analysisBy Khadija Sharife
Through the exploitation of loopholes in the tax system, under a veil of proprietary confidentiality, the diamond industry is systematically short-changing the citizens of South Africa.
At every step, from mine to ring finger, South Africa's diamond industry is benefitting from royalty and export tax structures riddled with loopholes, short-changing the citizens of one of the world's premier diamond sources of tens of millions of dollars a year in revenue.
In 2011, South Africa produced diamonds whose uncut, or rough, value was $1.73 billion, or 12 percent of global production, according to the most recent government data available. Yet from 2010 to 2011, diamond-producing companies paid South Africa's government just $11 million in mining royalties, according to the latest tax statistics report, produced by the South African Treasury and the South African Revenue Service (SARS).
A 100Reporters investigation of the diamond trade in South Africa has found that companies here pay a royalty rate far lower than that of other African states. Companies can also reduce or cancel out export taxes if they offer locally-mined diamonds to the state for purchase--even if the South African government never buys the gems, often due to formidably high prices.
In an apparent conflict of interest, De Beers Consolidated Mines Ltd., the dominant player until 2010, 'donates' paid staff to the State Diamond Trader (SDT), charged with assessing diamonds offered by De Beers and other companies to the state for purchase. Provided 10 percent of domestic diamonds are offered, these companies may then receive export tax exemptions.
The main beneficiary of a system tilted in the industry's favour is De Beers, the sprawling multinational cartel that accounts for 35 percent of global rough diamond production, mainly from Africa. Until recently, De Beers dominated the South African diamond industry.
In 2011, De Beers accounted for $1.34 billion of South Africa's production, and it remains the country's primary diamond importer and exporter. The only other significant player, Petra Diamonds, with whom De Beers controls 97 percent of the local diamond industry, neither imports nor exports.
From 2005 to 2012, diamond exporters, primarily De Beers, appear to have downplayed the market value of their rough diamond exports by $3 billion, according to an analysis* of declarations in corporate filings under the Kimberley Process (KP) Certification Scheme, the rough diamond tracking system used to keep conflict gems off the world market. The same undervalued gems were then sold at market prices around the world.
Lynette Gould, head of media relations for De Beers, declined to comment on the findings, or to address questions about the valuation, sales and import and export volumes of diamonds from South Africa. In an email, Gould wrote that the 'values and volumes of De Beers production is . . . proprietary'.
A BROKEN SYSTEM
To ensure that the government gets its share of revenues from the extraction of the country's diamonds, the South African government relies on a national agency, the Government Diamond Valuator (GDV), charged with determining the quality, and thus worth, of diamonds. But highly-placed sources in the diamond industry said that the GDV seldom issues independent assessments of the country's diamonds, opting instead to echo the valuations that De Beers puts forth in the company's price lists.
'The gap between the industry's presence in South Africa and its contributions to the country's coffers has its roots in how diamonds are valued in South Africa and who controls the process', said Claude Nobels, a former government diamond valuator.
'We had a plan to create a system, under the Nelson Mandela government, that would generate fair revenues for all parties involved', Nobels told 100Reporters. But to date, 'the diamond mining and trading industry has not truly benefitted South Africans. The loss to the state is billions of dollars', he said.
Calculating diamond revenue losses to the South African budget is complicated by a dearth of data, particularly concerning how diamonds are valued. Valuation, in turn, drives royalties and export taxes, as well various forms of tax exemptions. For example, companies can receive credits for importing diamonds to be cut and polished in South Africa, which in turn may reduce or even cancel export taxes.
Until 2012, government reports on diamonds generally showed blank spaces rather than revealing value and volume of local and export sales. Reports for other commodities such as gold and platinum, however, teemed with data. Martin Kohler, Deputy Director of Statistics for the Department of Mineral Resources (DMR), said the government withholds diamond data to protect big producers, the largest among them De Beers, unless the companies authorise the release of the information.
'De Beers, who had a predominant share of the diamond market in the past, authorised us to publish the aggregated production data only (but not sales data)', Kohler said in an email. According to Kohler, the recent sale of De Beers's mines to other owners meant that, 'the predominant position of De Beers has been diluted, and we are able to publish sales data with effect from January 2013 (but not before that date)'.
