rate due to a lower risk premium. This has the benefit of increasing the present value of the project to the firm.

A neutral tax regime aims to avoid decisions on the pace of recovery of a resource. This allows the company to freely plan its investment. In addition, reserve management becomes much easier, and its ability to respond to changing market conditions is enhanced. The company is also then motivated to improve the technology of extraction, increasing the value of reserves and hence potential surplus profits.

As can be seen from the foregoing, whether or not a firm or Government should give sole priority to a neutral tax regime depends on the circumstances of the region in question. The Government may have other considerations, which may take priority over neutrality. Such considerations include damage to indigenous people, equity, stability in revenues and geology. The firm itself must also consider the geology, the political situation, the fiscal regime, security, profit repatriation and control. Therefore, neutrality should not necessarily be the prime objective but should be one of many objectives, which can be applied to different situations and circumstances, both from the perspective of the firm and the Government.


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7.8 - INCOME TAX DEDUCTIONS FOR MINING INVESTMENTS

Like other non- mining businesses, mining companies are also allowed certain outgoings to be deducted from their income in order to arrive at their amount of taxable income.

CAPITAL EXPENDITUREFor the purpose of the Mines and Minerals Act, capital Expenditure, in relation to mining or prospecting operations, means expenditure:

On buildings, works, railway or equipment; On shaft sinking, including expenditure on sumps, pumps

chambers, stations and ore bins accessory to a shaft On the purchase of or on the payment of a premium for the use of

any patent, design, trade mark, process of other expenditure of a similar nature;

Incurred prior to the commencement of production or during any period of non – production on preliminary surveys, boreholes, development or management; or

By way of interest payable on any Loan for mining or prospecting purposes.

In accenting the Gains or profits from the carrying on of mining operations by any person in a charge year in respect of the capital expenditure incurred by the person on a mine, which is in regular production in the year, deductions will be allowed.

Section 43 B of the income Tax Act does not permit the deduction of any mineral Royalty payable and paid for any charge year prior to the charge year ending 31 March 2002.

7.9 - TAX CONCESSIONS FOR THE MINING INDUSTRY

For quite some time, there has been some form of discrimination in the taxation of mining companies. Konkola Copper Mines (KCM) and Mopani copper mines (MCM) have always enjoyed favorable taxation regimes that are by far much better than other mining companies.

As part of the process of resolving this current problem, Government has made a commitment, in which it will soon carry out a comprehensive review of the taxation of the Mining Sector. We are eagerly looking forward to seeing the changes in tax legislation that will bring about tax equity in the Mining Industry and we hope that this will not be too long from now.


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As an initial step in leveling the playing field the following reliefs have been extended to all mining companies who are involved in copper and cobalt production other than KCM and MCM:

A reduction in the corporate income Tax rate from 35% to 25%

A reduction in mineral Royalty Tax from 2% to 0.6% on the gross value or gross revenue of mineral Revenue produced in mining areas

No payment of WHT on dividends, royalties and management fees to share holders or their affiliates, and on interest payments to share holders or their affiliates, including any Lender of money to the affected mining companies.

EXAM FOCUS __________________________________________________________

It is important to know that the Mineral Royalty Tax is no longer payable only by holders of large-scale mining companies. Now, holders of Small and Medium Scale Mining Licenses will be required to pay the Mineral Royalty. This in effect means that they are now required to pay:

The corporate income Tax at the reduced rate of 25%; and Mineral Royalty Tax at the reduced rate of 0.6% of the Gross

Revenue of mineral revenue in mining areas.__________________________________________________________

7.10 - EXPENDITURE ON COMMUNITY SERVICES, INFRASTRUCTURE & COMPOUND ROADS

Schools and hospitalsIt is common in Zambia for mining companies to run schools and hospitals for their employees, and sometimes for the general public. The tax question is whether or not the cost of running such schools and Hospitals is capital or revenue expenditure. Here we can take a Leaf from Messrs. KPMG AIKEN and PEATS –A Guide to mining Taxation in South Africa which seems to support the view that:

Hospitals, schools, shops or similar amenities – including furniture and Equipment, owned and operated by the taxpayer mainly for the use of its employees is redeemable capital Expenditure. This implies that such costs are incurred in the ordinary course of trading, and hence allowed as a deduction in the Tax Computation


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Recreation buildings Recreational building and facilities owned by the taxpayer mainly

for the use of its employees is also a redeemable capital expenditure.

Expenditure of amateur sports falls within the ambit of Section 41 (I) ITA which provides as follows:

------------------------------------------------------------------------------------------------“Any amount paid by a person during a charge year to an ecclesiastical, charitable, research, educational institution of public character or to a National amateur sporting association or to any fund of a public character wholly and exclusively established for the use of the Public or for ecclesiastical, charitable, research, educational or amateur sporting purposes, shall be deducted from the income of that person for that charge year if:

The payments are in money’s worth; The payment s are made for no consideration whatsoever The minister of finance approves the institution, association or

fund to which payment is made or to be made…” -----------------------------------------------------------------------------------------------

Roads/ Rail Infrastructure Before proceeding further, we need to establish the tax principle concerning expenditure on road and rail infrastructure:

1. Roads/Rail infrastructure costs of the Mine site constitute non – deductible expenditure within the meaning of the Mining Deductions provisions of both the Income Tax Act and Mines and Minerals Act

2. Roads/ Rail infrastructure costs on the Mine site constitute allowable or deductible capital expenditure. Two Australian Tax Rulings exist that:

Where a company was required as part of the terms of being granted a mining lease for the purpose of commencing mining operations to make a contribution to the relevant local Authority for the upgrading of existing regional road system where the regional road system did not solely provide access to the mining site nor to be used primarily and principally for the transport of the mining product away from the mining site did not qualify for deduction as its character was considered a payment necessary to establish the mining operations similar to payments to holders of land intended for mining operations which were held not to constitute a qualifying expenditure in the case of UTAH development Vs F.C of Taxes – 15 ACT 4103.

Where a company incurred expenditure on reconstruction of a minor public road, which was used primarily and principally by the company's trucks to transport coal from the mine to the nearest main road, and hence to the shipping center, it was accepted the expenditure was a qualifying capital expenditure.


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In our Zambian contest, it becomes easily notable that capital expenditure incurred in the initial and consequent maintenance of Mining Township roads located on the mine site or plot are tax allowable.

