BEE ownership levels and statuses for QSEs and EMEs

On March 29^th, the dti released a (draft) Easter gift to South African businesses in the form of a first-ever BEE incentive, along with some changes to Skills Development which could have far-reaching, positive, consequences for the economy, if companies will focus on implementations aligned to impact rather than to compliance only – which is where BEE traditionally sits for most organisations.

Find a copy of the full Gazette via our website here.

In our opinion, most of these changes are – subject to an impact and not compliance focus mentioned above – welcome and good for business, for jobs, for youth, for poverty, for inequality and therefore, for the South African economy as a whole. At this stage, the amendments only affect the dti Codes, but given some of the changes are linked to our new President’s specific job creation agenda, we expect the Sector Codes to follow suit, particularly given the advantage which these amendments will give to companies in other sectors.

In order to minimise complexity and report only the highlights, we have not included all the detailed requirements and changes here, but rather an overview of the most important amendments and their implications for businesses. We encourage all of our clients and any other affected business to contact us for specific advice on how these amendments are likely to affect them.

Amendments to the enhanced recognition statuses for black-owned businesses

• Limitations have been placed on the ability for 51% and 100% black-owned QSEs and EMEs to achieve the enhanced recognition of Level 2 and Level 1 respectively, by limiting the determination of the 51% and 100% black ownership to the use of the Flow-Through Principle only. Affidavits, unfortunately, remain for these enhanced statuses.
  • This means that all of those businesses who created clever structures that allowed their existing shareholders to retain 74% real shareholding while creating an automatic Level 2 51% black-owned entity will no longer qualify. They can retain their 51% black ownership but will need to comply with all other elements of the Codes to earn a BEE recognition level.
  • It is not entirely clear whether this change is intended to impact on the definition of an Enterprise and Supplier Development beneficiary.
• Enhanced recognitions to Level 2 and Level 1 respectively for 51% black-owned generics has been introduced. This means that a company with R1b turnover and possibly tens of millions of rands of profits can avoid any other contribution to BEE other than having a 51% black shareholder. The Codes have made it very clear (less so for QSEs and EMEs) that absolutely no other principle or ownership enhancement –  private equity funds, NEF shareholding, government shareholding, mandated investments, modified Flow-Through principle, “once empowered always empowered” etc – can count here. Companies are required to obtain a BEE certificate measuring Ownership only.
  • We think this proposed amendment is a key miscalculation in this gazette. Not only is it hard to understand why wealthy black millionaire and billionaire shareholders should be exempt from making their own contributions to poverty and inequality in South Africa (our new President could reasonably be accused of slipping in further fat cat and gravy train opportunities for connected politicians and perhaps this is exactly the aim?), but it is likely to result in a renewed focus on “clever” compliance – or fronting – structures using flow through but managing control and stripping out profits, designed by well-paid advisors.

Amendments to Skills Development through the specific introduction of bursaries and scholarships

• Points have been redirected from learnership indicators and from the general skills development spend indicator to make way for a new indicator, weighted with 4 points and with a target of 2.5% of “payroll” (the other spend target has been equally reduced), which is focused on bursaries and scholarships
  • Bursaries or scholarships qualify when made to or in favour of any individual enrolled in an institution registered with the Department of Basic Education or the Department of Higher Education; in other words, any registered school, college, technikon, university or similar registered, institution.
  • The cap of 15% that applies generally to ancillary training costs (travel, accommodation, catering, etc) does not apply to bursary and scholarship spend
  • Stipends paid to students on a bursary is specifically allowed to be included as bursary spend
  • These changes are extremely positive because the Codes did not previously allow proper recognition for these ancillary costs, meaning corporates were less inclined to spend the money, even though from an impact perspective it is critical that students get holistic support and not just coverage for their course fees
  • No amendments have been made to the QSE scorecard, therefore one must assume that bursary and scholarships count under the general indicator for Skills spend, since the QSE scorecard refers back to the principles in Code 300. What is unclear, however, is whether the stipend recognition and lifting of the cap on ancillary costs for bursaries and scholarships would apply to QSEs since these allowances are made with specific reference to indicators which do not exist in the QSE scorecard
• Significantly, the threshold for informal (category F and G) training, has been raised from 15% to 25% of total skills development spend

Introduction of the Youth Employment Service (YES) Initiative to boost BEE levels

