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ANALYSIS: B-BBEE and its implications for fronting

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Shohana Hareeparsad addresses the amendments to the Broad-Based Black Economic Empowerment Amendment Act (Act 46 of 2013) and the Department of Trade and Industry’s Code of Good Practice as it relates to fronting

According to the Guidelines on Complex Structures and Transactions and Fronting (previously Statement 002) of the Department of Trade and Industry (DTI), fronting is defined as a deliberate or attempted circumvention of the B-BEE Act and the Codes.

THREE TYPES OF FRONTING PRACTICES

The DTI defines three types of fronting practices.

Window-dressing

This includes cases in which black people are appointed or introduced to an enterprise on the basis of tokenism and may be:

  • Discouraged or inhibited from substantially participating in the core activities of an enterprise
  • Discouraged or inhibited from substantially participating in the stated areas and/or levels of their participation

Benefit diversion

This includes initiatives implemented where the economic benefits received as a result of the B-BBEE status of an enterprise do not flow to black people in the ratio specified in the relevant legal documentation.

Opportunistic intermediaries

This includes enterprises that have concluded agreements with other enterprises with a view to leveraging the opportunistic intermediary’s favourable B-BEE status in circumstances where the agreement involves:

  • Significant limitations or restrictions upon the identity of the opportunistic intermediary’s suppliers, service providers, clients or customers
  • The maintenance of their business operations in a context reasonably considered improbable having regard to resources, and
  • Terms and conditions that are not negotiated at arm’s-length on a fair and reasonable basis.1

OVERVIEW: BEE LEGISLATION IN SOUTH AFRICA

•             Broad-Based Black Economic Empowerment Act 53 of 2003

•             Broad-Based Black Economic Empowerment Amendment Act 46 of 2013, and

•             The Revised Code of Good Practice (issued by the Department of Trade and Industry)

The core objectives of the B-BBEE Act of 2003 are black ownership and participation at management levels in enterprises that contribute to the country’s economy. This is envisaged to subsequently lead to the bridging of the gap created by unequal levels of income.

The B-BBEE Act of 2003 does not stipulate which acts are considered illegal as a means of defeating or circumventing its objectives. In order to address loopholes identified in the B-BBEE Act, the B-BBEE Amendment Act was proclaimed and came into effect on 24 October 2014.2

A significant amendment to the B-BBEE Act is the inclusion of the definition of fronting and the fact that it is regarded as a criminal offence. The Amendment Act covers the following aspects:

•             Legal definition of fronting

•             Barring of fronting practices

•             Penalties for fronting

•             Appointment of a B-BBEE Commission to investigate fronting

Section 10 of the B-BBEE Amendment Act states that every organ of state and public entity must take into account any relevant code of good practice issued in terms of this Act.

It is mandatory for organs of state and public entities to apply codes of good practice when determining qualification criteria for the issuing of licences, concessions and other authorisations in respect of economic activity or when developing and implementing a preferential procurement policy. The obligation extends to determining qualification criteria for the sale of state-owned enterprises, developing criteria for public private partnerships and criteria for awarding incentives, grants and investment schemes in support of BEE.

One such code is the Revised Code of Good Practice (General Notice 1019 of 2013), which was published by the  on 11 October 2013. The Revised Code makes provision that a  transitional period of six months will be in effect between 11 October 2013 and 30 April 2015, thus providing for an extension on the effective implementation date of the Revised Code.3 The Revised Code will come into effect on 1 May 2015.

The effective date of implementation has significance for the validity of B-BBEE certificates. A B-BBEE certificate issued prior to the effective date is valid for a period of 12 months after date of issue and need not be compliant with the Revised Code. However, after 30 April 2015 all BEE certificates will have to comply with the Revised Code.4

Significant changes are being introduced with regard to:

•             Elements of the code, which have been reduced from seven to five

•             Compliance thresholds

•             Priority elements

•             The revised scorecard, and

•             Verification of BEE status

SEVEN ELEMENTS REDUCED TO FIVE

The current generic code contains the following seven essential elements of BEE with which businesses need to comply in order to be awarded BEE status:

•             Ownership

•             Preferential procurement

•             Management control

•             Employment equity

•             Skills development

•             Enterprise development, and

•             Socio-economic development

The Revised Code reduces the seven elements to five, first by combining employment equity with management control and second by combining preferential procurement and enterprise development under a new heading, namely enterprise and supplier development.