EXAMPLE:MINERALS GLOBAL

A feasibility study was started in 2004 whose main objective was to explore the mineral potential of Chingola south. A renowned metallurgist Dr Rao spearheaded the study. During the year 2005, an agreement was signed between the Zambian Government and Minerals Global, a UK resident Mining Company, whose business interests in Zambia are taken care of by Dr Rao. The agreement triggered a K2 billion commitment to a program of drilling, metallurgical and engineering works, which firmly ushered the new incorporated Zambian subsidiary of Minerals Global - Minerals Global Zambia.

For the charge year ended 31 March 2007, Minerals Global Zambia has presented the following profit and loss account.

K’000 K’000Gross Trading Profit 658,000Add: Additional incomeGain on sale of metallurgical equipment 50,000Gross Rent Received (note 2) 45,000Debenture interest received (note 3) 55,000

----------- 808,000

Less: ExpensesPremium paid (note 4) 12,000Depreciation 300,000Loss on Disposal of motor vehicles 250,000Legal fees (note 5) 15,000Donations (note 6) 5,000Wages and salaries 420,000Drafting and mapping 6,000Drilling Expenditure 8,000Infrastructure costs (note 7) 250,000GRZ License fees 40,000Exchange Loss (note 8) 160,000Utilities and Electricity 20,871Chingola Trust school (note 9) 48,000

---------- (1,614,871)---------------

Loss before Taxation (806,871)Taxation -Provision For Taxation (note 10) (250,000)

----------------Net loss (1,056,871)

==========

Notes 1


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Minerals Global Zambia is a holder of a large scale mining License whose Net mineral proceeds stands at K1.2 billion. The following costs were directly incurred in relation to mineral sales:

K’000

Transport 14,000Cost of smelting 20,000Insurance up to port 30,000

---------64,000====

Note 2The Gross Rental Income was received from Local contractors

Note 3Debenture interest received: - The Gross amount of debenture Interest received is shown in the profit and Loss account. Income Tax had been withheld at source at the appropriate rate. The debenture interest was received from a Zambian company that is not a former mining division of ZCCM Limited. Note 4Premium paid: - The Company obtained a right for the use of a trade name from Minerals Global – UK at the beginning of the current charge year. The company paid a premium of K12 million as consideration for the grant of right. The company will exploit the right over a 40-year period.

Note 5 - Legal fees These include the following:

K’000

Cost connected with Acquisition of fixed assets 5,000Cost associated with issuing new share capital 6,000Cost associated with recovery of Loan 3,000General Legal Expenses (all allowable) 1,000

--------15,000====

Note 6 - DonationsThese were made to approved charitable Organizations.

Note 7 - Infrastructure costs These include the following:

The Chingola Municipal Council as a pre- feasibility study condition for future granting of Mining License by the Ministry of Finance and National Planning. This project cost K100 million.

The company constructed a Link road to the Chingola – Kitwe Road, which is mainly used by Mine Trucks. This cost K50 million.


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K100 million was spent on the construction of a railway line within the Mining site.

Note 8 - Exchange Loss The Exchange Loss was presumably unrealized.

Note 9 - Chingola Trust SchoolThese are running costs of the School, which is 100% wholly owned by Minerals Global Zambia and is mainly for the use of the employees.

Note 10 - Provision for TaxationThe provision for Taxation is based on the total company tax estimated at the beginning of the charge year and the amount of Company Tax already paid under the provisional system of payment of Tax for the charge year ended 31 march 2007 is K15 million.

Note 11 - Capital Allowances stand at K150 million

Required Calculate the taxable business profit for the company for the

year ended 31 March 2007. Calculate the final amount of company income Tax payable by

the company for the charge year 2006/07.

ANSWER:MINERALS GLOBAL ZAMBIA

Gross Rent ReceivedThis will be deducted from trading profit and Taxed separately under the WHT system. The rate of tax is 15%

Debenture interest receivedThe interest was received from a Zambian company that is not a former mining division of ZCCM Limited. For all former mining divisions of ZCCM, and mining companies in general, there is no payment of WHT on interest payments to shareholders or their affiliates, including any Lender of money to them. But since the interest was not received from a former mining division of ZCCM, the interest is subject to WHT. This interest is accordingly, not a final tax. But it will be taxed separately under the rules of separate taxation.

Premium paid Paragraph 14 of the fifth schedule provides for an allowance where a premium is paid for the use of machinery, plant, a patent, a Design, trade mark or copy right or other property of a Like nature which is used for business purposes. The premium allowance will be calculated as follows:

K’000


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Cost of Premium 12,000Allowance 2005/06 = 1/40th (300)

-------- 11,700 =====

Paragraph 14 (2) states that the deduction allowed for any charge year shall not exceed the amount of the premium divided by the number of years for which the right of use is granted, in this case 12, 000/40 = K300.

Legal feesLegal fees are allowable provided that they are incurred in connection with the trade and are not related to capital items. Therefore, disallow the following:

Cost connected with Acquisition of fixed Assets Cost associated with issuing new share capital

Infrastructure costs: Town RoadThe Chingola Municipal Council as a pre -feasibility study condition demanded the construction of this road. Hence the payment can be considered to have a character of a payment necessary to establish the mining operations. This is therefore not a qualifying capital expenditure.

Link Road This road is mainly used by mine Tucks and is presumably constructed on the mine site. The cost of constructing such a road is a Qualifying capital Expenditure.

Railway LineThe cost of constructing a railway line within the mining site is a qualifying capital Expenditure.Chingola Trust SchoolThe cost of running a school, which is wholly owned by the mining company and is mainly, used by its employees is a qualifying expenditure.


