Tuesday, August 31, 2004

Equity ownership tends to dominate black economic empowerment transactions in the private sector.  The charters for the petroleum and liquid fuels, mining and financial industries envisage a percentage of direct or indirect black ownership over a 6-10 year period that ranges from 10% to 26%.  In this context, certain recent black empowerment transactions have been criticized for being too elitist with corporate ownership only benefiting a select group of individuals. The BEE legislation and strategy documents intend “broad-based BEE” to allow “the economic empowerment of all black people, including woman, workers, youth…” and require measurable upliftment of the community.
Where empowerment is truly broad based, the participants might not all have the skills or experience necessary to manage the assets acquired by them in terms of the BEE transaction. Trusts, which are generally used where selected assets are earmarked for certain beneficiaries, would therefore be appropriate “vehicles” for truly broad based participation in companies:  skilled trustees can be appointed, unskilled  beneficiaries won’t be required to administer the assets, and the fiduciary responsibilities of trustees will serve as a mechanism to protect the beneficiaries’ interests. Trusts are also flexible, as the terms of trust deeds can be “tailor made” to reflect the founder’s intentions, subject to legislation and the common law.
Truly broad based empowerment deals require the identification of the individuals and communities who will benefit from the empowerment transaction, and negotiations should take place to obtain their buy in and to ensure that the participants are informed about matters which could affect the economic value of their stake. Time does not always permit for negotiations with potential participants to take place before the deal is struck. Discretionary trusts are particularly suitable where the identities of all the participants to the transaction have not been finally determined, although one must ascertain whether the appropriate charter will accept non vested rights held by the BEE beneficiaries. Until the assets or income vest in the beneficiaries, the trust itself will be subject to tax. However, the taxation of trusts is punitive, as trusts are subject to income tax at 40%, they do not qualify for tax rebates and are excluded from the benefits of tax deferrals available to companies in respect of group restructuring transactions. Consequently trusts are often disregarded as “vehicles” for BEE transactions.
The funding requirements of certain BEE transactions are such, that beneficiaries are required to “pay’ for the privilege of participating as beneficiaries of the trust.  Generally, beneficiaries will be reluctant to pay for the privilege of becoming a beneficiary in an ‘empowerment” trust, unless they acquire vested rights to the assets administered in trust.  Beneficiaries with vested rights to trust assets are subject to tax, at the tax rate applicable to them. However, situations may arise where assets are acquired by the trust, immediately vest in the beneficiaries in terms of the trust deed, but due to provisions of the trust deed or the nature of the assets, the assets cannot be disposed of immediately and remain under the administration of the trustees, for the benefit of these beneficiaries.  The beneficiaries could find themselves in a situation where they do have a tax liability but do not have the money to pay the tax.  In comparison, employees participating in employee share schemes have a right to defer tax.
Other tax questions arise: SARS should clarify whether a trust beneficiary may regard a “capital contribution” to the trust as forming part of the base cost of the asset that vests in the beneficiary, or whether SARS’ practice is to regard all capital contributions by trust beneficiaries as loans (or donations). Furthermore, where trust beneficiaries have vested rights, the selection of “new” trust beneficiaries will have to be carefully structured to ensure that this does not constitute a “value shifting arrangement” for CGT purposes.
Although trusts, by their very nature, are ideally suited to transactions where a variety of persons and communities are intended to benefit economically from BEE transactions, the intricacies of tax law and the industry charters will have to be taken into account when creating trusts for BEE transactions. 
It is time that tax policy and provisions be changed, at least in respect of trusts which are used for broad based black empowerment transactions.  The tax rate applicable to such trusts should be lowered so that it is comparable to the company tax rate, and the provisions of the corporate restructuring rules contained in the Income Tax Act no 58 of 1962 (“the ITA”) should be amended so that trusts can benefit from the tax deferral provisions in these rules.  Also, a tax deferral mechanism should be available to beneficiaries with vested rights who incur a tax liability without the means to pay the tax.
Betsie Strydom
Director Bowman Gilfillan Inc