On the 29 March, the Dti released proposed amendments to its Codes of Good Practice on Broad-based Black Economic Empowerment (B-BBEE) for public commentary within a 60-day period. The amendments present somewhat of a mixed bag for South African businesses.
This is according to Soria Hay, head of Corporate Finance at Bravura, an independent investment banking firm specialising in corporate finance and structured solutions with specialist expertise in B-BBEE ownership transactions.
Proposed amendments include, for example, stricter requirements for the enhancement status of small and emerging Black-owned businesses yet a surprising enhancement status for Black-owned generic entities.
There is an innovative new Skills Development indicator which will incentivise businesses to increase their BEE levels while supporting long-term economic growth possibilities.
Unexpectedly, no amendments are proposed for broad-based schemes despite criticism levelled at these by the Dti’s Minister Rob Davies that the majority of them lack in compliance.
Amendments to the enhanced recognition status for small Black-owned businesses
The Dti Codes of Good Practice were previously amended in 2015, with ownership at the core of the Codes. Measurable elements were narrowed down to 5 key areas including ownership, management control, skills development, enterprise and supplier development, and socio-economic development, with stricter compliance requirements. The proposed amendments target ownership and skills development.
Under the previous Codes, Black-owned Qualifying Small Enterprises (QSEs) and Exempted Micro Enterprises (EMEs) could automatically receive enhanced ownership status should they have met certain criteria.
QSEs (businesses with an annual turnover over R10 million but less than R50 million) and EMEs (with an annual turnover less than R10 million) previously qualified as Level 1 BEE status for 100% Black-owned enterprises and Level 2 BEE status for 51% Black-owned enterprises. Certification was based on any one of the following five criteria:
• At least 25% of costs of sales excluding labour costs and depreciation must be procured from local producers or local supplier in SA (for service industry labour cost are included but capped to 15%).
• 50% of jobs created are for Black people provided that the number of Black employees since the immediate prior verified B-BBEE measurement is maintained.
• At least 25% transformation of raw material/beneficiation, which includes local manufacturing, production and/or assembly, and/or packaging.
• At least spend 12 days per annum of productivity deployed in assisting Black EME’s and QSE’s beneficiaries to increase their operation or financial capacity.
• At least 85% of labour costs should be paid to South African employees by service industry entities.
The proposed amendments published last month impose an additional requirement on qualifying for enhanced status: determination of 100% or 51% Black ownership can now only be met through the Flow-Through Principle.
Under the Ownership element of the BEE Scorecard, the Flow-Through Principle traces ownership measurement through the chain of ownership to a natural Black person (and not a Black owned company). The Modified Flow-Through Principle, a later iteration, allows for the participation of non-Black participants at one tier of ownership.
Hay says that the use of the Flow-Through Principle for QSEs and EMEs has for some time been included in the B-BBEE Commission’s non-binding Practice Guide as the flow through principle to use, rather than the Modified Flow-Through Principle. “The Commission was concerned that the Modified Flow-Through Principle could enable the accrual of fictitious value to Black people in BEE ownership transactions. The fact that it will now be a legislative requirement to use the Flow-Through Principle only, mirrors the B-BBEE Commission’s crackdown on perceived fronting. QSEs and EMEs with complex structures would need to scrutinise these carefully to ensure that they adequately meet the Flow-Through Principle to guard against falling foul of the Commission.”
QSEs and EMEs will still be required to provide only an affidavit in order to state their BEE status rather than having to conduct a full verification.
Introduction of enhanced recognition for 51% Black-owned generic enterprises
The Generic Scorecard ownership elements as set out in code 100 will be amended to include an enhancement for 100% and 51% Black-owned generic enterprises to Levels 1 and 2 respectively. A generic enterprise is any company with an annual turnover of at least R50 million.
The amendment states that a generic enterprise which is 100% Black-owned and measured using the Flow-Through Principle only, will qualify for elevation to a “B-BBEE Level One Contributor” having a B-BBEE recognition level of 135%. A generic enterprise which is at least 51% Black-owned and measured using the Flow-Through Principle only, will qualify for elevation to a “B-BBEE Level Two Contributor” having a B-BBEE recognition level of 125%.
To qualify, the generic enterprise must have utilised no other principle or ownership enhancement element in the calculation of its Black ownership. This includes elements such as:
• the Modified Flow-Through Principle;
• the Exclusion Principle;
• a B-BBEE facilitator status;
• private equity funds;
• the exclusion of mandated investments;
• the sale of assets;
• equity instruments and other businesses; and
• ownership after the sale or loss of shares by Black participants (the ‘once empowered, always empowered’ principle).
Due to the enhanced status, these generic enterprises will not need to comply with the priority elements. As well as ownership these include Skills Development and Enterprise and Supplier Development. Black-owned generic entities will only be required to obtain a B-BBEE Verification Certificate verifying the element of Ownership.
Hay believes that the Dti has been overzealous with this proposed amendment. “Although it encourages businesses to embark on more inclusive strategies to push up their Black ownership levels, the long list of exclusions could result in companies devising sophisticated structures as work arounds.”
A new Skills Development indicator
Hay says that an innovative amendment to the Codes is the specific introduction of bursaries and scholarships in the Skills Development code series, using points redirected from learnership and general skills development to a specific focus on bursaries and scholarships.
Weighted with 4 points and a target of 2.5% of a company’spay roll, the bursaries and scholarships indictor will qualify when made to any individual enrolled in an institution registered with the Department of Basic Education or the Department of Higher Education. Importantly, there will no longer be a cap of 15% for ancillary training costs and stipends. Informal training has been raised from 15% to 25% of total skills development spend. The new weighting for Skills Development is 20 points plus 5 bonus points.
There is some clarity lacking in how the capping of ancillary costs would apply to QSEs. Despite this, Hay says that in general, this is an insightful amendment. “It will provide a strong incentive for South African businesses to prioritise the development of bursary and scholarship programmes because this will push up their BEE levels. At the same time, it will provide impetus to President Cyril Ramaphosa’s job creation agenda and the country’s inclusive education objectives.”
Broad-based schemes
Hay says that it is surprising that no amendments have been proposed for broad-based schemes. “B-BBEE Commissioner, Zodwa Ntuli, has been vocal about the perceived fronting that occurs via these schemes. She recently reported to parliament that companies are fronting their employees through trusts, and a subsequent ‘cleansing’ process currently involves as many as 45 companies that face prosecution and criminal investigation.”
Hay posits that the Dti may be adopting a cautious approach to amendments here until a concrete finding of non-compliance emerges from the prosecution of said companies.
Conclusion
There are concerns around status enhancements, and Hay suggests that companies closely review these during the public commentary period.