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Computation of Adjusted Trading Profit K’000

LOSS AS PER ACCOUNTS (1,056,871)Add: Disallowed Expenditure Depreciation 300,000Premium (12,000 – 300) 11,700Loss on Disposal of motor vehicles 250,000Legal Fees (5000+6000) 11,000Infrastructure cost – Town Road 100,000Unrealized Exchange Loss 160,000

----------- 832,700 ---------- (224,171)

Less: Income Taxed SeparatelyGross Rent 45,000Debenture Interest 55,000

----------- (100,000) ------------ (324,000)

Less: Capital Allowances (150,000) ------------

Adjusted Trading Loss 474,000 ======

Final Amount of Tax Payable

Tax on Rental Income: 15% X K45, 000,000 =K6, 750,000

Tax on Interest25% X K55, 000,000 = K13, 750,000

Tax ON Trading Activities:Nil

Mineral Royal Tax. First calculate the Gross Mineral Revenue, which is: K1.2 billion + K64 billion = K1, 264, 000,000. MRT = 0.6% X K1, 264, 000, 000 = K7 5,840,000


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Summary of Tax Payable/ RefundableK' million

Tax on Rental income 6,750Tax on interest 13,750MRT 7,584

--------- 28,084

Less: Provisional Tax Paid (15,000) ---------

Tax Payable 13,084 ======

5.11 – International Aspects of Mining Taxation

Zambia faces a major problem with multinational mining companies employing profit shifting techniques to reduce their tax liability in Zambia. Three areas of international taxation that are of concern are:

The basis of taxation of residents of Zambia Sugar Transfer pricing Thin Capitalization.

The basis of taxation of residents:

Zambia operates a source based system of taxation and every person in receipt of Income from a source within or deemed to be within Zambia will be liable to Income Tax in Zambia. The concept of residence is of secondary importance in that it only extends the tax net to cover interest and dividend income received from a foreign source. This means that Zambia does not tax its residents on their world wide Income but only on Zambian sourced Income and Interest and dividends received from sources outside Zambia. Under this system it would be open for Zambian residents to structure the affairs in such a way that some of the profits from mining operations could be derived from foreign sources. The most prudent way forward would be for government to tax persons on their world wide Income with tax credits allowed for foreign taxes paid.

Transfer Pricing

Transfer pricing is the practice of charging more or less than an independent party would pay for goods and services provided between related parties across national borders. This practice allows multinational groups to decide which of its subsidiaries will make profits and how much those profits will be. The practice usually is to ensure that profits are maximized in Countries with low or no tax rates (Tax havens) or in Countries which offer specific exemptions or tax relief. Zambia does not have any specific transfer pricing law although it appears that the double


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tax treaties that Zambia has negotiated with other Countries do contain transfer pricing provisions.

When one part of a multinational organization in one country transfers (that is, sells) goods, services or know - how to another part in another country, the price charged for these goods or services is called " Transfer Price" This price, more often than not may be a purely arbitrary figure, meaning by this that it may be unrelated to costs incurred. The transfer price can be set at a level, which reduces or even cancels out the total tax, which has to be paid by the multinational Enterprise. But in reality unrealistic transfer prices are not always motivated by fiscal or tax considerations.

Factors affecting transfer Pricing

An unstable political environment may force multinationals to charge high prices when dealing with fellow members of the MNE group to mitigate the potential risks associated with the political instability.

High rates of inflation Rigid exchange controls Confiscatory rates of taxation

Some countries may impose artificially high tariff barriers or otherwise restrict the free movement of goods in and out of their territory. MNEs will do whatever it takes to overcome these problems and in particular they will want to avoid economic double taxation.

The Zambian case - the inadequacy of our tax legislation

In Zambia the problem of international transfer pricing is increasingly robbing the Country of its Tax Revenues. And this to a larger extent is as a result of our tax legislation's inability to deal with the problem expressly. To be more precise, there is no transfer pricing legislation in our Income Tax Act of 1966 as we earlier noted. The Zambia Revenue Authority has often relied on the provisions of Section 95 - which is essentially a general Anti - Avoidance piece of legislation. Let us visit this section for a closer look:

Section 95 ITA - Transactions Designed to Avoid Tax Liability

S.95 (1)Where the commissioner general has reasonable grounds to believe that the main purpose or one of the main purposes for which any transaction was effected was the avoidance or reduction of the liability to tax for any charge year, or that the main benefit which might have been expected to accrue from the transaction within the 3 years immediately following the completion thereof, was the avoidance or reduction of liability to tax, he may, if he determines it to be just and reasonable, direct that such adjustments shall be made as respects liability to tax as he considers appropriate to counteract the avoidance or reduction of liability to tax which would otherwise be effected by the transaction.


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By any standard, this piece of legislation seems fraught with implementation difficulties because it may be difficult to prove that the one or the main purpose of a transaction was the avoidance or reduction of tax or that the main benefit accruing in the following 3 years was the avoidance or reduction of tax. If you are looking at a sale or purchase of goods for example, the main commercial purpose is usually just to carry on the activities for which the company was set up and on which it depends for its commercial survival. The level of pricing may quite all right have a tax angle but that was not the purpose of the transaction.

It is however possible to see that in combating international transfer pricing using our domestic laws, we might as well see help in Section 29(1)(a) ITA 1966 which prohibits the deduction of expenditure not incurred wholly and exclusively for the purposes of the business. Arguably an excessive price paid to an associated company or even an artificial reduction of a price received could be found wanting by this rule.

Thin Capitalization

A company is said to be thinly capitalized if a person funds the business with more debt than the business could sustain had it been funded as a stand alone entity, borrowing from unconnected persons acting at arm's length. MNEs use this scheme by excessively funding a branch or subsidiary with interest bearing loans rather than share capital. This is an attractive alternative for non-resident investors, as the borrower generally receives a tax deduction for the interest paid. By contrast, dividends paid on shares are not deductible so that the underlying profits bear the full rate of company tax.

Thin capitalization is a problem that has troubled most of the major trading Nations for many years particularly if they receive inward investment, as is the case for Zambia. Many Countries deal with this problem by rules which deny deductions for Interest in defined cases, and possibly re- characterize the payment of interest as Dividends. There are many technical and practical issues in implementing such rules.

One such problem is caused by modern financial instruments. The evolution of diverse forms of financial instruments makes it easy for interest – like receipts to be converted into other forms of payment.

Minimization of world taxation through tax planning

Multinationals are rightly concerned about the danger of double taxation through incompatibilities in National Tax Systems but it is equally true that they have opportunities to use these incompatibilities with the objective of reducing their worldwide taxation costs. It is reasonable that they should do this by lawful methods since tax is an expense. The consequences of excessive tax mitigation by MNEs however could be to create an equal and opposite economic distortion to that created by unrelieved double taxation and deprive countries of a reasonable share in the profits of MNEs. There are a number of methods, which are used by


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MNEs tax planners to minimize their worldwide taxation some of which we have already discussed above, i.e. transfer pricing and thin capitalization. The other scheme used is the use of what are known as tax havens.

