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FINANCE & MINERALS AND ENERGY PORTFOLIO COMMITTEES
1 November 2006
DIAMOND EXPORT LEVY BILL: BRIEFING BY NATIONAL TREASURY
Chairperson: Mr N Nene (ANC)
Documents handed out:
National Treasury Presentation on the Diamond Export Levy
Draft Diamond Export Levy Bill as at 11 October 2006
The Treasury said that the Constitution prescribed that any tax or levy must be imposed by way of a Money Bill and only the Minister of Finance could introduce such a Bill. The primary objective of the export levy on rough diamonds was the same as under the Diamonds Act, that is, to ensure a sufficient supply of rough diamonds to local cutters to promote local beneficiation. A 5% levy applied to all rough diamonds exported.
Similar to provisions previously contained in the Diamonds Act, the Levy Bill contained relief measures that could offset the 5% levy liability in full or in part. Relief measures existed to minimise any potential distortions and unintended negative impacts of the proposed levy. Only producers could use the measures and they were entitled to an import credit for any imported rough diamonds.
The Bill had a 5-year time limit for assessments. This 5-year period began after the submission of a diamond levy return to which that assessment period related. If no return was submitted, the time limit for assessment continued indefinitely and persons could claim refunds for overpayments.
At the present time, the 15% diamond export levy was technically still applicable, except for the waiver via a previous Section 59 agreement. The waiver via the Section 59 agreement only applied for one year from the coming into force of the Diamonds Amendment Act, 2005.
Mr C Morden, a Chief Director of Tax Policy at the Treasury, said that the diamond industry had long been the preserve of De Beers and had been clouded in secrecy with little information. De Beers controlled around 80% of the supply of rough diamonds up until the early 1990s and now it controlled less than 50% of diamond supply. A single rough diamond could vary in value from a few dollars per carat to tens of thousands of dollars. Diamonds of the same weight varied in value depending on the shape, colour, and clarity of the stone and sometimes even the location of the sales or production.
There was no terminal market value where prices were quoted and despite the publication of price lists there were “discounts to” and “premiums to” the listed price. There was currently a global shortage of diamonds. De Beers’ diamond stocks had declined from $4.8bn in 1998 to an estimated $1bn at the end of 2004. Producers were becoming more oriented to driving demand (led by De Beers with their change in strategy initiated in 2000) and vertical integration was becoming more prevalent.
Cutters and polishers (and jewelers) were backwardly integrating into production as rough diamonds became scarcer. Producers were also investigating future involvement in cutting and polishing. Countries that hosted producing mines were becoming more demanding in terms of the value chain process and consolidation of the industry was likely to take place. Declining production in Australia was causing a shortage of rough diamonds in India. Synthetic gem diamonds were a reality and were posing a threat to the industry. Polished diamonds were graded according to four important characteristics: carat; colour; clarity and cut. The quality of the cut could make a difference of up to 30% of the value of a diamond.
Taxes were primarily imposed to raise revenue to fund Government expenditure and to achieve a degree of redistribution through income taxes, consumption taxes and excise duties amongst others. Other objectives of taxes included equity; protecting local industries; to discourage; social security; environmental objectives; payments for extracting a depletable resource and for local beneficiation (LB).
However, taxes could result in the economic distortions and must therefore take account of efficiency considerations and the tax system must provide a degree of certainty to taxpayers. The Diamonds Act of 1986, sought to promote LB by imposing a 15% levy on rough diamonds exported from South Africa. The levy operated as a quasi regulatory measure, designed to encourage the supply of rough diamonds to local cutters. Producers could get exemptions from the 15 % levy through a section 59 agreements. There were two types of exemptions: where the exporting party demonstrated the promotion of LB via other means such as the long-term contractual supply of rough diamonds to local cutters and by offering local rough diamonds to the bourse before exporting them.
The 2005 amendments were aimed at deleting the section 59 exemptions; replacing the Diamond Board with the Diamond and Precious Metal Regulator (DPMR); reducing the number of diamond export centres to one (the Government controlled Diamond Exchange and Export Centre (DEEC)) and to provide for the establishment of the State Diamond Trader (SDT) to increase the supply of rough diamonds to local cutters and polishers.