Kohler said such information was strictly confidential 'where one company has more than 75 percent market share, or where there are less than three producers of a mineral, unless all such producers have granted permission to publish the data'.
In November 2013, the company moved its sorting, valuing, and selling centre to Gaborone, Botswana from London. According to a knowledgeable source, the South African government pressured De Beers to shift sales activities to Africa, specifically South Africa. De Beers caved in to the pressure but preferred Botswana as a partner. The company signed a ten-year agreement relocating global production sales to Gabarone. South Africa, wary of being seen as a domineering neighbour, acquiesced, the source said.
'BRICKS IN THE WALL'
To understand South Africa's diamond industry and the system of taxation that now governs it, it helps to look to the industry's origins, which are synonymous with De Beers. Historically, the apartheid regime cultivated close relations with South Africa's diamond industry. John Vorster, an apartheid-era prime minister, once described corporate support from De Beers and other large companies as 'bricks in the walls of the regime's continued existence'.
De Beers was formed in 1888 by colonialist Cecil Rhodes and acquired by Ernest Oppenheimer's Anglo-American in the 1920s. By 1987, Anglo-American PLC controlled over 60 percent of the wealth listed on the Johannesburg Stock Exchange, through an estimated 80 listed entities.
Despite its dominant role in the global diamond trade, De Beers has a history of running afoul of the law in important markets. In 2008, the European Union forced De Beers to end decades of price fixing with Russia's Alrosa, another dominant diamond producer. At the time, De Beers controlled 50 percent of global rough diamond production.
Meanwhile, for more than 60 years, De Beers was banned from directly trading in the United States because of price fixing, despite the fact that the US accounts for half the world's diamond jewellery sales. In 2012, a settlement of $295 million was reached between the US government and Anglo-American, which currently owns 85 percent of De Beers.
In South Africa, De Beers functioned in a protected niche even after the end of apartheid. For instance, it paid no export taxes on diamonds until 2007. According to parliamentary documents, De Beers extracted the advantage in a twist worthy of a B-movie: for years, it held the government at bay by citing a smudged, unsigned document generated under the apartheid regime, just prior to the first democratic elections, that allegedly provided the company with an export tax exemption for 13 years.
Further, extractive industries in South Africa, including diamonds, did not pay royalties until 2010, with the adoption of the Mineral and Petroleum Resource Royalty Act.
According to the African Development Bank, South Africa was the 'only major mining country on the continent without a royalty on mining' until the act's passage. To address the gaps in the system, the act mandated that companies pay royalties at rates ranging from 0.5 to 7 percent. Royalties, calculated against criteria such as gross sales and the company's net operating mining profits, are compensation to the nation for the permanent loss of non-renewable resources. Yet in crafting and applying the royalty rate, the diamond industry, rather than the South African government, has had the upper hand.
Take the rate itself, for example. Botswana and Namibia, major diamond-producing states, have royalty rates fixed at 10 percent. Yet because of its sliding royalty scale, South Africa averages an annual royalty rate of about 2 percent, which netted the government a total of $57.5 million from 2010 to 2012.
'The revenues from diamond royalties are very low - just 1.1 percent of sales for 2011', said Mark Curtis, a U.K.-based development finance consultant for global non-governmental organizations. 'If diamond companies paid the mid-royalty range of 3.5 percent, royalties would have amounted to $24.8 million more than the state actually received', he said.
The explanatory draft of the act originally pegged royalties at 10 percent of the value of diamonds at the 'mine-gate' and at 8 percent after processing. But the government reduced the rate following pressure from the diamond industry. Created around a complex profit-based system, royalties are considered a 'cost' by business, and depend on the value of minerals sold.
Though diamonds are valued by their clarity, the same cannot be said of South Africa's diamond industry or its largest player, De Beers.
Unlike other South Africa diamond companies, De Beers does not allow the government to publish key information about the value of the diamonds it extracts. As a result, the state and the public cannot verify the fairness of the royalty De Beers ultimately pays.
