South African Diamond Board: hearings

Meeting report

PUBLIC ACCOUNTS STANDING COMMITTEE
18 May 2005
SOUTH AFRICAN DIAMOND BOARD: HEARINGS

Chairperson: Mr F Beukman (ANC)

Documents handed out:
SA Diamond Board Annual Report

SUMMARY
The Committee conducted a hearing on the SA Diamond Board (SADB) operations and financial management following presentation of its 2004 Annual Report. The Annual Report included the Auditor-General’s heavily qualified opinion on the financial statements of the SADB. This related mainly to the validity of export duty exemptions given to producers for the export and sale of diamonds in terms of the Diamond Act.

Members were very concerned that a copy of the 1992 Agreement between De Beers and the Board could not be found by any of the interested parties. Export duty revenue accruing to the State had fallen sharply from 1989 onwards as it appeared that some producers had been given exemption from paying duties. They commented that the Department of Minerals and Energy (DME) had sent a representative to the hearing that could not adequately answer questions and that the general regulation and governance in the diamond sector appeared to be in a ‘state of chaos’. The Committee resolved to further investigate before making its recommendations to the National Assembly.

MINUTES
The discussions were led by Mr T Mofokeng - ANC (Investigation), Ms A Dreyer - DA (Legal Opinion), Mr G Madikiza – UDM (Governance), Mr P Gerber – ANC (Legislation) and Mr D Gumede – ANC (Internal Control).

The SA Diamond Board was represented by Mr A Chikane (Chairperson), Mr L Selekane (Chief Executive Officer), Mr J Mthethwe (Financial Manager) and Ms E Engelbrecht (Administrative Manager). The Auditor-General’s Office was represented by Mr S Fakie (Auditor-General), Mr I Vanker and Mr H Mostert. Ms Zulu responded from the Department of Minerals and Energy.

The Auditor-General’s Report
The Auditor-General’s Report had investigated the export and sale of diamonds in terms of the Diamond Act (Act No. 56 of 1986). It had queried the validity of export duty exemptions provided to producers under Section 63 of the Act based on agreements entered into under Section 59 of the Act. An investigation into the validity of Section 63 by the Auditor-General had been inconclusive.

Abbey Chikane (SABD Chairperson) explained that an SADB investigation was instituted by former Minister of Minerals and Energy, Mr P Maduna (June 2001) to investigate Section 59 Agreements and related matters. A report had been presented though essential documents were not available including the Section 59 Agreement. Dr J Bredell (SADB) had been appointed as Chairperson of the Section 59 Committee and has since been involved with resolving the matter of the Section 59 Agreement in terms of the Diamond Act and in examining the legality of the document. The National Treasury has argued that the Agreement was not legal. The Agreement had been made between the Board and De Beers on the one hand and the Board and TransHex on the other. There were therefore two documents that were Section 59 Committee Documents from both De Beers and TransHex. These documents were available.

Mr Selekane (SADB CEO) addressed the management of documentation. A new system of accountability regarding documentation had been put in place. The Section 59 Agreement had been negotiated between the Section 59 Committee with TransHex and De Beers. The agreements had been reviewed annually to determine whether there was enough capacity in the country to cut and polish goods that were deemed to be uncuttable goods. It was not economically viable to cut and polish within the country. The purpose had been to shift the baseline to develop caratage that could have been economically cut and polished within the country.

Discussion
Mr Gerber (ANC) requested clarification from Mr Selekane on whether a signed copy of the Section 59 Agreement with De Beers was available. Mr Selekane agreed to make copies of the agreement available to the Committee.

Mr Fakie (Auditor-General) responded to the statement that the agreement had been reviewed on an annual basis by emphasising that the subject matter of the investigation was specific to the agreement signed on 19 March 1998 for which a signed copy was available. However the 1998 Agreement had referred to the 3 December 1992 Agreement. A signed copy of the 1992 Agreement was not available. The 1992 Agreement resulted in the stockpile of diamonds exported to London. Mr Fakie requested verification from Mr Selekane as to whether SADB had a copy of the 1992 Agreement. Mr Selekane responded by acknowledging that SADB was not in possession of a copy of the Section 59 1992 Agreement.