The Constitution prescribed that any tax or levy must be imposed by way of a Money Bill and only the Minister of Finance could introduce such a Bill. The primary objective of the export levy on rough diamonds was the same as under the Diamonds Act, that is, to ensure a sufficient supply of rough diamonds to local cutters to promote LB. A 5% levy applied to all rough diamonds exported. Synthetic (human) made diamonds were excluded. The levy was triggered by section 69 of the Diamonds Act and applied to the “value” of exported rough diamonds. In order to prevent artificial under-valuations, the 5% would be applied to the greater of the following two values: the value specified by an exporter on a return as required by section 69 of the Diamonds Act, or a value assessed by the DPMR (the Government diamond valuator) as described under section 65 of the Diamonds Act.
Prof K Engels, a Chief Director of Tax Policy at the Treasury, said that if a person sold rough diamonds in exchange for foreign currency and physically exported those diamonds, their sales value would be converted into rands at the closing spot rate on the date of export. Any levy or penalty payable in terms of this Act must be paid into the National Revenue Fund. The levy would be imposed as 5% (as opposed to the previous 15% rate as per the Diamonds Act). The 5 % rate was viewed as sufficiently high to discourage the export of rough diamond while being low enough not to encourage smuggling.
A bill of entry for export submitted by an exporter of rough diamonds to a South African Revenue Service (SARS) Customs official triggered liability for the levy. The date of payment of the levy depended upon the nature of the exporter. Producers had to pay the levy every six months and independent dealers had to pay the levy at the time of export.
Similar to provisions previously contained in the Diamonds Act, the Levy Bill contained relief measures that could offset the 5% levy liability in full or in part. Relief measures existed to minimise any potential distortions and unintended negative impacts of the proposed levy. Only producers could use the measures and they were entitled to an import credit for any imported rough diamonds. These credits could be used to offset a producer’s export levy liabilities. The credits ensured that the levy applied only to net exports. The credits applied only upon official entry of the rough diamonds into South Africa. The credit was equal to 5% of the value of imported rough diamonds.
The credits arising during a period will offset the levy owing. The level of offset would be prescribed by the Minister of Finance in regulations. The amount was at 100% currently. All excess would be carried forward to following assessment periods for as long as that excess lasts (or the taxpayer remained in existence). After consultation with the DPMR, the Commissioner could in determining the value of any imported rough diamond, adjust that value to reflect an ‘arm’s length’ price and prevent artificial over-valuations.
A taxpayer could not acquire a producer solely or mainly for import credits (acquisition of a more 50% equity interest in a producer solely or mainly for that producer’s unutilised imported credits resulted in the wholesale denial of those credits). The import credit did not apply to a producer that already benefited from the receipt of a Ministerial levy exemption described in section 6 or 7. This denial of import credits was required as a matching principle, that is, credits for imported diamonds had to be matched against the levy on exported diamonds in order to ensure that the levy applies on a net export basis.
The Minister of Minerals and Energy had the power to exempt a producer from being required to offer its rough diamonds intended for export at the DEEC. Section 6 of the Levy Bill provided for an automatic exemption from the 5% export levy if the producer had been granted an exemption to offers on its diamonds on the DEEC in terms of section 74 of the Diamonds Act. The level of the exemption would be prescribed in regulations by the Minister of Finance (100% currently). This exemption did not apply to a producer that already benefited from the import credit in section 5 and neither did it apply to any rough diamond purchased from the SDT.
The Minister of Minerals and Energy could exempt a producer from the 5% export levy as long as that diamond was properly offered to the DEEC and the producers satisfied of one of the following two conditions: its activities in South Africa were supportive of LB and was a small miner (a producer whose rough diamond sales do not exceed R10 million per year). The level of the exemption would be set in the regulations.
In addition each diamond offered at the DEEC had to satisfy the following four requirements in order for that diamond to qualify for this exemption. These requirements were that the rough diamond had to be offered for sale at the DEEC for a minimum of four days; the offer at the DEEC had to not have resulted in a sale; the diamond sold for export had to yield a price that was at least equal to the price at which that diamond was offered for sale at the DEEC and proof of the reserve price had to be submitted. These requirements preserved South Africa’s “right of first refusal” by measuring whether the offer was real. This exemption did not apply to a producer that had already benefited from the import credit in section 5 and the exemption in section 6. It also did not apply to any rough diamond bough from the SDT.
