The Exclusion Principle

In calculating Black ownership under the Broad-Based Black Economic Empowerment (B-BBEE) Codes, the general rule is to trace ownership through all layers of a structure until you reach natural persons. However, the Codes recognize that certain types of ownership, held by entities that are not realistically expected to be transformed, can distort the true picture of Black economic participation. To address this, the Exclusion Principle allows for specific types of ownership to be excluded from the calculation, providing a more accurate reflection of effective Black ownership. This article explains the Exclusion Principle, the entities and investments it covers, and the strategic implications of applying it.

The Core Idea: Removing Non-Transformable Ownership

The fundamental purpose of the Exclusion Principle is to prevent the dilution of Black ownership by entities or investments that are, by their nature, not subject to B-BBEE transformation. For example, it wouldn’t be logical to expect a pension fund, which holds assets on behalf of a diverse group of beneficiaries (both Black and non-Black), to have a specific level of Black ownership. Including such entities in the ownership calculation would artificially lower the percentage of Black ownership in the measured entity.

Entities and Investments Subject to Exclusion:

The Codes allow for the exclusion of several specific types of ownership:

1. Organs of State and Public Entities: Ownership held by South African government departments, municipalities, state-owned enterprises (SOEs), and other public entities is excluded. This is because these entities are considered to be owned by the state on behalf of all citizens, and their ownership structure is not subject to B-BBEE transformation.
2. Mandated Investments: This is a broad category encompassing investments held by various institutional investors, provided that the investment is made on behalf of a mandate from a natural person or organ of state. Key examples include:
   • Pension Funds: Investments made by South African pension funds (as defined in the Pension Funds Act).
   • Medical Schemes: Investments made by South African medical schemes (as defined in the Medical Schemes Act) out of members’ funds.
   • Collective Investment Schemes (Unit Trusts): Investments made by South African collective investment schemes (as defined in the Collective Investments Schemes Control Act).
   • Long-Term Insurers: Investments made by South African long-term insurers (as defined in the Long-Term Insurance Act) out of policyholder funds (not the insurer’s own reserves).
   • Friendly Societies: Investments made by friendly societies.
   • Banks: Investments made by South African banks (as defined in the Banks Act) out of depositor funds (not the bank’s own reserves). The depositor portion is determined by apportioning the investment in the ratio that depositor funds bear to own reserves.
   • Mutual Banks Investments made by South African mutual banks out of depositor funds.
   Important Note: The exclusion for mandated investments is limited to a maximum of 40% of the total ownership of the measured entity. This prevents excessive exclusion that could obscure genuine Black ownership.
3. B-BBEE Facilitators: The Minister of Trade, Industry and Competition can designate certain Organs of State or Public Entities as “B-BBEE Facilitators.” These entities are treated as having:
   • 100% Black ownership
   • 40% Black women ownership
   • 20% Black designated group ownership
   • No acquisition debts
   • No third-party rights
   This effectively boosts the Black ownership score of a company that has a B-BBEE Facilitator in its ownership structure. This is an exception to the general exclusion of Organs of State.
4. Section 21 Companies and Companies Limited by Guarantee (Optional Exclusion): A measured entity can choose to exclude up to 40% of the ownership held by Section 21 companies (non-profit companies) or companies limited by guarantee. This is because these entities are often used for charitable or community purposes and may not have a readily identifiable ownership structure that aligns with B-BBEE principles. However, if a Section 21 company houses a Broad-Based Ownership Scheme or Employee Ownership Scheme, the rules governing those schemes apply, not this exclusion.
5. Foreign entities: Where a multinational has sold a portion of its South African operations, the value of the unsold portion of the business can be excluded.

The Mechanics of Exclusion:

When applying the Exclusion Principle, the excluded ownership is effectively removed from both the numerator (Black ownership) and the denominator (total ownership) of the ownership calculation. This ensures that the percentage of Black ownership is calculated only on the remaining, measurable portion of the ownership.

Example:

• Company A (the measured entity) has the following ownership:
  • Black Individuals: 20%
  • Pension Fund (Mandated Investment): 30%
  • Non-Black Individuals: 50%
• Applying the Exclusion Principle (assuming the 40% limit is not exceeded):
  • We exclude the 30% held by the pension fund.
  • Remaining Ownership: 20% (Black) + 50% (Non-Black) = 70%
  • Effective Black Ownership: 20% / 70% = 28.57%

Without the exclusion, Black ownership would have been calculated as 20% / 100% = 20%. The exclusion increases the recognized Black ownership.

Strategic Implications and Limitations:

• Accuracy: The Exclusion Principle provides a more accurate reflection of effective Black ownership by removing non-transformable entities.
• Maximizing Points: Applying the exclusion can significantly increase the calculated percentage of Black ownership, leading to higher Ownership points.
• 40% Limit: The 40% limit on excluding mandated investments prevents abuse of the principle.
• Modified Flow-Through Incompatibility: A company that applies the Exclusion Principle cannot also use the Modified Flow-Through Principle. This is a crucial trade-off. The Modified Flow-Through Principle (which allows treating a >51% Black-owned company as 100% Black-owned) can often be more beneficial than the Exclusion Principle, so companies must carefully consider which approach is more advantageous.
• Optional Exclusion for Section 21 Companies: Companies must decide strategically whether to exclude Section 21 companies/companies limited by guarantee. If these non-profits have a significant level of Black participation, including them (and potentially obtaining a competent person’s report to quantify that participation) might be more beneficial than excluding them.
• Due Diligence: It’s important to verify that an entity truly qualifies for exclusion (e.g., confirming that a pension fund meets the definition of a mandated investment).

Conclusion:

The Exclusion Principle is a vital tool in the B-BBEE Ownership calculation, ensuring that the measurement of Black ownership is not distorted by entities or investments that are not subject to transformation. Understanding which entities and investments qualify for exclusion, the limitations (like the 40% cap and the incompatibility with Modified Flow-Through), and the strategic implications is crucial for accurate B-BBEE scoring and effective ownership structuring. Companies should carefully analyze their ownership structures and seek expert advice to determine whether and how to apply the Exclusion Principle to maximize their B-BBEE Ownership points while maintaining compliance.