Governance and getting the deal done

Broad-Based Black Economic Empowerment (B-BBEE) ownership deals are a cornerstone of South Africa’s transformation agenda. While these deals can unlock significant benefits for businesses, including improved B-BBEE scorecards, access to government tenders, and enhanced market access, they also introduce a complex web of governance requirements. Failure to adhere to these requirements can lead to significant risks, including loss of B-BBEE recognition, legal challenges, and reputational damage.

This article dissects the key governance aspects of B-BBEE ownership deals, considering company law, income tax implications, and the practical realities for small, medium, and large businesses. We also cover multinational companies below.

Company Law Requirements: The Foundation of Governance

The Companies Act, 2008 (Act 71 of 2008) forms the bedrock of corporate governance in South Africa. When structuring a B-BBEE ownership deal, several sections of the Act become particularly relevant:

1. Memorandum of Incorporation (MOI): The MOI is the primary governance document for a company. It outlines the company’s purpose, powers, and the rights and responsibilities of shareholders and directors. A well-drafted MOI is crucial in a B-BBEE deal. It should:
   • Define Black Ownership: Clearly define “black people” as per the B-BBEE Codes of Good Practice. This is essential to avoid ambiguity and potential disputes.
   • Shareholder Rights: Specify the rights of black shareholders, including voting rights, dividend rights, and rights to appoint directors. These rights must be carefully balanced to ensure that black shareholders have meaningful influence without unduly restricting the rights of existing shareholders.
   • Transfer Restrictions: Implement restrictions on the transfer of shares to ensure that the black ownership remains stable and compliant with B-BBEE requirements. These restrictions may include pre-emptive rights for the company or other shareholders, or a requirement for approval by the board of directors.
   • Board Representation: Stipulate the number of black directors required on the board and the process for their appointment. This ensures that black shareholders have a voice in the company’s management and strategic direction.
   • Exit Mechanisms: Outline clear exit mechanisms for black shareholders, such as put options, call options, or rights of first refusal. This provides certainty and protects the interests of all parties.
2. Shareholders’ Agreements: A shareholders’ agreement is a private agreement between the shareholders of a company that supplements the MOI. It can provide more detailed governance provisions tailored to the specific B-BBEE deal. Key aspects to address in a shareholders’ agreement include:
   • Decision-Making Processes: Define the decision-making processes for key matters, such as strategic plans, budgets, and significant transactions. This should specify the voting thresholds required for different types of decisions and the circumstances in which the black shareholders’ consent is required.
   • Information Rights: Grant black shareholders access to company information, including financial statements, board minutes, and management reports. This is crucial for them to exercise their rights effectively.
   • Dispute Resolution: Establish a mechanism for resolving disputes between shareholders, such as mediation or arbitration. This can help to avoid costly and time-consuming litigation.
   • Deadlock Provisions: Address potential deadlocks in decision-making, for example, if the board is evenly split. This may involve the appointment of a tie-breaker or a mechanism for one party to buy out the other.
3. Board of Directors: The board of directors has a fiduciary duty to act in the best interests of the company. In a B-BBEE ownership deal, the board must ensure that the company complies with all applicable laws and regulations, including the B-BBEE Codes. This includes:
   • Oversight of the B-BBEE Deal: The board must actively oversee the implementation and ongoing management of the B-BBEE ownership deal.
   • Compliance Monitoring: The board should establish processes to monitor the company’s compliance with the B-BBEE Codes and the terms of the ownership deal.
   • Risk Management: The board should identify and manage the risks associated with the B-BBEE ownership deal, such as the risk of non-compliance or disputes.
   • Independent Directors: Consider the appointment of independent non-executive directors to provide objective oversight and ensure that the interests of all shareholders are protected.

Income Tax Requirements: Structuring for Efficiency

The South African Income Tax Act, 1962 (Act 58 of 1962) has significant implications for the structuring of B-BBEE ownership deals. Careful tax planning is essential to minimize the tax burden on all parties. Key considerations include:

1. Share Valuation: The valuation of shares is crucial for determining the purchase price and the tax implications of the deal. A fair and independent valuation is essential to avoid disputes with the South African Revenue Service (SARS).
2. Funding Mechanisms: The funding of the B-BBEE ownership deal can have significant tax implications. Common funding mechanisms include:
   • Equity Contributions: Equity contributions are generally not tax-deductible.
   • Debt Financing: Interest on debt financing is generally tax-deductible, but the terms of the debt must be commercially reasonable to withstand scrutiny from SARS.
   • Vendor Financing: Vendor financing can be a tax-efficient way to structure the deal, but it must be carefully structured to comply with the relevant tax rules.
3. Dividends: Dividends paid to shareholders are generally subject to dividends tax. The rate of dividends tax may vary depending on the shareholder’s tax status.
4. Capital Gains Tax (CGT): The sale of shares may trigger CGT. The CGT implications should be carefully considered when structuring the exit mechanisms for black shareholders.
5. Tax Clearance Certificates: The company should ensure that all relevant parties obtain tax clearance certificates to demonstrate their tax compliance.