Tax Havens

Some Countries do not charge heavy taxes on MNEs established on their territory either through a parent or a subsidiary or a permanent establishment. These are known as tax havens.

Tax Havens in tax planning MNEs may seek to reduce source and residence country Taxation, by profit shifting to tax havens. For example through, a simple transfer pricing, the parent company would sell goods to a related company in a tax haven for cost plus a small profit, which in turn sells to a subsidiary in the source Country for an inflated price. Consequently, the subsidiary makes minimal profit, and most profit is in the tax haven

5.12 – CARRY FORWARD OF LOSSES IN UNITED STATES DOLLARS

CHIBULUMA MINES PLC Vs ZAMBIA REVENUE AUTHORITY

This is an Appeal by Chibuluma Mines Plc, whom we shall hereafter refer to as ‘the Appellant’. The Appeal is in respect of assessments issued by the Zambia Revenue Authority, herein after referred to as ‘the Respondent’.

The Appellant is a company incorporated under the Laws of Zambia whose main objective is mining. On 30th September 1997, the Appellant, through a Sale and Purchase Agreement, acquired various assets from Zambia Consolidated Copper Mines Limited (hereinafter referred to as “ZCCM”) with a view of furthering its objectives. Apart from the ascertained and fixed monetary consideration of US$17, 500,000.00 (Seventeen Million Five Hundred Thousand United States Dollars only) paid by the Appellant for the assets it acquired from the said ZCCM, there were other considerations which inter alia included payments to be made under an ancillary contract called the Cobalt Price Participation Agreement. For the purposes of this Appeal, we shall refer to this Agreement as the “Cobalt Agreement”. The said Agreement was produced in the Appellant’s Submissions. We shall mark it as “P 1”.

On 6th May and 10th June 1999 the Appellant submitted to the Respondent respectively tax returns for the 1997/98 and 1998/1999 tax years. After receipt of the said returns, the Respondent undertook an audit to verify the information contained in the returns. After this exercise, the Respondent did two things which form the basis of the Appeal.


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Firstly, the Respondent disallowed payments made by the Appellant to ZCCM under the Cobalt Agreement. The amounts disallowed were US$1,018,000.00 (One Million Eighteen Thousand United States Dollars only) and US$492,810.00 (Four Hundred and Ninety Two Thousand Eight Hundred and Ten United States Dollars only) for the years 1997/98 and 1998/99 respectively.

Secondly, the Respondent, in its assessments, carried forward the losses of the Appellant in Zambian Kwacha notwithstanding the fact that the books of accounts for the relevant period had been kept in United States Dollars.

According to the Appellant, the payments to ZCCM made pursuant to the Agreement were disallowed by the Respondent for three reasons; The expense was a capital item and not revenue in nature; The expense alternatively could not qualify as a mining deduction under the fifth schedule to the Income Tax Act as Companies that are allowed deductions of the Cobalt Contribution under the Income Tax Act are expressly stated and do not include Chibuluma Mines Plc.

These facts, as presented in the Appellant’s submissions, were agreed by both parties. Both parties elected not to call any viva voce evidence and indicated to the Tribunal that the facts presented in written statements, submissions and documents were not in dispute and were agreed. We were called upon to determine the following points as a matter of law;

1. Whether payments made by the Appellant to ZCCM under the Cobalt Agreement were allowable expenses under Section 29 or alternatively as read with the fifth-schedule to the Income Tax Act.

2. Whether the Appellant’s losses could be carried forward in United States Dollars.

The Appellant in the main submission advanced two grounds of Appeal in respect of the two issues that need to be resolved. According to the Appellant, the payments that have been made regularly under the Cobalt Agreement were not capital in nature. The Appellant points out that in considering whether payments were capital or revenue, regard had to be had to the nature and character of payments. The fact that the payments were made as part of the Sale and Purchase Agreements should not be the major factor in concluding whether the expenses were for acquisition of assets of a revenue nature. The Appellant referred us to Clause 2.1 of the Cobalt Agreement (“P 1”), which provides the formula which is the basis of the Appellant making payment to ZCCM. It provides:-

“The cobalt contribution shall be (40% x A) x B where ‘A’ is equal to the specified cobalt price per pound and; ‘B’ is equal to the aggregate number of pounds of cobalt sold by the company and which originates from Chibuluma West Mine in each quarter on the basis of the recovery rate.”


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The Appellant has submitted that the interpretation to be placed on this formula is that the obligation to pay cobalt contributions to ZCCM only arises when cobalt from Chibuluma West is sold in a quarter at a specified price. The Appellant points out that the cobalt contribution payments are based on turnover and as such are in contrast with payments for purchase of the capital assets. They further add that payments of capital are usually fixed and are attached to the cost of assets acquired. They point out that the cobalt contribution has no ceiling and cannot be linked to a specific asset in the balance sheet. They further refer us to Clause 9.1 of “P 1”, which provides;

“The obligation to pay the additional sum will cease on the date that mining operations cease at the Chibuluma West Mine and the large scale mining licence covering such operations is surrendered and not regranted (which for avoidance of doubt shall include the licence not being replaced or submitted) over the area comprising the Chibuluma West Mining Licence.”

The Appellant’s interpretation of this clause is that the Cobalt Agreement requires the Appellant to pay the contributions as long as they continue mining at Chibuluma West Mine. They contend that had the cobalt contribution been a payment towards the value of the assets acquired, there would have been an upper ceiling based on the value of the assets acquired and beyond which no further payments would have to be made.

The Appellant has also argued in the alternative that if the cobalt contributions are not deductible as revenue expenditure, then they should be treated as capital and be deductible under paragraph 22(1) of Part VI of the fifth-schedule of the Income Tax Act. They point out that the provision allows for a deduction for capital expenditure incurred. They also submit that the law, which prohibits deduction of cobalt contribution payments, were for certain expressly mentioned companies which only came into effect on 1st April 2000 and hence has no application to the assessment under dispute.

