Diamond Export Levy hearings: Treasury response

FINANCE & MINERALS & ENERGY PORTFOLIO COMMITTEES
14 November 2006
DIAMOND EXPORT LEVY HEARINGS: TREASURY RESPONSE

Chairperson: Mr N Nene (ANC)

Documents handed out:
National Treasury Preliminary Responses to Public Representations on Diamond Export Levy

SUMMARY
National Treasury provided a response to public submissions made on the Diamond Export Levy. The Treasury reminded the Committee about the objectives of the Bill. The Bill should not be viewed in isolation. It was the last leg of an overhauled regulatory paradigm. It provided a detailed response to the COSATU and the National Union of Mineworkers (NUM) submission.

The Diamond Council of South Africa had asked if the 5% levy would not have the effect of actually encouraging smuggling. Through broad consultation, Treasury and the Department of Minerals and Energy had determined that the 5% rate was high enough to encourage local beneficiation and low enough to discourage smuggling.

Trans Hex had asked if producers that complied with the Mining Charter could be exempt from the imposition of the levy. The fulfilment of Mining Charter requirements had nothing to do with the objective of the Bill. Government had always taken the position that no tax-related incentives should be available for simply meeting Charter requirements.

The Diamond Council of South Africa asked if the credit should not apply to all exporters of rough diamonds (State Diamond Trader, dealers and cutters) rather than just producers. Treasury replied that the extension of this rule to cutters and dealers should not create any added anti-avoidance concerns.

The South African Diamond Producers Organisation asked if a producer had a right to object with a Government diamond valuator in respect of diamond value. The Bill did not include a right of objection if both the producer and the Government diamond valuator disagree about diamond values. This omission would be remedied in the next version of the Bill.

MINUTES
General Comments
Prof Keith Engel, Treasury Director of Legislative Policy, firstly restated the objective of the Bill which was to grow the local beneficiation diamond industry. The purpose of the Levy was not to raise revenue. The Diamond Industry (like all companies) was already subject to the 29% rate in Income Tax. Further revenue would come from the Royalty Bill (currently out for public comment) which imposed a 5% resource rent tax on rough diamonds (on a gross ad valorem basis). No reason existed to impose another charge. The proposed export levy was not new. It replaced the current 15% levy which had been in existence since 1986. The 5% rate had been set to act as a deterrent for exports while at the same time discouraging smuggling.

The Bill should not be viewed in isolation. It was the last leg of an overhauled regulatory paradigm. Each diamond producer had to offer up to 10% of its “run-of-mine” rough diamond production to the State Diamond Trader (SDT) for supporting local beneficiation through the on-sale of those diamonds to local cutters and dealers.

Section 59 agreements would cease to exist. All rough diamonds intended for export must undergo a formal bidding process at a Diamond Exchange and Export Centre (section 48A of the Diamonds Act) (DEEC), which secured a “right of first refusal” for the local industry. Up to two centres are envisioned at present. One important aspect of the Diamond Export Levy was its relationship to the SDT. Without the Levy, the purchase of diamonds from the SDT by local cutters could easily result in leakage with local cutters simply purchasing diamonds for re-export.

At present, South Africa had about 2100 local diamond cutters and in 2005 produced about $16,78 million in carats and $10,82 million in value. During that same year, local cutters cut roughly 540 200 in carats and $2.63 million in, which amounted to a mere 3.2% in carats and 24.4% in value. However, the industry also produced a substantial amount of diamond imports. South African cutting operations depended on the type of diamonds involved. South African cutters mainly cut high value diamonds (Categories 1 and 2). However, very few industrial diamonds were cut (42 550 in carats and 0.3% in value).

The question was by how much, and how fast could local cutting capacity be increased. The SDT would have the authority to purchase up to 10% of run-of-mine production for local cutting which was potentially 1.678 million in carats, and 1.082 million in value. In the short term, the Levy would act solely as a backstop to this increased level of South African production caused by the SDT. The combined impact of both the SDT and the Levy must be carefully considered. The objective was to ensure that local cutting capacity steadily increased without causing local market saturation that undermined diamond values which would trigger job losses in local production.

The Bill was prepared through broad consultation involving private industry and inter-Governmental co-operation between the Treasury, the Department of Minerals and Energy (DME), the State Diamond Board, the South African Police Service and the South African Revenue Service. All of the key diamond producers, dealers and cutters were also part of the consultation process.