Mr Beukman queried whether any steps had been taken since the AG’s request to obtain the Agreement.
Mr Chikane responded that the document could not be found by the SADB, nor the Department of Minerals and Energy. Mr Mofokeng asked when the investigation report of the task team, involving the CEO and the Government Diamond Valuator, had been completed and to whom it had been addressed. Mr Chikane responded that the report had been inconclusive as the 1992 Agreement had not been available. The report was completed in 2002 and was addressed to the SADB, Department and to the Auditor-General’s office.

Mr Mofokeng (ANC) requested the SADB to explain problems encountered with the investigation with specific reference to unresolved issues.

Mr Chikane explained that the major obstacle had been the unavailability of the Section 59 Agreement of 1992. Without the document, it had not been possible to extrapolate what had been agreed upon at that point. The matter was handed over to the Department and the Ministry had not been able to obtain a copy of the Agreement.

Mr Mofokeng requested the Department to comment on steps taken following the recommendations of the task team.
The Department representative responded that archives had been searched to find the Agreements but the search was not successful. Meetings have been held between the Minister, the Auditor-General and Director-General on progress. The matter was still under discussion between the Minister and the Director-General’s Office - a response was being awaited from the Minister.

Mr Mofokeng turned his attention to export duties. According to the Auditor-General ‘s figures supplied by De Beers to the audit firm, the export duties of the period 1980 – 1988, varied from approximately R19 million to R56 million. The year before the Section 59 Agreement of 1992, the duties had dropped drastically to R15 000. Mr Mofokeng commented that such a drastic drop ought to have raised serious concerns at the SADB and he questioned how the matter had been addressed.

Mr Chikane explained that a Technical Committee at SADB had since been established to analyse information and statistics gathered from different producers and traders within the country. Prior to the Technical Committee it had not been possible to make any comparison of previous, current and future production of diamonds in the country. The issue involved National Treasury and the SADB.

Mr Grote (National Treasury) explained that diamond export duty between 1989 and 1998 had raised concern within the Tax Policy Division of the National Treasury and a National Tax Reform strategy had been implemented to address the low growth trends. Treasury Diamond Export Duty delivered a substantial revenue take between 1980 - 1988 of approximately R390 million. The purpose of an export duty had been to add value to minerals and to raise revenue. The Diamond Act (1986), which had prescribed the Section 59 Agreement in Section 63, had caused the collapse of the diamond export duty in 1989. There seemed to have been a possibility that a decision was made to exempt mines from export duty. National Treasury consulted SARS tax advocates for legal advice as this related to a tax legislation piece (Section 63). SARS produced a report that has been provided to SCOPA. There had been no information on sales statistics available on diamonds since 1990, because industry had not wanted to publish what the sales of diamonds in South Africa were for strategic reasons. Treasury requested the Department to provide information and after lengthy investigations information was provided. Mr Grote agreed to provide complete statistics to the Committee. Mr Grote noted that in establishing revenue-making instruments, it was pivotal to develop proper mechanisms ensuring appropriate data and statistical compilation. The SADB was not equipped for this as it lacked special instruments including risk assessments and the legal staff to enforce tax law.

Mr Mofokeng questioned the manipulation of stockpiles and the loss of documents and reported manipulation of records. Mr Mofokeng questioned whether any further investigations had been made. Mr Gumede (ANC) further stated that since the new board took over, there had been ample time to conduct investigations.

Mr Chikane, responding to the issue of stockpiling, replied that an investigation had been conducted by PKF and a report had been submitted to the Auditor-General. To determine accountability, a more inclusive team led by the Auditor-General and including the SADB and Department would conduct future investigations together. Past investigations had been very fragmented.