The second ground advanced is with respect to the issue of tax losses to be carried forward. The Respondent has drawn our attention to the letter dated 24th November 1998, which has been produced as part of the Bundle of Documents. We shall refer to this letter as exhibit “P 2”. The Respondent granted approval to the Appellant to keep its books of accounts in United States Dollars pursuant to the provisions of Section 55(3) of the Income Tax Act. According to the Appellant, on the basis of the approval from the Respondent, they were entitled to the following:

Prepare and maintain its accounting records in United States Dollars.

At the end of each financial year, prepare its financial statements and income tax computations in United States Dollars.

The financial statements and income tax computations denominated in United States Dollars would be submitted to the Zambia Revenue Authority for purposes of complying with Section 46 of the Income Tax Act.


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For payment purposes, the tax figure computed in United States Dollars be converted into Zambian Kwacha at the rate ruling on the balance sheet date as published by the Bank of Zambia.

The Respondent has similarly advanced two main grounds in opposing the Appeal.

Firstly, they argue that the cobalt contributions are capital payments on proper construction of Clause 2(B) of the Agreement, which provides;

“The consideration for the sale of assets by the seller will comprise, inter alia; US$17, 500,000.00, the seller loan note, the copper price participation, the allotment to the seller (or a nominee thereof of fifteen percent of the ordinary shares of the company ….”

The Respondent submits that it is normal practice to get the meaning of words from dictionaries when such words are not defined in the Statutes. They then urge us to consider dictionary meaning of the word “consideration”. According to the Respondent, the cobalt contributions are an inseparable part of the total cost of the assets which the Appellant paid as consideration for. In support of this argument, the Respondent has relied on the decided case of ROBERT ADDIE & SONS LIMITED v. COMMISSIONERS FOR INLAND REVENUE 8 T C 671. The Respondent further points out that it is immaterial how payment is computed or paid. According to the Respondent, what is critical is the character of the expenditure. They further point to the decision in GENERAL REVERSIONARY & INVESTMENT COMPANY v. HANCOCK, 7 TC 358 where it was stated;

“It seems to me impossible to hold that the fact that a lump sum was paid instead of a recurring series of annual payments alters the character of the expenditure, as it would be held that, if an employer were under voluntary arrangement with his servant to pay the servant a year’s salary in advance instead of paying each year a salary, as it fell due, he would be making a capital out lay ….”

As regards to the Appellant’s alternative argument that the cobalt contribution payments are deductible under part VI of the Fifth-Schedule, the Respondent’s position is that they do not qualify. The Respondent argues that deductions for mining expenditure fall under paragraph 19 of the Fifth-Schedule. The payments allowed in paragraph 19(e) are “on the purchase of or on the payment of a premium for use of a patent process or other expenditure of a similar nature.” The Respondent points out that equally paragraph 19(C) cannot be used in aid of the Appellant’s case as it refers to “interest payable on any loan for mining or prospecting purposes.”

The Respondent has referred us to paragraph 20 so as to buttress its argument. They point out that paragraph 20 prohibits the allowability of non-mentioned capital expenditure under mining deductions. They further refer the Tribunal to


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paragraph 21(1), which does not allow for deduction of the expenditure not defined.

The Respondent has also argued that the Income Tax Act Amendment of 2000 does not in any way support the Appellant’s argument on this point. They argue that all what this amendment does is to confirm that prior to 1st April 2000, cobalt contribution payments were not held as deductions under the Fifth-Schedule of the Income Tax Act.

With respect to the second ground that touches on carry forward losses, the Respondent has argued that it is a legal requirement for Zambia Revenue Authority to inform taxpayers of their liability through an assessment in terms of Section 65(1) of the Income Tax Act. They point out that they did not, through their letter exhibit “P 2”, state that the assessments and computations would be in United States Dollars. According to the Respondent, all what the letter did was to state that the Appellant’s computations would be converted at the Bank of Zambia rate into Zambian Kwacha.

The Respondent, in an endeavour to buttress this argument, has drawn us to the provisions of Section 29(1) of the Bank of Zambia Act, which is to the effect that legal tender in Zambia is the Zambian Kwacha. In view of this, the tax has to be assessed and computed in Zambian Kwacha as the legal tender.

We have carefully considered the issues before us. The first issue that we have to determine is whether the cobalt contributions were revenue expenditure. Section (29) (1)(a) of the Income Tax Act provides;

“In ascertaining the gains in any charge year, there shall be deducted the losses and expenditure other than of a capital nature incurred in that year wholly and exclusively for the purpose of the business….”

The Appellant has argued that the cobalt contribution payments were expenses of a revenue nature and fall within the ambit of Section 29(1)(a) of the Income Tax Act. The Respondent points out that the payments were part of the consideration for the purchase of assets of Chibuluma Mine though to be payable over the life time of the mine. In our considered view, this expenditure was not of a revenue nature. We entirely agree with the Respondent that these expenses were not necessarily incidental to the working of the mine. The Cobalt Agreement “P 1” is very clear. Apart from the US$17,500,000.00 (Seventeen Million Five Hundred Thousand United States Dollars), which was paid for the purchase of the mine and assets, there was other consideration which inter alia included cobalt participation payments. The decisions in both ROBERT ADDIE & SONS LIMITED v. COMMISSIONERS FOR INLAND REVENUE8 T C 671 and GENERAL REVERSIONARY & INVESTMENT COMPANY v. HANCOCK, 7 TC 358, in our view, supports the Respondent’s position. The payments were not for purposes of working the mine. They were part of the consideration for acquiring


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the assets. In our view, these payments cannot properly fall within the ambit of Section 29(1) (a) of the Act.

Having found that the expenses were not revenue in nature and hence not deductible under Section 29(1) (a), we now have to consider the alternative argument that the expenses are deductible as capital expenses under Section 33(a) of the Income Tax Act.