The Levy Bill provided for two sets of levy payers: producers (diamond miners) and non-producers (independent dealers and cutters). Producers had to register with SARS and pay their export levies twice a year and non-producers had to pay the full levy when exporting rough diamonds. The definition of producer extended beyond holders of mining rights to reflect the business reality of group operations, which often separated mining from sales.
Thus, companies within the same consolidated financial group could be treated as a producer if approved by the Minister of Minerals and Energy and that consolidated group company sold diamonds of that producer. The Commissioner had the freedom to determine the required registration process of producers. The Bill said that registration had to occur within 45 days after the date that a person became a producer and the Commissioner could cancel registration upon application.
Cancellation could only occur after the last day of the 6-monthly assessment period on which a person qualified as a producer. Natural persons utilised six-monthly periods based on their year of assessment prescribed by the Income Tax Act starting on 1 March and ending on the last day of February. Other persons relied on their financial year. The actual return plus payment had to be submitted 30 days after each 6-monthly assessment period. All registered producers (which included consolidated diamond sellers) had to submit a single return at the same time and place determined by the Commissioner. This single return requirement would ensure that this single economic unit could be audited accordingly.
Registered producers, submitting bi-annual returns, had to maintain sufficient books and records for the Commissioner to verify compliance. These books and records had to be maintained for a minimum of 5 years. This 5-year minimum requirement matched the time limit for assessments described in section 16 (as well as the time limit for refunds in section 17). The Bill operated as a self-assessment system, like VAT. A notice of assessment triggered an additional 30-day liability for payment (subject to objection and appeal). The Commissioner had the power to reduce assessments without the formal objection and appeal process and could withdraw assessments without the formal objection and appeal process.
The Bill had a 5-year time limit for assessments. This 5-year period began after the submission of a diamond levy return to which that assessment period related. If no return was submitted, the time limit for assessment continued indefinitely. Even if a return was submitted, the 5-year provision did not apply if the Commissioner had reason to believe that failure to pay the levy stemmed from fraud, misrepresentation or a non-disclosure of material facts.
Persons could claim refunds for overpayments. Refunds had a 5-year time limit and both the Commissioner and levy payers were eligible for interest to the extent of underpayments and overpayments. This interest was calculated on a monthly basis and calculated in accordance with the rate in section 1 of the Income Tax. The Commissioner was responsible for administering the Diamond Export Levy Act but the Minister of Minerals and Energy would be responsible for assisting the Commissioner on issues requiring diamond expertise.
Administrative processes were covered by reference to the Income Tax Act. The Commissioner and the Minister of Minerals and Energy could freely share information for enforcement of the Bill and discretionary decisions by the Commissioner and the Minister of Minerals and Energy were subject to objection and appeal. The Diamond Export Levy Act would be determined solely by its terms without reference to any other Act (unless that other Act makes specific mention of the Diamond Export Levy Act).
The Bill will come into operation on a date set by the Minister of Finance and this discretionary date would ensure that operation of the Bill coincided with the coming into existence of supporting administration apparatus (including the apparatus relating to the SDT). At the present time, the 15% diamond export levy was technically still applicable, except for the waiver via a previous section 59 agreement. The waiver via section 59 agreement only applied for one year from the coming into operation of the Diamonds Amendment Act, 2005 (the Minister of Finance had the power to continue the section 59 agreement waiver until this Bill was fully operational). Without this deferral, a situation could where the 15% export levy applied without any section 59 agreement relief.
The Diamond Export Levy Act fully replaced all diamond levies required by the Diamonds Act. All diamond levies imposed by the Diamonds Act had been removed, including the 15% export levy as well as the fees and levies to fund the previous State Diamond Board. Two key exemptions within the Diamond Export Levy were left to Ministerial waiver: exemption from the DEEC (section 6) and exemption for diamonds offered (but not sold) at the centre (section 7). Both Ministerial waivers were left to the regulations.
The regulations provided Government with some flexibility so changes could be made. However, the starting regulations had to be issued quickly to provide the industry with certainty. Local diamonds needed to generate economic activity beyond mere extraction so producers had to get some level of exemption from the Diamond Export Levy to the extent that producers generated or regularly supported local or regional sorting and valuing; cutting and polishing; jewellery making and manufacture, diamond retail and marketing directed to intermediate or final consumers.