Practical Governance for Different Business Sizes

The governance requirements of a B-BBEE ownership deal will vary depending on the size and complexity of the business.

1. Exempt Micro Enterprises (EMEs): EMEs are generally exempt from the detailed B-BBEE scorecard requirements. However, they still need to comply with the basic principles of the B-BBEE Act and the Companies Act. Governance for EMEs can be relatively informal, but it is still essential to document the ownership structure, the rights of shareholders, and the decision-making processes in a simple MOI and shareholders’ agreement.
2. Qualifying Small Enterprises (QSEs): QSEs are subject to a more detailed B-BBEE scorecard. Governance for QSEs should be more formal than for EMEs. This includes:
   • A well-drafted MOI and shareholders’ agreement.
   • A board of directors with at least one black director.
   • Regular board meetings and minutes.
   • Clear processes for decision-making and information sharing.
   • Compliance monitoring and reporting.
3. Generic Enterprises: Generic enterprises (large businesses) are subject to the full B-BBEE scorecard and the most stringent governance requirements. Governance for generic enterprises should be highly structured and robust. This includes:
   • A comprehensive MOI and shareholders’ agreement.
   • A diverse board of directors with significant black representation and independent directors.
   • Formal board committees, such as an audit committee and a remuneration committee.
   • Detailed policies and procedures for compliance with the B-BBEE Codes and all relevant laws and regulations.
   • Regular internal audits and external verification.
   • Robust risk management processes.

Here’s a breakdown of the key differences and additional governance layers MNCs must navigate:

1. International Corporate Structures & Group Governance:

• Subsidiary vs. Branch: MNCs typically operate in South Africa through a subsidiary (a locally incorporated company) or a branch (an extension of the foreign parent company). The choice affects governance:
  • Subsidiary: The subsidiary is a separate legal entity, subject to South African company law (Companies Act). The governance structure mirrors that of a local company, but the parent company (often in a different jurisdiction) exerts influence through its shareholding and board representation. The MOI, shareholders’ agreement, and board composition must comply with South African law.
  • Branch: The branch is not a separate legal entity. The foreign parent company is directly responsible for the branch’s operations. While the branch must comply with South African B-BBEE requirements, the parent company’s global governance policies and reporting standards come into play. This can create tension if the parent company’s policies are not aligned with South African B-BBEE requirements.
• Group Policies & Procedures: MNCs have established global policies and procedures for areas like:
  • Compliance: Ensuring adherence to all applicable laws and regulations. This includes anti-corruption, anti-bribery, and data privacy. A B-BBEE deal must fit within this framework.
  • Risk Management: Identifying and mitigating risks across the group. The B-BBEE deal must be assessed for its financial, legal, reputational, and operational risks.
  • Financial Reporting: Compliance with International Financial Reporting Standards (IFRS) or US GAAP. The financial implications of the B-BBEE deal (e.g., share valuation, funding, dividends) must be accurately reflected in the group’s financial statements.
  • Internal Controls: Maintaining strong internal controls to protect assets and ensure the integrity of financial reporting. The governance framework must incorporate these controls.
• Intercompany Agreements: MNCs often have intercompany agreements (e.g., service agreements, licensing agreements, transfer pricing agreements). These agreements must be structured to be arm’s-length to comply with South African transfer pricing rules and avoid tax disputes. The B-BBEE deal may impact these agreements, requiring adjustments.
• Centralized vs. Decentralized Control: MNCs vary in their level of centralized control. Some give significant autonomy to their South African subsidiaries, while others exert tight control from the global headquarters. The level of autonomy affects the governance of the B-BBEE deal. Highly centralized control often means that the deal must be approved by the global headquarters, which can add to the complexity and timeline.

2. Cross-Border Regulatory Compliance:

• B-BBEE Codes of Good Practice: MNCs must comply with the B-BBEE Codes, which are specific to South Africa. This includes the ownership element, as well as other elements such as management control, skills development, enterprise and supplier development, and socio-economic development.
• Exchange Control Regulations: If the B-BBEE deal involves foreign investment or repatriation of funds, the company must comply with South African exchange control regulations.
• Transfer Pricing Regulations: Transactions between the South African subsidiary and the foreign parent company (or other group companies) must be priced at arm’s length to avoid transfer pricing disputes with SARS.
• Foreign Corrupt Practices Act (FCPA) / UK Bribery Act: MNCs based in the US or the UK must comply with their respective anti-corruption laws. This can affect how the B-BBEE deal is structured and the due diligence that is conducted on potential black partners.