The Appellant has argued that the Respondent’s position is that the cobalt contribution payments are an inseparable part of the total cost of the assets which the Appellant paid a consideration for. We have carefully considered the arguments on this issue. Indeed the Respondent forcefully argued that the payments were not of a revenue nature but capital in nature. They however argue that though the expense is capital in nature, it is not permitted to be deducted under Section 33(b) of the Income Tax Act as read with part VI of the Fifth-Schedule. They point out that paragraph 19 of Part VI of the Fifth-Schedule qualifies what is to be deducted. The Respondent further augments this position by referring us to paragraph 20 of Part VI of the Fifth-Schedule, which is to the effect that there shall be no capital expenditure deductions allowed except under the provisions of this part. On determining this issue, the starting point should be Section 33(b) of the Act, which provides;

“Capital allowances are deducted in ascertaining the gains or profits of a business and the emoluments of any employment or office for each year – for capital expenditure in relation to mining operations, according to the provisions of parts I and VI inclusive of the fifth-schedule”

Part VI specifically relates to mining deductions. However, Section 33(b) does not restrict the deductions to only those that are in part VI. Section 33(b) refers to “the provisions of Parts I to VI” inclusive of the Fifth-Schedule. This wording is confusing. It suggests that in determining capital allowances for mining operations, parts I to VI should be taken into account equally. It should not be restricted to part VI, which specifically refers to mining operations. The confusion is heightened by the provisions of paragraph 20 of part VI of the Fifth-Schedule which suggests that there shall be no capital expenditure deductions allowed except under the provisions of this part. The part being referred to is part VI. The Respondent has relied on this provision for its argument that expenditure is restricted to what has been defined in paragraph 19 of part VI. According to the Respondent, the cobalt contribution does not fall under paragraph 19(a). That paragraph states;

“Capital expenditure’ means expenditure in relation to mining – on buildings, works, railway lines or equipment on shaft sinking, including expenditure on pumps, pump chambers, stations and ore bins accessory to a shaft on purchase of or on the payment of a premium on the use of any patent, design, trademark, process or other expenditure of a similar nature incurred prior to the commencement of production or during any period of non-production on


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preliminary surveys, boreholes, development or management by way of interest payable on any loan for mining or prospecting purposes”

According to the Respondent, the consideration can only fall under (c) or (e) of paragraph 19. According to the Respondent, sub-paragraph (e) cannot apply as the cobalt contribution does not relate to the payment for a premium or use of a patent or process. Similarly, they argue that sub-paragraph (c) mentions payment of interest on any loan for mining or prospecting purposes. They point out that the cobalt contribution does not fall under this sub-paragraph. The Respondent further buttresses this argument by stating that paragraph 22(1) does not allow for the deduction of any kind of capital expenditure under mining deductions provisions.

In our considered view, the Respondent’s submissions on this argument would be tenable if we were to find that the provisions for mining deduction are only to be found in paragraphs 19, 20 and 22 of the Fifth-Schedule. However, Section 33(b) where from the Fifth-Schedule derives its authority, makes it very clear that in ascertaining gains or profits of mining operations, capital expenditure has to be taken into account in accordance with the provisions of parts I to VI inclusive of the Fifth-Schedule. (The underlining is ours for emphasis). The Respondent simply wants us to interpret paragraphs 19, 20 and 22 of part VI of the Fifth-Schedule. However, this is not what Section 33(b) states. In BARCLAYS BANK ZAMBIA LIMITED v. ZAMBIA REVENUE AUTHORITY - 1999/RAT/50, we referred, with approval, to the oft cited dicta in BRANDY SYNDICATE v. INLAND REVENUE COMMISSIONERS - [1921] IKB 614;

“There is no presumption or equity about tax. Tax is simply what the law states.”

Therefore, in determining this issue, we will look at all relevant provision in parts I to VI of the Fifth-Schedule inclusive. It has been a well established general principle of law that taxation of a subject is not to be done lightly. The taxing statute must not leave room for doubt and controversy c.f the Tribunal’s Ruling in SPECTRA OIL CORPORATION LIMITED v. ZAMBIA REVENUE AUTHORITY – 1999/RAT/33 where we referred to INLAND REVENUE COMMISSIONERS v. AYRSHIRE EMPLOYERS MUTUAL ASSOCIATION LIMITED – 1946 1 ALL E.R 637. There is nothing in the language of Section 33 that precludes us from looking at all provisions of parts I to VI of the Fifth-Schedule in deciding whether the cobalt payments, which was part of the consideration for acquisition of assets were capital expenses. Having come to the conclusion that we are not restricted to the provisions of paragraphs 19, 20 and 22, we have taken the liberty to look at paragraph 25 of part VI of the Fifth-Schedule, which provides;


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“Subject to the provisions of paragraph 26, when change in the ownership of a mine takes place, the considerations for the assets, which qualify, for the purposes of this part, as capital expenditure shall, for income tax purposes – be allowable as capital expenditure incurred by the owner……”

According to the undisputed facts, the following assets were bought by the Appellant from ZCCM:- Leases, The benefit of the Service Contracts, The fixed patent, The Environmental Licence, The benefit of the licensed intellectual property, The machinery

The motor vehicles, Office equipment, The records mentioned by the seller prior to the effective date, The stock, All other property and assets owned by the seller and used in the operations immediately prior to completion.

According to the Appellant, most of these assets for which cobalt contribution payments were used as part of the consideration, qualifies for deduction on their own under the Fifth-Schedule. According to paragraph 26, if these assets qualify for deductions under the schedule, the expense in acquiring the same by the new owner, as such qualifies as a deduction. We therefore hold that the cobalt contributions are deductible as mining deductions and the Appeal on this ground succeeds.

We now turn to the issue of whether the Appellant can carry forward its tax losses in United States Dollars. According to the proven facts, by the letter dated 24th November 1998, exhibit “P 2”, the Respondent allowed the company to keep and submit financial statements in United States Dollars. The said letter also permitted the Appellant to submit its tax computations denominated in United States Dollars for the purposes of Section 46 of the Income Tax Act. The Respondent has however decided to carry forward the tax losses in Zambian Kwacha. The Appellant maintains that on the basis of the approval given in exhibit “P 2”, the tax loss should be denominated and carried forward in United States Dollars and that in the future, should there be taxable income from the same source, that income will be denominated in United States Dollars and the tax losses would then be relieved against that income in the same currency. According to the Appellant, the resultant profit (if any) would be denominated in United States Dollars and the tax due thereon would be converted into Zambian Kwacha at the applicable or ruling rate of exchange.

In determining this issue, we have looked at the relevant provisions of the Income Tax Act. Section 55(3) of the Act provides;

“A person carrying out mining operations may elect to keep books of accounts in United States Dollars of all transactions relating to, connected with or incidental to, such operations if the Commissioner- General is satisfied that not less that seventy-five percentum of that person’s gross income is earned in the form of foreign exchange from outside the Republic.”