The Diamond Export Levy had to account for market realities. The levy exemptions had to exist where there was an over-supply of certain categories of diamonds or there were more diamonds than local cutters could cut (or an over supply was anticipated).
The Chairperson asked what the net effect of reducing the levy would be. Would it not reduce income?
Mr Morden said that the objective of the Bill was mainly to support the regulatory environment therefore they could justify any net effect of the level of the levy.
Mr B Mnguni (ANC) asked what conditions the current levy was applied since it applied very rarely. What were the unintended consequences of the change in the levy?
Mr Morden replied that if the 15% levy and the exemptions were not there the local supply would have been much lower as the exemptions were conditional. This ensured that there was some LB. Now the SDT could play a more interventionist role. In time, the levy may not be necessary but this was a transitional period. Taxes provided incentives for people to pay all their taxes but there would always be people who tried to pay as little tax as they could. One unintended consequence could be that if there was no relief, South African producers could be negatively affected by lower prices in the local market which could affect their investment choices.
Mr Morden replied that the level of the levy really was not important as the net result would be an additional supply of diamonds for the local market. There would be some revenue from the levy but this was not the main objective.
Mr I Davidson (DA) said that the provisions in place since 1986 were clearly incentives. The 5% levy and the added exemptions led to the question if the levy was really necessary. Why not just have the SDT supply the local market rather than setting up this cumbersome, complex system? What was the basis of the exemptions and how was the 5% figure arrived at? What level of beneficiation was expected?
Mr A Mgomezulu, the Deputy Director-General of Mineral Regulation in the Department of Minerals and Energy (DME), said that the levy was not meant just for collecting revenue but for encouraging LB and discouraging exports. The minimum level of LB they wanted was for 10% of all South African produced diamonds to be beneficiated here. There were also other fees besides the 5% levy and producers had to offer at least 10% of their diamonds to the SDT.
Mr Morden said that this was not a new tax. The Constitution had prescribed that issues such as taxes had to be inserted in Money Bills. Whether the SDT could handle the whole system alone was unclear but the DME was not sure it could, hence the need of the levy. If in a few years if the SDT was in position to operate alone, changes could be made accordingly.
Dr S Van Dyk (DA) asked if the purpose of the levy was to stimulate the industry or to make diamonds more readily available. Would the Act not increase imports because of the lower levy which would negatively affect local beneficiation (LB)?
Mr C Kekana (ANC) said that the Bill was an attempt by the Treasury to act like the police in trying to stop smuggling. How could LB be increased if the 5% levy was only meant to stop smuggling?
Prof Engel replied that the question was if the 5% levy acted as a deterrent for smugglers? The figure of 5% had to be one that kept people honest but still deterred smugglers. Some of the past exemptions worked but the objective now was to deter artificial export.
Mr K Moloto (ANC) said that given that the 15% levy was rarely applied in the past, how sure were they that their valuation methodology was accurate? What were the concerns of the industry with regards to the 5% levy?
Mr L Silekani, the CEO of the South African Diamond Board, said that with regards to valuations there were two options: to appoint independent valuators kept on retainer to settle disputes on pricing and benchmarking with open market prices. Internationally, a committee had been set up to discuss the issue of the prices of rough diamonds as things like emotions affected prices. Mr Morden said that the industry did not want any taxes but they accepted that they had to be there, and after consultations they were comfortable with the 5% levy.
Mr M Johnson (ANC) asked how the appeal procedure was structured and to what extent avoidance of the provisions would occur, such as big companies setting up smaller holdings to utilise the exemptions.
Prof Engels replied that the appeal process would be the same one as in the revenue laws procedures. Mr Mgomezulu added that the Bill encouraged producers to supply local cutters and jewellers. They had built up mechanisms to track ‘front’ companies, but they did not want to discourage those who acted honestly.
Adv H Schmidt (DA) said that the Treasury should have opted for certainty and not flexibility as they had done with these provisions.
Mr Mgomezulu replied that there was a ‘carrot and stick’ principle in the Bill. If producers gave the SDT 10% of their produce, and polished the other 90% in South Africa, more exemptions may be given but the SDT could compel them to offer more if necessary as well.
Mr Y Bhamjee (ANC) asked how LB was measured. Had it been measured? If not, why not?
Mr Morden replied that LB was what proportion of South African diamonds were locally polished, cut and then sold as jewellery.
The meeting was adjourned.