Are mining transactions some sort of tax lottery?

By Redempta Maira

If you bought several lottery tickets, would you describe this as an investment? I am sure your response would be ‘NO!’ On the other hand, money put into mining exploration is described as investment while at times the chances of a return are no better - and yet the sums invested in exploration are substantial.

So why invest? Well, whilst most exploration projects do not make it to development, some will - and investment can still make sense so long as the investor is able to diversify risk across multiple projects. This diversification of risk can either be automatic in the case of a large multinational with multiple projects, or by way of investors pooling / spreading their investments (maybe by way of investment in mining specialist funds) across a number of small (‘Junior’) exploration companies listed in large capital markets.

One characteristic of the mining/ extractive sector is transactional activity, frequently as a consequence of factors such as

(i) The need to raise additional financing

(ii) a desire to spread risk with other parties (iii) a recognition by one party that it does not have the capacity to continue with the project - perhaps a junior explorer looking to pass an asset on to an entity in a better position to develop a project.

These transactions can be in the form of sale of shares (of the mining licence holder or of the company holding shares in the mining licence holder) or in the form of transfer of interest in a mining licence.

The tax implications in relation to a sale of shares are generally well understood in terms of income tax (on any capital gain) and stamp duty. On the other hand, less well understood are the so-called ‘Change of Control’ (CoC) provisions which can also be triggered by a transaction relating to shares.

Where there is a change of shareholding in a company (either direct[1]ly (share-holding of Tanzanian entity) or indirectly (share-holding of overseas holding entity)), such sale can trigger the CoC provisions if the transaction results in a change of underlying ownership of the mining licence holder by more than 50 percent. When this happens, the company will be treated as realising all its assets owned and liabilities owed before such change.

The CoC rules were first introduced in July 2012, with the purpose of capturing into the tax net an indirect disposal of a Tanzanian company where the transaction is not the sale of shares of the Tanzanian entity but of a parent company of the Tanzanian company. However, the provision is much more wide ranging, potentially capturing transactions that should not be within scope. In particular, a deemed realisation is now automatically triggered whenever there is a change in underlying ownership of more than 50 percent - without exception (for example, irrespective of: lack of tax avoidance motive; nature of assets within Tanzania; proportion of transaction value attributable to Tanzania). Of great concern is that the provisions potentially could extend to transactions that in substance are transactions to raise capital for additional investment into an exploration asset; and it is not rocket science to realise that application of a 30 percent tax on inbound investment capital is a great disincentive to investment!

 The CoC provisions are not the only ones that can effectively result in tax on inbound investment capital

A similar scenario can result for a transaction in a mineral licence where the direct interest in the licence is diluted in favour of another investor in exchange for a commitment to fund exploration expenditure - a so-called ‘farm in’ transaction. The challenge with farm in transactions arises following 2016 changes which seek to treat the ‘carry’ of future costs to be incurred on the project as part of the consideration for the sale of an interest in a mining licence.

 There are challenges in this approach including: valuation of the amount to be included as the present value of the reasonable estimate of such future expenditure commitment; and technical basis for taxing an amount where there is no definitive obligation to pay a set amount of consideration in the future, but simply a right (or option) to incur that expenditure so as to earn the interest in the mineral right. Aside from this, the overriding objection is that the practical effect is to apply a 30 percent tax on investment capital.

Value-added tax (VAT) can be another concern for extractive transactions as in certain cases, the interpretation is taken that a transfer of a mineral right does not qualify as “the transfer of an economic interest” and so should be subject to VAT. Given the likely challenges for the purchaser in obtaining timely repayment of the VAT, the VAT cost can be a “showstopper” for extractive sector transactions.

A further challenge on the transfer of a mineral licence is the potential lack of income tax relief as a business cost for costs incurred on a mineral licence. This concern arises because of changes in 2016 to categorise an interest in a mining licence as an “investment asset”.

More recently, changes introduced in the Finance Act, 2020 have added to the concerns regarding taxation of gains from realisation of investment assets. The concern relates to a revised definition of the date of realisation, now the earliest of (1) the date of execution of contract for sale (2) the date of parting with possession, use or control of a realised asset; or (3) the date of payment of part or whole of the consideration. The challenge in this case is the non-recognition of the fact that transfers of mineral rights are frequently subject to various contingencies which if not met would result in non-completion of the transaction. One contingency is the requirement for prior approval from the Mining Commission for the transaction to proceed.

In practice, the authorities would require the parties to produce a tax clearance certificate from the Tanzania Revenue Authority (TRA) as a prerequisite to obtaining such approval. It therefore becomes a chicken and egg situation as taxpayers are required to pay the tax on disposal in advance of formal completion of the transaction.

As transactions are the lifeblood of a healthy extractive sector, it is important that the tax treatment of such transactions does not act in such a way that might deter transactions from happening.

Ultimately, tax policy should be formulated so as to collect the appropriate amount of tax without resorting to legislation which is either too complex, impractical or cumber some to implement efficiently - and which whilst giving the Government an appropriate return, also ensures sufficient potential return for the investor to motivate investment.

Redempta Maira is a Senior Manager, Tax Services, at PwC Tanzania. She has also worked on secondment with PwC Ghana