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It is not in dispute that the Appellant had the approval. On the other hand, Section 46(1) provides that;

“Every person liable to tax in a charge year, other than an individual whose income entirely consists of emoluments within the provisions of part IV (which relates to Pay As You Earn), shall furnish, to the Commissioner-General, a return of income and such particulars as may be required for the purposes of ascertaining the income chargeable, if any, and the tax liability due, if any, under this Act.”

Sub-Section (2), inter alia goes on to provide;

“The return required under this section shall: - Contain a statement of the person’s income liable to tax, including income deemed under this Act to be the income of the person in respect of whom the return is submitted; Contain a statement of the person’s income liable to tax, of the amount of tax due, based on rates of tax applicable for such charge years, and ………… The income tax returns and computations that are submitted for purposes of Section 46 are prepared on the basis of figures taken out of books that are kept by the taxpayer. In this particular case, the Appellant kept its books in United States Dollars. The Respondent argues that though the Appellant was allowed to keep its books in United States Dollars, it is a legal requirement for Zambia Revenue Authority to inform a taxpayer of its liability, which should not be in United States Dollars. The Respondent has buttressed its arguments by referring us to Section 29(1) of the Bank of Zambia Act, which is to the effect that the legal tender in Zambia is Kwacha. We have carefully looked at the arguments of the Respondent that have been based on Section 65 of the Income Tax Act and Section 29 of the Bank of Zambia Act. Section 65(1) provides;

“Notice of assessment shall be given to the person charged.”

In our considered view, this section is not helpful to the Respondent’s argument that returns and computations should be in Zambian Kwacha. It simply states that the notice of the assessment should be given to the taxpayer. Equally, Section 29 of the Bank of Zambia Act is unhelpful. A return is not a unit of currency or “legal tender” for the purposes of the Bank of Zambia Act. The Appellant has not proposed that it pays its tax liability in United States Dollars. In fact, the Respondent, through its written submission has stated;

“The Zambia Revenue Authority submits that our letter dated 24th November 1998 categorically mentioned under paragraph (b) that for payment purposes the tax computed will be converted into Kwacha at the rate of exchange ruling on the balance sheet date as published by the Bank of Zambia.”

With due respect to the Respondent, this is the exact argument that the Appellant has taken. The Appellant’s position is that the tax loss should be carried forward in United States Dollars and be available for offset in United States Dollars against profit equally denominated in United States Dollars and the resultant tax thereon be paid in Zambian Kwacha.


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If a company that maintains its books in United States Dollars registers a taxable profit, tax on that profit is naturally payable to the Zambia Revenue Authority in Zambian Kwacha at the ruling rate of exchange. The tax loss that will be carried forward in United States Dollars will equally be offset against the taxable profit that will be computed in United States Dollars.

In our considered view, at the time of the assessments under dispute, there was no express provision in the Income Tax Act that prohibited the denominating of losses in United States Dollars and submitting returns in United States Dollars. The assessments are for the 1997/98 and 1998/99 charge years. Our view is fortified by the amendment to Section 56(1) contained in Act No. 3 of 2002. This amendment introduced a new Section 56(1), which provides;

“Notwithstanding the provisions of subsection (3) of section fifty-five, every return furnished under subsection (1) of section forty-six by any person shall be accompanied by such accounts and other documents, in Kwacha, as are necessary to support the return and shall be signed by the person furnishing the return.”

This amendment came into effect on 1st April 2002. It appears that before 1st April 2002, companies that were allowed to keep books in United States Dollars under Section 55(3) of the Act could submit returns in United States Dollars for the purposes of Section 46. The amendment of 1st April 2002 expressly prohibited that. In effect, the amendment intended to cure a mischief. The mischief in this case was to prohibit the submission of returns in United States Dollars notwithstanding the provisions of Section 55(3). In SPECTRA OIL CORPORATION LIMITED v. ZAMBIA REVENUE AUTHORITY – 1999/RAT/33, this Tribunal cited, with approval, passages from Bennion on Interpretation of Statutes, 3rd Edition, at page 707;

“Parliament intends that an enactment shall remedy a particular mischief. It is presumed therefore that parliament intends the court construing the enactment, to endeavour to apply the remedy.”

On page 708 the author goes on;

“Parliament is taken to do nothing without a reason. Therefore, there is reason for every Act and every Enactment within it……so the reason for Parliament passing an Act must be in some defect in the existing Law, for were it not defective, Parliament would not need or want to change it. The defect is the mischief to which the Act is directed.”

The mischief which Act No. 3 of 2002 intended to correct was in no doubt the state of affairs which made it permissible to file tax returns in United States Dollars on the basis of Section 55(3) as read with Section 46. There is now no doubt that after 1st April 2002, returns must be submitted in Zambian Kwacha, notwithstanding the provisions of Section 55(3). Before that, the law was not clear. If at all there is a doubt or ambiguity (as was the case before 1st April 2002), such ambiguity must be construed in favour of the taxpayer. C.f. this


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Tribunal’s ruling in INDUSTRIAL CREDIT COMPANY v. ZAMBIA REVENUE AUTHORITY [1999/RAT/73], where we referred to the principal of “doubtful penalization” as enunciated in Bennion, Statutory Interpretation – 3rd Edition at page 637.

The Appellant has not proposed that the tax be paid in United States Dollars. The tax will be converted and paid in Zambian Kwacha, which is the legal tender. As the assessments under review relate to the pre-2002 amendment, the provisions of the new law do not apply to these assessments. The Appeal on this ground succeeds to the extent that the tax losses will be carried forward, in United States Dollars which, however, must be available for offset against future profits in United States Dollars at the prevailing rate of exchange.

2.13 – INDEXATION OF MINING LOSSES AND CAPITAL ALLOWANCES

Government is mindful of both the high capital requirements and the risks attaching to mining investment, and accordingly recognizes the need for careful consideration of possible tax incentives. In the 2006 National Budget, the Minister has proposed to introduce indexation of losses and capital allowances for Mining Companies. This means that the losses carried forward and capital allowances will be protected against adverse movements in exchange rates. This is important for mining companies because they are allowed under the Income Tax Act to use the United States Dollars as the reporting currency, meaning that any adverse movements in the exchange rate has the potential to erode their deferred tax assets. These provisions have been provided for by the insertion of a new section 30 (A) immediately after Section 30 of the Income Tax Act and is applicable to all Mining companies holding a large scale Mining Licence.