Detailed Response to submissions
Prof Engel said that COSATU and the National Union of Mineworkers (NUM) had asked if the exclusion of synthetic diamonds from the definition of “rough diamond” created opportunities for evasion by exporters by exporting natural diamonds mislabelled as synthetic for purposes of evading the levy. His answer was “perhaps.” The levy only applies to natural diamonds because only these diamonds represented the economic loss of a limited, irreplaceable resource. Synthetic diamonds were not subject to the levy because they were readily reproducible. The Diamonds Act similarly ignored synthetic diamonds as an object of regulation.

What had to be considered were the avoidance aspects of synthetic diamonds versus the potential to create jobs through local manufacturing? Admittedly, distinguishing real diamonds from synthetic diamonds was becoming increasingly difficult, especially in respect of natural diamonds enhanced by the synthetic process. If action were to be taken, regulatory oversight would be required for synthetic diamonds in addition to the proposed extension of the levy.

The Diamond Council of South Africa (DCSA) asked if the 5% levy would not have the effect of actually encouraging smuggling. Prof Engel replied saying “no.” Through broad consultation, Treasury and the DME had determined that the 5% rate was high enough to encourage local beneficiation and low enough to discourage smuggling. Anecdotal evidence suggested that the actual cost of smuggling probably ranged between 2.5% to 3.5%. Whether a legitimate diamond holder would smuggle diamonds solely to evade the levy for a 1.5% to 2.5% spread was questionable.

Another question was whether the exemptions under section 6 and 7 of the Bill applied on a temporary or long-term basis. This depended on the situation. The duration of the exemption was an issue for ministerial discretion. For instance, the DME Minister could exempt from the levy a specific diamond consignment or a producer’s exported rough diamonds for 12 months. This timing issue would be clarified in regulations.

De Beers asked if both the credit and exemption relief measures should be allowed to apply contemporaneously. Simultaneous credits and exemptions can give rise to double-dipping. For instance, if an imported rough diamond generated credits and was later exempt when exported in rough form, net credits would result without any beneficiation of diamonds. On the other hand, some sympathy existed if imported diamonds were locally cut, followed by an exempt export of rough diamonds after application of section 6 or 7. At issue was how to distinguish between the two, especially given the difficulty of tracing diamonds.

Trans Hex had asked if producers that complied with the Mining Charter could be exempt from the imposition of the levy. Prof Engel said that the fulfilment of Mining Charter requirements had nothing to do with the objective of the Bill. Government had always taken the position that no tax-related incentives should be available for simply meeting Charter requirements.

De Beers and the South African Diamond Producers Organisation (SADPO) asked if rough diamonds won or recovered from a marginal mine could be eligible for exemption under this section. The proposed Royalty Bill already provided relief for marginal mine producers. The concern of this Bill, unlike the Royalty Bill, was not to raise revenue but to encourage beneficiation. The need to encourage local beneficiation existed regardless of whether the diamond was from a highly profitable mine or a marginal mine.

De Beers also asked if rough diamonds that are economically not cuttable in South Africa could be exempt from the levy. The answer was no. The ability of local cutters to beneficiate diamonds was at the heart of the debate. The goal was increase local cutting via the export levy and other means. The automatic omission of rough diamonds from the levy under this line of argument would result in the concession of the local industry to foreign control.

COSATU and NUM asked if the relief measures ran counter to the objective of local beneficiation. The levy was only part of the equation. All levy relief measures were preserved by tight controls both in this Bill and by the recently amended Diamonds Act, with the establishment of an SDT, the requirement that all exported diamonds must be offered at the DEEC, and the cessation of section 59 agreements.

In terms of the import credit, the goal was to encourage the import of rough diamonds so that local cutters could have access to foreign diamonds. The other exemptions were conditional. For instance, producers obtaining export exemption under section 6 had to demonstrate that they promoted local beneficiation through other means.

COSATU and NUM asked if the credit be should be limited to imported rough diamonds that were economically cuttable by South Africans in order to prevent artificial import credits? All foreign diamonds should be encouraged for import, thereby promoting rough diamond availability for local cutters. Of concern was whether non-cuttable diamonds would be overvalued for excess credits. However, this problem could be contained by the use of Government valuations upon import.

The DCSA asked if the credit should not apply to all exporters of rough diamonds (SDT, dealers and cutters) rather than just producers. Prof Engel replied saying “yes.” The credit should serve as a natural incentive to import rough diamonds. Also, the importation of rough diamonds created import/export parity by neutralising the loss of an exported rough diamond. The extension of this rule to cutters and dealers should not create any added anti-avoidance concerns.