In addition, to determine the value of a diamond, DeBeers and other companies use complex and closely-held pricing formulas that they do not permit the government to review. De Beers's pricing formula counts 12,000 categories.
According to one European valuator who worked closely with De Beers, the company's price book was not a single listing, but rather an 'elaborate system used to value diamonds for different purposes. By manipulating various categories with price points, they can increase or decrease the value of diamonds . . . These figures have nothing to do with fair market prices'.
Speaking on behalf of De Beers, Gould said, 'I'm afraid the information on pricing is proprietary and therefore confidential'.
Other companies also maintain proprietary pricing systems. In an email, the Government Diamond Valuator confirmed that it did not 'have access to the pricing policies of other diamond companies', but asserted that the Government Diamond Valuator assessed 'each parcel imported or exported to determine a value deemed to be fair market value'.
However, highly placed sources in the diamond industry, including a former government valuator, said the GDV relies on random spot checks, and verifies only the size of diamonds, not their quality. One official close to the Department of Minerals and Resources confirmed that mispricing of diamonds was easily possible due to what was considered the 'very subjective nature of pricing'.
In 2007, the South African government established an export tax of 5 percent on diamonds. But from 2009 to 2013, according to the latest tax statistics report, it yielded only $21.9 million to the national purse.
The state has pulled in little revenue due to exemptions built into the 2007 Diamond Export Levy Act. The exemptions were created ostensibly to encourage mining companies to make quality diamonds available to domestic industry, before shipping abroad. Companies that offer rough diamonds to local buyers for cutting and polishing, or beneficiation, through a government mechanism called the State Diamond Trader system, can obtain breaks on export taxes.
Large companies like De Beers can get the exemption if they sell 40 percent of their South African rough diamonds to buyers in South Africa, and offer 10 percent to the State Diamond Trader.
The State Diamond Trader, however, often cannot afford to purchase rough diamonds because the price is too high. The trader's annual reports disclose that purchasing diamonds for the local beneficiation industry was difficult due to, 'unsustainable rises in prices at producer level' and 'limited rough supply'.
De Beers further provides fully-paid staff to the trader to conduct diamond valuation, according to reports of the State Diamond Trader, which describe the presence of De Beers staff at the government agency as a 'donation'.
In an email, De Beers said, 'the arrangement between De Beers and the SDT is subject to confidentiality and information relating to this arrangement cannot be provided without the SDT's consent'.
Futhi Zikalala, CEO of the State Diamond Trader, told 100Reporters that each parcel was individually valued. 'The process is legislated. We do valuations for the 10 percent offered to the SDT. It takes four or five days at a time, with 10 cycles a year.'
Asked whether she would comment on the apparent conflict of interest in the State Diamond Trader's long-standing use of De Beers's donated staff, she responded, 'Actually, no. I do not understand why you are asking that question.'
A source close to the Department of Mineral Resources said that use of De Beers's staff was for practical reasons: the SDT was under-resourced and in need of diamond experts.
In October 2013, the Minister of Minerals Resources, Susan Shabangu, said that the State Diamond Trader system had failed and would require an overhaul.
Companies can also win export tax exemption if they import rough diamonds for local beneficiation. The higher the value of the imported gems, the greater the import credits a company can generate to ultimately offset their export taxes, creating a system vulnerable to price manipulation.
But the arrangement appears to have done little to nurture domestic cutting and polishing industry. According to figures cited in a South African parliamentary report (2013), South Africa currently hosts just 300 polishers, down from 3,000 in 2008, when 140,000 carats, maximum, were locally beneficiated (see sidebar).
The report cited diamond industry officials who stated that the local cutting and polishing industry was 'in distress'. While the 2008 recession had impacted the global diamond industry everywhere, beneficiation industries elsewhere-including India, China and neighbouring Botswana-bounced back, even expanding training facilities as well as cutting and polishing labour. In 2013, African Romance, a medium-sized state-backed beneficiation diamond company, was liquidated. Reasons cited included the absence of consistent quality diamond supplies.