INDEXATION OF LOSSES

The 2006/07 Amendment Act, introduces the indexation of carried forward losses for any mining company holding a large-scale mining licence issued under the Mines and Minerals Act and carrying on the mining of base metals. This measure allows mining companies to maintain real values of their losses carried forward by linking the loss to the exchange rate of the Kwacha to the United States Dollar. The suggested indexation formula is given below:


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INDEXATION FORMULA

1 + (R 2 – R 1 ) x loss brought forward R1

Where:

R1 = The Kwacha against the United States Dollar exchange rate ruling on the last day of the preceding accounting year in which the loss is being claimed.

R2 = The Kwacha against the United States Dollar exchange rate ruling on the last day of the accounting year in which the loss is being claimed.

The rate to be used for this purpose is the Bank of Zambia mid-rate at the end of the accounting period.

INDEXATION OF CAPITAL ALLOWANCES

The 2006/07 Amendment Act introduces the indexation of capital allowances for any mining company holding a large-scale mining licence issued under the Mines and Minerals Act and carrying on the mining of base metals. This measure allows mining companies to maintain real tax values of their capital allowances by linking the allowance to the exchange rate of the Kwacha to the United States Dollar.

INDEXATION FORMULA

Where:

R1 = The Kwacha against the United States Dollar exchange rate ruling on the last day of the preceding accounting year in which the loss is being claimed.

R2 = The Kwacha against the United States Dollar exchange rate ruling on the last day of the accounting year in which the loss is being claimed.

The rate to be used for this purpose is the Bank of Zambia mid-rate at the end of the accounting period.

1 + (R 2 – R 1 ) x Capital allowance R1


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EXAMINATION TYPE QUESTION WITH ANSWER


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HORIZON DEEP MINING PLC

Horizon Deep Mining Plc was set up in December 2005 after a long but fruitful takeover debate of one of the Mining divisions of the Zambia Consolidated Copper Mines Limited. The company has had difficult times in its first two years of operations but its directors are confident that the company will start making profits by the end of the third year when the company is fully capitalized. And this will, to a larger extent depend on a favourable response from the Ministry of finance concerning the company's request for financial support.

For the year ended 31 December 2006 the auditors have provided financial information with the following clause in their opinion:

'Without qualifying our opinion, we draw attention to the fact that the financial statements have been prepared on a going concern basis, the validity of which depends upon the continued support of the Government at the set -up stage and in subsequent early years of operations. In the absence of this support, adjustments may be necessary to reclassify and reduce the value of assets and provide for further liabilities, which might arise in future.'

Horizon Deep Mining PlcStatement of Net Expenditure for the year ended 31 December 2006.

US $ K'000Operating Expenses 314,018 1,188,558Salaries & related costs 189,490 619,915Exchange losses 13,451 12,763,931Depreciation 43,785 60,350Other expenses 28,707 87,470

---------- --------------589,451 14,720,224

Interest received (217) (651)---------- --------------589,234 14,719,573

Tax 52 228--------- --------------589,286 14,719,801===== =======

Important InformationTranslation of foreign currenciesTransactions during the year in foreign currencies are converted into Zambian Kwacha and US Dollars at rates ruling at the transaction dates. Assets and liabilities at the balance sheet date, which are expressed in foreign currencies, are translated into Zambian and US Dollars at rates ruling at that date. The resulting differences from the conversion and translation are charged to net expenditure during exploration and to profit and loss during the period of mining operations.


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Exchange Differences

The Kwacha exchange losses are a result of translation of the amount pending allotment of shares from United States Dollars to Kwacha. The United States Dollars exchange losses result from translation of Kwacha expenditure into United States Dollars.

Segment Information

The company is involved solely in exploration mining, which is done within the Republic of Zambia in Chingola South.

Exploration and prospecting expenditure

The exploration and prospecting expenditure incurred by the company are accumulated until such time as an economic ore body is defined or prospect is abandoned. Costs for a producing prospect are written off on a unit of production method while costs for a prospect abandoned are written off. Costs are expensed in full in the year of abandonment.

Losses

The company has tax losses of approximately K51,795,552,000. In accordance with current tax legislation, the losses are available for set off against future taxable profits from the same source for a maximum period of 10 years.

Summary of Income for the year: K'000

Bank interest received 651,000Gross Loss (650,772)

------------ 228

Less: Expenses (Check Statement of net Expenditure) (14,719,801)----------------

Net loss (14,719,573)=========

Additional information

Note 1Operating Expenses K'000Accounting and audit fees 53,653Drafting, mapping and surveying 96,226Engineering, geological & geographical surveys 537,008Meals - travel 391Miscellaneous 284Insurance, drilling, freight & GRZ licences 500,995

-------------1,188,557


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========Note 2Salaries and related costs: K'000Salaries and wages 615,953Contract labour - site 369NAPSA 2,528Personal Levy 1,065

------------619,915======

Note 3Other Expenses K'000Medical 25,025Travel 502Meals 687Entertaining 1,630Other allowable business expenses 59,625

---------87,469=====

Note 4Capital allowance Schedule K'000Equipment, commercial vehicles & furniture 81,166Computers and related accessories 17,100Office equipment 8,449Industrial buildings 2,069

---------108,784=====

Required:You are required to compute the Income tax payable by the company, if any for the Charge year 2006/07.


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ANSWER:

HORIZON DEEP MINING PLC – 31.03.07

Computation of Adjusted Taxable IncomeK’000

Net Loss as per Accounts (14,719,573) Less: Bank interest (Taxed Separately) (615,000)

-----------------(15,334,573)

Add Disallowed Expenditure:Translation Exchange losses 12,763,931Depreciation 60,350Meals – travel 391Miscellaneous 284Travel 502Meals 687Entertaining 1,630

----------------(2,506,798)

Less: Capital allowances:Equipment, commercial vehicles & Furniture (81,166)Computers and related accessories (17,100)Office Equipment (8,449)Industrial buildings (2,069)

---------------- (2,615,582) Tax losses brought forward (51,795,552)

-----------------(54,411,134)========

Taxation of Interest:651,000,000 X 35 % = K227, 850,000.

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