PRIORITY ELEMENTS

In the Revised Code ownership, skills development, and enterprise and supplier development are identified as priority elements on which firms are expected to attain a minimum of 40%. A large enterprise is required to comply with all the priority elements, while a qualifying small enterprise (QSE) is required to comply with ownership as a compulsory element as well as either enterprise and supplier development or skills development.

An exempt micro enterprise (EME) or a QSE which is 100% black-owned qualifies as a level one contributor with a B-BBEE recognition level of 135%. A 51% black-owned enterprise qualifies as a level two contributor with a B-BBEE recognition level of 125%.

Should a firm not comply with the sub-minimum targets specified on the priority elements, the entity’s BEE status will automatically be discounted by one level.

An important addition to the enterprise and supplier development element is the concept of an empowering supplier. According to the definition in the Government Gazette, this is a B-BBEE South African-compliant entity. A QSE needs to meet any one of the criteria listed below while a generic (large enterprise) needs to comply with three of the criteria:

  • At least 25% of cost of sales must be procured from local suppliers in South Africa
  • At least 50% of job creation are for black people
  • At least 25% of the transformation of raw materials include local manufacturing, production, assembly and packaging, and
  • 12 days per annum are used for assisting black EME and QSE beneficiaries to increase their operation or financial capacity

A sub-minimum criterion of 40% has to be achieved for this element.

Compliance thresholds

Compliance

 

 

 

 

REVISED SCORECARD

The scorecard relates to the generic scorecard.

An enterprise requiring BEE status will be measured on each of the five elements and given points that will lead to a recognition level.

Ownership and enterprise and supplier development hold 65% of the weighting points in terms of the generic scorecard. The element of enterprise and supplier development measures the extent to which entities buy goods and services from empowered suppliers with B-BBEE recognition levels.

The Revised Code is more stringent in its classification of B-BBEE contributor status levels. The different B-BBEE contributor level points have been revised and have resulted in a very different point distribution, with it being more difficult to achieve a level 4 status. The Revised Code has also increased the qualifications points (see first table on page 26).

VERIFICATION OF BEE STATUS

EMEs and QSEs in selected industries are not required to have their BEE status verified by an accredited agency. Only an affidavit is required, provided that black ownership exceeds 50% and annual turnover is between R10 million and R50 million.

The BEE status of certain industries will need to be verified by an accredited agency, however (see first table on page 26).

This is a significant advantage when tendering for state and corporate contracts. The credentials of large enterprises will still have to be verified by a procurement specialist or verification agency.

CONCLUSION

Fronting became commonplace by industries and companies in an effort to circumvent the process of economic and equitable transformation. Prior to the B-BBEE Amendment Act, fronting was a common law offence of fraud. However, those circumventing the B-BBEE Act in this way were not punished by, for example, the imposition of a fine or term of imprisonment.

The B-BBEE Amendment Act has criminalised fronting as a statutory offence. For the first time in South Africa an offender may be imprisoned and a company fined for not adhering to B-BBEE legislation.

In addition, the B-BBEE Amendment Act has imposed stricter requirements for awarding of B-BBEE status to companies. This will ensure that the practice of fronting is more difficult to commit and that offenders are punished.

Compliance2

 

 

 

 

NOTE

  • 1 Department of Trade and Industry Guidelines on Complex Structures and Transactions and Fronting (previously Statement 002).
  • 2 Proclamation by the President of the Republic of South Africa, Commencement of the Broad-Based Black Economic Empowerment Amendment Act, Government Gazette, 2013.
  • 3 DTI, Extension of Transition Period, Notice 226 of 2014, Government Gazette 36928, 11 October 2013.
  • 4 DTI, Statement of Clarification – the Transitional Period, 8 July 2014.

 

Author:

Shohana Hareeparsad is an assistant manager in the Forensic Services Division within the advisory area of PwC

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