3. Board Composition & Decision-Making:

• Local Board vs. Global Oversight: The South African subsidiary’s board must comply with South African company law, including the requirements for black representation. However, the global parent company usually has a significant say in the appointment of directors.
• Dual Reporting Lines: The management of the South African subsidiary may have dual reporting lines – to the local board and to the global headquarters. This can create potential conflicts of interest.
• Decision-Making Processes: The decision-making processes must be clearly defined in the MOI and shareholders’ agreement. This includes the voting rights of black shareholders and the process for resolving disputes. The global headquarters may need to approve certain significant decisions.
• Diversity & Inclusion: MNCs often have diversity and inclusion policies that go beyond B-BBEE. The B-BBEE deal should align with these policies.

4. Tax Planning & Structuring:

• Transfer Pricing: As mentioned, all intercompany transactions must be at arm’s length. The B-BBEE deal can impact these.
• Thin Capitalization Rules: South Africa has thin capitalization rules that limit the amount of debt that a subsidiary can have. This can affect the funding of the B-BBEE deal.
• Withholding Taxes: Dividends, interest, and royalties paid to the foreign parent company may be subject to withholding taxes.
• Double Tax Agreements: South Africa has double tax agreements with many countries. These agreements can affect the tax implications of the B-BBEE deal.
• Permanent Establishment: If the South African subsidiary’s activities are considered to create a permanent establishment for the foreign parent company, this can have significant tax implications.

5. Reporting & Transparency:

• B-BBEE Verification: The South African subsidiary must undergo an independent B-BBEE verification process to obtain a B-BBEE certificate. This certificate is used to demonstrate compliance with the B-BBEE Codes.
• Group Reporting: The B-BBEE deal must be reported to the global headquarters. This includes the financial implications of the deal and the company’s B-BBEE scorecard.
• Sustainability Reporting: Many MNCs publish sustainability reports that include information on their B-BBEE performance.
• Stakeholder Communication: The company must communicate the B-BBEE deal to its various stakeholders, including its employees, customers, and suppliers.

6. Practical Governance for MNCs:

• Dedicated B-BBEE Team: MNCs should establish a dedicated B-BBEE team to manage the B-BBEE deal. This team should have expertise in South African B-BBEE, company law, tax, and finance.
• Legal & Tax Advice: It is essential to obtain expert legal and tax advice from South African professionals. The advice should consider the specific circumstances of the MNC.
• Due Diligence: Conduct thorough due diligence on potential black partners. This includes verifying their ownership, their financial capacity, and their business experience.
• MOI & Shareholders’ Agreement: The MOI and shareholders’ agreement must be carefully drafted to address the specific needs of the MNC and to comply with South African law.
• Compliance Monitoring: Implement processes to monitor the company’s compliance with the B-BBEE Codes and all other relevant laws and regulations.
• Training: Provide training to employees on B-BBEE and the company’s B-BBEE strategy.
• Regular Review: Regularly review the B-BBEE deal to ensure that it is still compliant and that it is achieving its objectives.

In Summary:

Governance for MNCs undertaking B-BBEE deals in South Africa is significantly more complex than for local companies. It requires a deep understanding of South African law, the MNC’s global policies and procedures, and the interplay between the two. The key is to ensure that the B-BBEE deal is structured in a way that is legally compliant, tax-efficient, and aligned with the MNC’s overall business strategy and risk management framework. Careful planning, expert advice, and strong governance are essential for success.

Conclusion

B-BBEE ownership deals are powerful tools for transformation, but they demand meticulous attention to governance. By understanding the company law requirements, the income tax implications, and the practical considerations for different business sizes, companies can navigate the complexities of B-BBEE and achieve their transformation goals while mitigating the risks of non-compliance. A proactive approach to governance, with clear documentation, strong board oversight, and sound legal and tax advice, is essential for success. Remember to regularly review and update the governance framework to reflect changes in the business, the B-BBEE Codes, and the legal landscape.

We have extensive experience in BEE ownership deals from ‘one-man bands’ all the way up to foreign Public companies operating in South Africa. While each situation is unique, our proprietary approach uses a combination of Acquisition, Management and Commitment Agreements, together with custom MOI and Rules, all of which are ‘battle tested’ to make sure that the governance around your BEE ownership deal is simple-yet-sound. Please contact us for assistance around your specific needs.