Update: Mongolia convicts SouthGobi trio of tax evasion

Three former employees of SouthGobi Resources (TSX: SGQ) including a U.S. citizen are slated to spend the next five years behind bars after a Mongolian court found them guilty of tax evasion.

A panel of appointed judges from the Second District Criminal Court of Justice sentenced American Justin Kapla and two Philippine nationals, Hilarion Cajucom Jr. and Cristobal David, to prison sentences ranging from five years and six months to five years and ten months. The court also fined SouthGobi US$18 million as a “civil defendant” in the case. 

The decision — reached after a three-day trial that ended on Jan. 30 — is certain to make mining executives think long and hard about whether to invest in future mining projects in the country. 

The three employees have been detained and prevented from leaving the country since October 2012. Kapla had been president of SouthGobi Sands LLC, SouthGobi Resource’s Mongolian operating subsidiary, and Cajucom and David were the subsidiary’s general managers of finance.  

SouthGobi Resources, which was not a party to the criminal proceedings and was not allowed to call witnesses in its own defense, says it has not committed tax evasion and is waiting for written reasons for the judgment. In the meantime, president and chief executive Enkh-Amgalan Sengee called the conclusions “erroneous,” said there was “a complete lack of evidence to support this harsh verdict,” and added that “we fully support our former employees and will lodge an immediate appeal.”

Sengee did not provide a comment before press-time, but Alexander Molyneux, a former president and CEO of the company between 2009 and 2012, calls the case a “farce” and says it is payback for attempting to sell the company to a Chinese state-owned company. SouthGobi entered into an agreement in April 2012 to sell up to 60% of its shares to Aluminum Corporation of China (CHALCO). The deal was  terminated later the same year on Sept. 3, nine days before Molyneux left the company.

“When we announced the proposed sale of the company to Chinalco in early 2012, we were approached by many senior Mongolians, right up to members of the National Security Council, who told us they would punish us for the move to try to sell to a Chinese state company,” Molyneux writes in an email to The Northern Miner. “They told us they would run a campaign against the company that would result in it being transferred back into Mongolian hands. We complained all the way to the President’s office and were denied any assistance . . . It seems to me like the Mongolians are succeeding in their systematic program. You can see the case is a farce . . . the judgment is based on testimony from so-called ‘experts’ that have missed pieces of evidence or simply misinterpreted items. Third-world countries are notorious for changing the rules but what’s scary in this case is they have no qualms impacting the lives of honest, hardworking family men.”

Molyneux went on to say that he places the blame squarely on the president of Mongolia, Tsakhiagiin Elbegdorj, who was re-elected to a second term in June 2013. “The case is so high profile there, it could not have escaped his attention,” Molyneux argues. “Furthermore, he is a Harvard law graduate, so one cannot argue he isn’t sophisticated enough to understand what’s going on.”

Bertrand Troiano, SouthGobi’s current chief financial officer, however, points out that Molyneux does not speak for the company. “This is a gross miscarriage of justice for our former colleagues and our company, Molyneux’s choice of words is poor, though,” he writes in an email to The Northern Miner. “There is no association between him and our company and he does not speak for us.”

In a Feb. 2 press release announcing the verdict and its plans to appeal, SouthGobi warned that if the verdict is not reversed, the company is “likely to be unable to meet its obligations, which could result in voluntary or involuntary insolvency proceedings.” As of Jan. 30, SouthGobi had US$3.3 million in cash and US$1.2 million in restricted cash held in Mongolia.

SouthGobi argues that the four separate reports issued by experts appointed by the relevant authorities in Mongolia (one report after each series of investigations) “have all been different and contradicted one another in terms of content and final sums of purported tax evasion.”

Specifically, the amount in the latest report of Dec. 2014 (MNT35.3 billion), is 85% lower than the amount alleged in the second experts’ report of Dec. 2012 (MNT234 billion), and 59% lower than the amount alleged in the third experts’ report of Jan. 2014 (MNT84.9 billion), SouthGobi explained in a lengthy press release on Feb. 2.

The company notes that the inconsistencies were recognized by the same panel of judges in August 2014, who at that point viewed the prosecutor’s accusations as lacking evidence and ordered the case be returned for re-investigation.

“The company believes that the latest report, like the previous reports, fails to provide any evidence supporting the case against SGS and its former employees,” SouthGobi stated.

SouthGobi argues that it prepared its financial statements in compliance with International Financial Reporting Standards and lodged all its tax returns as required under the country’s tax law.

For the period under investigation (between 2007 and 2011), SouthGobi says it earned revenues of MNT456.8 billion (US$349.7 million) from coal sales and paid MNT103.1 billion (US$79.7 million) in taxes in Mongolia. The amount of purported tax evasion, when added to the taxes already paid by the company, would mean SouthGobi’s tax rate as a percentage of revenue (not profit) would be 74%, 41% and 30% respectively, SouthGobi said. This would be “grossly above the amounts prescribed to be paid on taxable income under Mongolian law.”

The company says it hired one of the largest and most reputable international auditing firms to conduct an independent assessment of the allegation, which SouthGobi says concluded that the experts’ reports had no basis and were the result of incomplete reviews and an erroneous interpretation of the company’s financial statements. According to SouthGobi, the auditing firm concluded that the experts failed to consider all relevant information and documents provided by the company during the three-year investigation.

SouthGobi points out that on Jan. 29, the prosecutor recommended that any sentence should exclude imprisonment, but then reversed that stance, and on Jan. 30 recommended that the sentence include jail time.

The company’s Ovoot Tolgoi coal mine is 40 km from the China-Mongolia border and started production in April 2008. On Nov. 10, 2014, the company reported that production of raw coal in the third quarter fell to 0.17 million tonnes, down from 0.55 million tonnes in the second quarter. The decrease was due to the company’s decision in June 2014 to cut production and place about half of its workforce on furlough in response to poor market conditions.

Turquoise Hill Resources (TSX: TRQ; NYSE: TRQ) owns a 47.9% stake in SouthGobi Resources and Rio Tinto (NYSE: RTP; LSE: RIO) owns 51% of Turquoise Hill Resources.

On the court ruling news, SouthGobi shares dropped 9¢ on minimal trading volume to close Feb. 3 at 55¢, within a 52-week range of 41¢ to 95¢. 

With 219 million shares outstanding, its market capitalization
is $117 million.