Legal Opinion
Ms Dreyer (DA) proceeded to query the legal issues relating to the SADB and Auditor-General investigations. She requested commentary from the Department representative. The Department had been invited to be present at the meeting. However, their representative was unable to address questions posed and instead requested that questions be tabled and written responses would be supplied. Dissatisfaction was strongly expressed by Mr Gumede (ANC) at the inadequate representation from the Department. In response to further questioning by Ms Dreyer regarding the monetary policy and administration, it became clear that the Reserve Bank needed to be approached.

Governance
Mr Madikiza (UDM) questioned how the issue of regulation of the diamond industry, governance and the composition of the SADB had been addressed. Mr Chikane explained that the Diamond Act was not compliant with corporate governance and best international practice. The forthcoming passage of the Precious Metals and Diamonds Bill would address the inherent conflict of interest of the Diamond Act. In the interim, more government representatives have been involved to deal with conflict resolution to improve corporate governance.

Mr Madikiza questioned why it had been stated in the Annual Report that the SADB had established an Audit Committee when this was in contradiction to the Auditor-General’s findings. Furthermore he questioned why 80% of good governance regulations had not been adhered to.

Mr Chikane responded that the Audit Committee was established subsequent to the Auditor-General’s report. Mr Selekane supported that prescribed meetings of the Audit Committee had not taken place and hence their exclusion from the Auditor-General’s report. He emphasised that the situation had been addressed and that the functional Audit Committee consisted of chartered accountants, an industry representative and the CEO. Mr Selekane responded that in developing compliance with governance requirements an Asset Management system had had to be created to improve efficiency and accountability.

Legislation
Mr Gerber sought clarity on the current status of the draft amendment bill. Mr Chikane responded that the bill had been reviewed by the State Law Advisor. Mr Selekane added that a public hearing to discuss the Bill had been scheduled for 25 and 27 May. The bill had been scheduled to be adopted on 6 June. Due to the document not being referred to the Portfolio Committee from the Chief State Law Advisors Office there would be a possible two-week delay.

Mr Gerber said the Committee was concerned about the composition of the SADB as there was an imbalance of government and industry representatives. He queried whether this imbalance was addressed in the new bill. In addition, he queried whether Section 63 (export duty exemption) in the new bill was adequate as it had been considerably reduced.

Mr Selakane explained that within the new bill only three members from industry had been recommended to the new board of the regulator. The rest of the board would be comprised from government. One member from the South African Police Services, one member from the Reserve Bank, one from National Treasury and two from the Department would also serve on the board. Mr Grote explained that Section 63 belonged in a money bill and had been inadequately placed. The section required a separate piece of legislation.

Mr Gerber requested clarity on the difference of cost per carat of export versus the import of uncut diamonds as presented in the Annual Report. Mr Selekane explained that the imported diamonds were industrial diamonds and not of good quality explaining why the imports were cheaper than the exports. According to Section 59 De Beers was permitted to export diamonds free of duty and re-import diamonds to supply their subsidiary Element 6 at Springs. The industrial diamonds had been imported in large quantities.

Referring to the cost of cut and polished diamond imports versus exports, Mr Gerber questioned why there was a discrepancy in the cost with imports being cheaper than the exports.

Mr Selekane explained that the polished exports were high value goods and these costs had come from De Beers in terms of the Section 59 Agreement. The South African industry had had a preference for polishing from +2 carat diamonds as these fetched a high price in the market. The imports were goods that had been deemed non-cuttable in South Africa and site holders had preferred to export them to countries where the cost of cutting and polishing was cheaper then in South Africa e.g. India. The exported figures represent diamonds that were exported for cheaper cutting and polishing. The figures indicated lots of caratage but low value. The diamonds were re-imported into the country for jewellery manufacturing. However, these diamonds had mainly been re-exported to clients in the UK.