• EMEs, QSEs and generics can all enhance their levels by up to 2 levels, if they meet the eligibility criteria and the targets set for work experience and job absorption
• The eligibility criteria are focused on meeting the sub minimums for each priority element (differently defined for QSEs and generics) or meeting an overall 50% average across the priority elements. This means that companies can potentially avoid ownership altogether and still get bumped up a level from where they would be before a level drop due to not meeting the Ownership sub-minimum, but they would have to get an average of 70%-100% scoring across Skills and Enterprise and Supplier Development, depending on if they are generics or QSEs.  This puts entities without any Ownership within range of a Level 5, compared with the current likely best case scenario of Level 7.
  • In addition, QSEs and generics are obliged to at least maintain their level of BEE compliance from the year preceding the introduction of the YES initiative in order to qualify. It seems this requirement is before any level enhancement provided through YES, meaning companies can’t slack off and reduce their spend levels from previous years.
  • Generics also have the additional requirement of having to score full points for the newly introduced spend on bursaries and scholarships defined above.
  • EMEs have no eligibility criteria, so can potentially achieve Level 2 annually if meeting the YES targets.
• The headcount targets for providing work experience through fixed term or temporary 12 month contracts (termed “new jobs”) are calculated against the company’s baseline headcount, its Net Profit After Tax or its turnover (depending on which is the highest number), or, in the case of QSEs and EMEs, turnover only.
  • If work experience positions cannot be accommodated by the company, these can be sponsored for other EMEs and QSEs, therefore, if QSEs and EMEs are willing to put in the time required to truly develop entry-level resources, they could get free or partly subsidised resources
• “Absorption” is unclear although it appears to be a renewal of a fixed term contract or a permanent employment contract. The absorption requirement is surprisingly low at 2.5-5%, and misleading except for only the largest companies. For example, companies with a turnover of R400m can reasonably expect to have a target of 20 work experience positions, of which 1 needs to be absorbed to reach the 5% target. The QSE or EME with less than 20 employees (which is probably a large percentage of such businesses) needs only 1 work experience position, but since you can’t absorb a fraction of a person, their absorption target becomes 100%. Realistically, therefore, the absorption target for companies with a turnover less than R400m is likely to be considerably higher than 5%, which may be unsustainable.

Other general amendments

• Clarification on how the sub minimums work
• Clarification on how to determine the points and consequently, the BEE level, of unincorporated JVs
• The headcount for the training of unemployed people is for learnerships, apprenticeships and internships and not any training on the Skills matrix
• Double counting for unemployed learners across both learnership indicators is disallowed
• Absorption applies to both “learnership” indicators (though presumably does not apply where existing employees were put onto learnerships

No changes made to broad-based schemes

• Notably, no amendments whatsoever have been made to Employee Share Ownership Schemes and Broad-based Trusts, despite the dti’s ongoing criticism of these schemes and promises of “imminent amendments” over the past 3 years.

In summary, assuming these amendments are passed, BEE ownership will immediately become both more important and less important. The qualification for enhanced statuses for QSEs and EMEs will – rightly so – become considerably harder.  Businesses not using the Flow-Through Principle to achieve their 51% black ownership have the choice of giving up more real ownership or spending money annually on other initiatives, although their recognition under the 51% black ownership indicator under Procurement will presumably be unaffected.

51% black Ownership for generics, using the Flow-Through principle only, will become coveted, given the cost of compliance against all the other elements. Fronting and clever compliance structures will likely increase. At the same time,  the pressure for companies to be 51% black should immediately go down, if companies apply detailed financial and technical analysis to their supplier requirements. Those 9 points under Procurement represent 1 to 2 level changes for companies that are achieving Level 6 to Level 4, and a significant portion of the 15 points required to get from Level 7 to Level 6. With 2 enhancement levels available under the YES initiative, companies with less appetite to walk a fine fronting line will probably be more inclined to enhance their level here than find ever more inventive ways to score Procurement points from “51% black-owned” companies – depending also, of course, on their ability to meet spend targets in other areas.

It seems the YES initiative has been very precisely designed as an incentive, and will probably have just the desired effect in terms of take-up across the board. Barring the usual compliance approach to this component that we have come to expect from companies, it is refreshing to finally see a carrot in BEE, as opposed to the ubiquitous sticks.