COSATU and NUM asked if the credit created the risk that a producer could exploit the measure by merely stockpiling imported rough diamonds purely for the purpose of claiming import credits. This would not happen as the stockpiling of rough diamonds made little economic sense if it was meant to avoid the levy given the economic opportunity costs of letting diamonds sit idle. The days of stockpiling by De Beers to maintain control over the market were over due to their change in the business model. Also, the suspected scheme would merely result in deferral of the levy with the stockpiled diamonds ultimately being subject to the levy upon delayed export.

COSATU and NUM asked if the import credit should take into account more than just value (such as carats, grade and size). Levies (and other Governmental charges) were always based on value and the Diamond Export Levy itself was based solely on value, making it difficult to effective base the credit offset on some other form of criteria.

The DCSA asked if the SDT should be eligible for import credits when acquiring diamonds from abroad. A strong argument could be made that the SDT should be eligible for import credits if the credit was extended to other non-producers. However, the use of import credits to export South African diamonds could raise questions of fairness from producers.

With regard to the Ministerial exemption in terms of section 6 of the Diamond Act, De Beers asked if producers should be allowed to temporarily export rough diamonds for purposes of exhibition or display without being subject to both the imposition of the levy or the DEEC. While some anti-avoidance concerns may be of concern, the Bill would be changed to allow for the temporary export of diamonds under strict conditions where temporary exports should be limited to a 6-month period. The allowable purposes for export would also have to be strictly controlled.

The DCSA asked if this exemption should apply to all exporters of rough diamonds (SDT, dealers and cutters) rather than just producers. The underlying regulatory exemption (under section 74 of the Diamonds Act) was only intended for producers in unique situations. A possible extension could be extended for dealers and cutters if the proposed exemption covered temporary exports.

Trans Hex proposed that producers that offered 100% of their production at the DEEC should be exempt from the levy. Prof Engel replied that the Diamonds Act already required that all rough diamonds intended for export should be subject to the bidding processes of the DEEC. The issue was whether something more was required. For instance, if the local cutting market was saturated, an offering at the DEEC would suffice as long as the diamonds were offered in a meaningful way.

The DCSA asked if this exemption should apply to all exporters of rough diamonds rather than just producers. Too many avoidance concerns existed if this exemption were extended. For instance, producers could find that local dealers acquiring diamonds at the DEEC were simply doing so for export. On the other hand, some sympathy existed for local cutters who beneficiated the bulk of their diamonds, but sought to export a small portion of rough diamonds for better profit yields.

SADPO asked if the relevant rules laid down by the Commissioner in the Tax Acts applied to the time periods and procedures in relation to assessments, objections and appeals, and other administrative matters contemplated in this Bill. The Bill explicitly relies on the bulk of the well-established administrative rules of the Income Tax Act. This reliance was consistent with other revenue measures, such as the Skills Development Levy.

They also asked if a producer had a right to object with a Government diamond valuator in respect of diamond value. The Bill did not include a right of objection if both the producer and the Government diamond valuator disagree about diamond values. This omission would be remedied in the next version of the Bill. Diamond producers should have a right to court access in respect of this key issue.

They asked what the meaning of “market value” was in respect of diamonds. For instance, would international values be taken into account? The definition of value would be clarified in the Regulations. While valuation was always a subjective issue, some fundamental principles could be outlined as starting points. The consideration of international values would be one of those starting points.

COSATU and NUM asked if the DME had to report to Parliament on the impact of this Bill and the amendments to the Diamonds Act. Prof Engel replied that as a general matter, all legislation must be measured in respect of ongoing success. Subsequent monitoring in respect of this Bill was important in order to ensure that Bill did not have unintended consequences in respect of producers.

Discussion
Mr C Kekana (ANC) asked if there was enough will and capacity to increase the number of trained cutters to deal with the increased number of diamonds.

Mr L Silekani, the CEO of the South African Diamond Board, replied that the capacity was there. The number of skilled workers could be doubled very easily in the short-term. In the long-term, this number could be increased to between 8 000 and 10 000. The challenge was always a lack of access to rough diamonds by small enterprises.

Mr Y Bhamjee commented that in the past there were many exemptions but they were not applied fully. Many people benefited from this, and more clarity was needed on this.

Meeting adjourned.