BEE Partner, South Africa Economy Watch

Tax law is dynamic. Any tax commentary could be outdated After the final Codes have been approved as law, time will reveal inconsistencies with the application of BEE and the Tax Act.

Private parties will probably make submissions to National Treasury on amending tax law to accommodate BEE. The point is that it is too early to give conclusive advice on BEE and tax. Further, the nature of tax advice varies according to the base of the company, making it a difficult topic to discuss conclusively in this format.

The text aims to point out some of the areas that need consideration before implementation. These issues should be discussed at length with tax practitioners. The source of some of the following information is from a SA Institute of Chartered Accountants submission to National Treasury, which was prepared by Jackie Arendse.

Ownership, the Purchase and Sale OF Ownership Interest

The Tax Act only allows a taxpayer to deduct finance costs where they are incurred “carrying on a trade” as defined by the Tax Act. Most BEE parties will use finance to buy shares and the finance costs originating from the loan may not be deductible against income depending on the nature of the investment.

Employee share schemes are often facilitated through financial assistance or a straight donation, both of which could be deemed fringe benefits. If shares allocated through an employee share scheme are fringe benefits they could be taxed in the hands of the employee, giving rise to a cash-flow problem.

Where a BEE deal is facilitated through using options and the BEE party exercises the option to purchase the shares for a profit, the BEE party realises a profit that may be taxable. In exercising the option, profits are usually used to finance the cost of the shares, leaving the BEE party with cash-flow problems when paying any tax originating on these profits.

Transferring ownership may incur capital gains tax (CGT) in the seller’s hands. Where the seller facilitates the financing of the share purchase for the BEE party and derives no cash inflow from the sale, the capital gains tax payable may result in a cash-flow problem for the seller.

The sale of shares or assets may trigger recoupment on capital allowances for the measured entity and stamp duty for the BEE party.

Where the measured entity sells its operations to a New Co, in which the BEE party also has shares, the measured entity is selling to a related party because New Co has predominantly the same shareholders as the Existing Co. An existing business is not allowed to claim capital allowances on the market value of the assets purchased from a related party (Section 11(e)(viii) and 12C(4)).

Sweat equity is where a BEE party earns shares in the organisation through services rendered. The BEE party is rewarded with shares instead of a salary. The expenses incurred in the production of the shares are, potentially, not deductible by the BEE party. From a capital gains tax aspect, there is no base cost on the value of the shares, resulting in a higher gain on the sale of the shares and disproportionate CGT. The income in the form of shares may be taxable as income tax on issue, creating cash-flow challenges for the BEE party.

A BEE party exposed to multiple deals may be deemed a share dealer. Share dealers’ profits are income taxed as opposed to capital gains taxed. Incorrect structuring may result in higher taxes for the BEE party.

Enterprise and Social Economic Dvelopment

Contributions towards enterprise development are not necessarily in the production of income and therefore the contributions are not always tax effective.

Socio-economic development contributions not made to a registered charity are potentially not deductible as they are not considered to be in the production of income.

Section 18A allows a deduction for contributions to public benefit organisations (PBOs). The organisation must be a registered PBO, not only a charity to qualify for the deduction. The organisation must have met requirements prescribed by SARS to qualify as a PBO.

In the 2003 South African case Warner Lambert SA (Pty) Ltd v CSARS, a Supreme Court of Appeal’s ruling may increase the probability for deduction of BEE expenditure for socio-economic and enterprise development. A brief outline of the case follows:

The South African company of American multinational Warner- Lambert claimed corporate social investment (CSI) as deductible expenditure under section 11A. SARS rejected the claim. The Supreme Court of Appeals ruled in favour of the claim on the following grounds. In the USA, under the Sullivan Code, companies were legally obligated to make certain contributions to CSI. If those contributions were not made the company directors were penalised and that company would potentially lose business. Accordingly, the court interpreted the South African contribution as a necessary expense in the production of income, which makes it deductable under section 11A.

While this has not yet been tested in court in a BEE context, fortune favours the brave. Someone may wish to argue that enterprise development and socio-economic development contributions are now in the production of income because BEE contributions are a business necessity. Perhaps SARS will issue an interpretation on this matter before it requires a court trial.

From the Black party’s angle, receipt of goods, capital or otherwise, may qualify and accordingly be classified as income in that person’s hands. The unintended result is taxable income, leaving the Black party with cash-flow problems.

In his 2007 budget speech, Minister of Finance Trevor Manuel mentioned that the tax law would be amended to take BEE into account. It seems likely that many of the issues raised above will be addressed by these amendments.

This list is not exhaustive and it should not be relied on for tax purposes. The intention is to raise awareness of tax issues that stakeholders must consider and take full advice on before engaging in the deal. Structure is critical to tax planning and the interested party must do it before signing the deal. Reactive tax strategies are not effective.

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