The Supreme Court of Appeal's recent decision in Assmang (Pty) Ltd v The Commissioner for the South African Revenue Service (Sars), has sent a clear and sobering message to taxpayers. In tax law, substance invariably trumps form. While this principle is not new, its application in the context of diesel refunds highlights the immense peril taxpayers face.

This appeal concerned an entitlement to diesel refunds for fuel levies and the Road Accident Fund levy under the Customs and Excise Act 91 of 1964. The dispute culminated in Sars issuing an amended letter of demand dated 4 July 2014, claiming the repayment of diesel refunds, plus interest and penalties, amounting to a staggering ZAR 39,566,010.40.

To qualify for the diesel refund, Assmang had to prove that (i) it was the purchaser of the eligible fuel; (ii) the fuel was used in its own eligible primary activities; and (iii) its logbook system, the Liquid Automation System (LAS), could document that every litre of fuel was ultimately used in these eligible activities.

In the course of its mining business, Assmang contracted with various mining services companies (contractors) for drilling, loading, and hauling of waste material. Although there were several contractors, the appeal was limited to the claims for diesel refunds related to three.

In the context of services provided by the three contractors, the legislation contemplates that the diesel has to be purchased by the mine (the 'user') and supplied to the contractor without recovery of the cost. This is defined as contracting on a 'dry basis'. The commercial difficulty with a strict dry rate is that the contractor would be unconcerned about its diesel usage as it was not being directly liable for the diesel cost. A 'wet rate', where the contractor supplies both the plant and the diesel is commercially safer for the mine as the contractor pays an agreed all-inclusive rate regardless of the amount of diesel used. Contracting with a wet rate, however, would mean the mine would not be the purchaser and user of the fuel, and thus would not be able to claim a diesel refund.

The contracts between the contractors and Assmang provided for wet and dry quotes. Where the contractors had agreed for the mining services to be provided on a 'wet rate', the cost of the diesel consumed by the contractor for the month would be deducted from the payment certificate or on an Excel spreadsheet. The contractor would then invoice a net amount to Assmang. Where the contract provided for a 'dry rate', in practice, the cost of the diesel would also be deducted on the Excel calculation, and the contractor would similarly issue an invoice to Assmang for the net amount.

Assmang submitted that because the 'wet rate' quoted contains both plant hire and diesel costs, the deduction meant the only thing Assmang truly paid for was the plant hire. Assmang stressed that it purchased the diesel and supplied it to the contractor, and at no time did ownership of the diesel pass. Therefore, it argued, the services were provided on a 'dry basis'.

The contracts further provided for a capped diesel amount where excessive use in a month by the contractor would result in a penalty. Alternatively, a contractor could profit from a better hire rate for being fuel efficient. The contractual penalty was thus an incentive for the contract miners to use fuel efficiently. These clauses which reward fuel efficiency and penalise fuel wastage arguably speak to the overall intention of the parties – that Assmang, not the contractor was responsible for the supply of the fuel. Structuring the agreement in this way (rather than providing all fuel to the contractors with no caveats) is conducive to the economic reality in which the mine operates, where operational costs run high, and a failure to provide contractual parameters around the consumption of fuel could result in financial hardship on the part of the mine.

Notwithstanding the above, the SCA was unconvinced. The court observed that the conversion of wet rates to dry rates was dealt with decisively by Judge Davis in Canyon Resources (Pty) Ltd v The Commissioner for the South African Revenue Service. In that case, the wet rate was supposedly converted to a dry rate by the contractor passing credit notes in favour of the mine for the diesel it had used. Judge Davis found that the credit note was merely a bookkeeping exercise and that the contractor was, in effect, purchasing the fuel.

The SCA found Assmang's method to be analogous. What Assmang did was to calculate on a spreadsheet what each contractor owed it on a monthly basis for fuel. Instead of using a credit note as in Canyon Resources, these calculations were done on a spreadsheet, but the net effect was the same. The court found that the contractors, not Assmang, carried the risk of fuel price fluctuations and usage efficiency. The financial reality was that a wet rate was contracted. The fuel was not supplied for free to the contractor. In fact, the capped system permitted the contract miners to profit from the diesel made available to them by Assmang.

Even more fatal was the critical gap in the evidentiary chain, as Assmang could not prove what the diesel was used for after it was dispensed. The use of fuel for 'eligible purposes' is central to the diesel rebate claim, and users are required to have a meticulous paper trail, tracking each litre of fuel to its eventual use. Assmang contended that the LAS recorded the precise quantity of diesel dispensed, the price, the time and date, and to whom it was dispensed. As each piece of equipment has a unique unit number, Assmang argued that the reasonable assumption is that diesel dispensed into a drill rig was used to perform drilling on the mining site.

The SCA found this was not enough. The LAS enabled tracking only up to the point of supply to the contract miner. There were no logbooks or records after that point to prove the contractors' use of the diesel in qualifying primary activities of Assmang. The court stated:

"The records relate to the dispensing of fuel but no other information is provided on how and for what purpose the relevant vehicles and other equipment was used upon filling up. It is not sufficient to make ‘a reasonable assumption’. Note 6(q) of Part 3 of Schedule 6 of the Act requires specific detail which is essential to ascertain whether the fuel was utilised for an approved activity and the quantification thereof. In the absence thereof

The Assmang judgment underscores a significant conflict between commercial prudence and the rigid requirements of tax legislation. The very mechanisms a mine uses to control costs and incentivise efficiency in its contractors are what disqualify it from claiming the diesel refund. The current system effectively forces taxpayers into a commercially less desirable 'true dry' contract to access the diesel refund, with no regard for the commercial and economic landscape in which these laws operate.

The standard of record-keeping set by the SCA in this decision further creates a very high compliance burden. The judgment results in mines having to adopt a level of oversight and detailed record-keeping over its contractors' operations which may be impractical and further complicate the commercial relationship. In practice, it leaves mines between a rock and a hard place, where excessive oversight over contractors is legislatively required, but doing so may result in retaliation from contractors, and ironically, in fuel wastage.

Perhaps this calls for a more commercial legislative or administrative reform that shifts the focus from the contractual form of the supply of diesel to the verifiable, substantive use of the fuel. If a taxpayer can prove through a robust and integrated electronic system that every litre of diesel was factually used in a qualifying primary activity on its premises, the commercial nature of the contract (wet or dry) should be secondary.

Written by Joon Chong & Nirvasha Singh, Partners at Webber Wentzel