Mr Beukman requested clarification from the Department as to the level of liaison between it and the SADB. The Department responded that the Department representative on the SADB was at the level of Chief Director.

Internal Control
Mr Gumede led the questioning regarding Internal Control for the management and safeguarding of assets. Mr Gumede commented that the issue of the Audit Committee could not be condoned. He questioned whether the electronic system had proven to be effective.

Mr Selekane stated that the system had proven to be effective in improving internal control systems. Following recommendations from the Auditor-General’s office, regulation of debtors had improved along with de-activation of inactive licences. Mr Mthethwe (Financial Manager) concurred that the system was satisfactory and reliable in regulating assets.

Mr Gumede further questioned the use of N1 forms completed by inspectors. The forms had been used to generate invoices; however they had been erroneously completed. Due to errors it had not been possible to trace invoice amounts to general ledger and to verify invoices against N1forms. Mr Gumede questioned whether there had been any steps taken to address the issue and determine responsible persons and whether the SADB was cogniscent of the ramifications for financial management procedures and controls. He further questioned the steps taken to avoid recurrence.

Mr Mthethwe responded that oversight had occurred with the inspectors. The issue had been discussed with the inspectors to ensure that in future errors would be avoided. Documents are cross-referenced to ensure that transactions were not conducted without the production of an invoice.

Open Questions
Mr Gerber questioned Treasury regarding the legal possibility of challenging Section 59 Agreements. Mr Grote responded that Section 63(1)(a)(ii) of the Agreement had been referred to SARS’ senior Tax Officer on the basis that National Treasury recognised that a blanket tax was not the intention of the legislature. SARS’ Tax Office had agreed but one of the big producers had contested this and argued that the Agreement was legally binding. The potential revenue loss had been too great and the issue needed to be fully investigated through appropriate legal channels. An independent legal council that had experience, knowledge of tax law and the statutes should ideally be appointed.

Mr Mofokeng requested clarification on the contradiction between Section 62 of the Diamond Act and Section 77 of the Constitution of 1996 as highlighted by Finding 3 of the Auditor-General’s report.

Mr Grote responded that the Constitution had been explicit in providing that all money raising and expenditure issues should be addressed in the Money Bills introduced by the Finance Minister. In 1986 there had been no Constitution although there were numerous laws. The Department in its revision of the Bill had sought to address this outstanding issue. A draft of the Money Bill dealing with the Export Duty would have to be done by Treasury on instruction from Cabinet to be embodied into law.

Mr Mofokeng questioned the Department whether there had been consideration of allowing SARS to take over collection of duties and levies of diamond exports. The Department representative confirmed that the matter had been tabled to Department principals.

Mr Trent questioned SADB on the Auditor-General’s comment stating that no provision had been made for post retirement benefits. Mr Selekane responded that permission were being obtained to make provision. Mr Vanker (Auditor-General’s Office) provided further explanations regarding the accounting standards.

Dr Woods questioned why Treasury had not embarked on legal proceedings to obtain documents from the producers regarding the Section 59 Agreement. In addition he questioned whether Treasury had been satisfied with calculation of levies which depended on the government diamond valuator and the lack of checks and balances from the side of Reserve Bank.

Mr Grote responded that National Treasury was not directly responsible for legal action as the Diamond Act was part of the Department’s regulatory function. Mr Grote further explored challenges of establishing a fair market value of diamonds through the Mineral Royalty Bill, the Government Diamond Valuator, global markets and setting of high reserve prices.

The Auditor-General offered a final comment regarding the cost of pursuing further investigations. Without additional documentation further investigations would not achieve a great deal. An alternative could be the creation of a Commission of Enquiry or seeking legal counsel. Mr Chikane agreed and advised that National Treasury could play a leading role in resolving the issue.

Mr Gerber expressed his incredulity that 19 million carats of diamonds could have been exported out of the country tax free a few months prior to a new government taking power. SCOPA would process the information presented and a resolution would be made.

The meeting was adjourned.