Until 2013, De Beers exported gems from its mines in Namibia, Botswana and South Africa to London for valuation and then imported them into South Africa for sale to select buyers called sightholders. The sales values declared to sightholders are confidential, the company said.
South Africa boasts curiously high import prices for diamonds. While higher import values are said to correspond to the quality of select rough diamonds, South Africa's import price appears significantly more than the price of diamonds imported to other countries such as Israel, arguably one of the world's leading gem quality cutting and polishing centres.
For example, South Africa's average import prices, at $544 in 2009 and $773 in 2010, were significantly higher than Israel's at $165 and $156, respectively, according to certificates filed under the Kimberley Process.
In 2007, South Africa's import price hit a staggering $1,706 per carat with a total import value of $2.1 billion. Yet only $670 million would be sold to De Beers's pre-approved South Africa-based purchasers, known as Diamond Trading Company sightholders. Though these figures were published in a De Beers report, when asked for annual DTC local sales, Gould responded that the information was proprietary.
According to a diamond specialist previously employed by the South African government, who spoke on condition of anonymity, import and exported diamonds were often 'mispriced' by an average of 20 percent or more.
The other countries with similarly high import averages were those where De Beers also held a large presence, such as Namibia.
'South Africa's import figures are improbable', said a European Government Diamond Valuator. 'These prices are exceptionally high as an average price.'
Most imported diamonds appear to be re-exported uncut and unpolished. While imports make up relatively small volume, or carats, they drastically increase the value of rough diamond exports. Subtracting the values and volume of imported diamonds shown on South Africa's KP certificates from corresponding exports, the actual price per carat of rough diamonds being exported for the first time falls dramatically.
When asked about the anomalies in reported trade figures for diamonds under the Kimberley Process in South Africa, where De Beers is a dominant player, Gould responded, 'The primary purpose of the KP process (or the issuing of the certificates at least) is for Governments to certify the origin of diamonds, not to keep track of the volume and value of diamonds imported or exported; that is the function of the relevant Regulator and GDV'.
THE GOVERNMENT DIAMOND VALUATOR
While the Government Diamond Valuator is responsible for independently appraising gems and for monitoring the trade in diamonds, it remains questionable whether the South African valuator is able to provide an independent assessment. Such assessments are critical for the South African government, and public, to secure royalties and export taxes that reflect the true worth of the country's diamond trade.
Former De Beers director Bertie Lincoln, in a rare quote under oath to a South African court 17 years ago, described the Government Diamond Valuator as 'an auditor. The value is the price which is in the [De Beers] Price Book. So the government valuator has got no input into the value of a diamond'.
The Government Diamond Valuator did not respond to follow-up questions about the source of information informing the GDV's Price Book, the size of the agency or office, the amount of time available for valuation of imported and exported diamonds, and other questions.
'The significant differences between the dollar-per-carat for South African rough diamond imports and exports suggest possible price manipulation for the purposes of aggressive tax avoidance', said public finance specialist, Len Verwey. Companies like De Beers, he stated, may indeed have a plausible explanation, in which case, 'diamond companies as well as the Government Diamond Valuator should provide more transparent reporting to society on the factors that determine such valuations'.
Verwey stated that the Government Diamond Valuator's credibility 'in ensuring fair market value for diamond transactions is essential to its success'.
But critics of South Africa's current royalty and taxation system are sceptical that the government will impose greater transparency on De Beers and other major producers.
'Inevitably', stated one former De Beers employee, 'the company will stonewall and the GDV will run a mile' from transparency and accountability in the diamond valuation system.
He added, 'No one will want this brought into the open.'
*The information on transfer pricing manipulation of diamonds comes from a report by Sharife and Sarah Bracking, published by the Leverhulme Center for the Study of Value, University of Manchester, and supported by a grant from Oxfam Great Britain.
THE VIEWS OF THE ABOVE ARTICLE ARE THOSE OF THE AUTHOR/S AND DO NOT NECESSARILY REFLECT THE VIEWS OF THE PAMBAZUKA NEWS EDITORIAL TEAM