BEE: Tax implications
25 June 2014
Posted by: Author: Erich Bell
Author: Erich Bell (Tax Technical)
Broad-Based Black Economic Empowerment (BEE) is a regime that affects
almost all businesses in South Africa and for an expanding business, a good BEE
scorecard can sometimes be the difference between clinching a life-changing
tender as opposed to turning into ashes. Businesses, depending on the
classification of the business, have to choose a certain amount of BEE
elements, of which one may be ‘enterprise development’.
Enterprise development is aimed at assisting or accelerating the
development, sustainability and ultimate financial and operation independence
of a black business. One of the qualifying enterprise development contributions
includes a grant that may be advanced by the measured business to the beneficiary
entity. This article will only consider
the tax implications for the measured business providing a cash grant for BEE
purposes and it will consequently not delve into the tax implications of any
other qualifying enterprise development activity.
Normally for income tax purposes, when a business incurs general
expenditure that relates to its income earning operations (floating capital) as
opposed to establishing, improving or maintaining its income earning structure
(fixed capital), it would be entitled to deduct the expenditure from its income,
which would result in a lower taxable income that would ultimately be subject
to tax. The interesting question that comes to mind is whether the grants
forming part of enterprise development would form part of the measured
business’ income earning operations, in which case the business may receive a
tax deduction, or if it forms part of the business’ income earning structure,
in which case no tax deduction would be allowed. Furthermore, the question also
comes to mind whether these grants may give rise to a donation for donations
tax purposes, in which case donations tax may become payable at a rate of 20
per cent on the value of the grant. For ease of reference I will discuss each
of these elements under separate headings.
grant qualify as an income tax deduction for the measured business?
As stated above, whether the grant would qualify for a tax
deduction would depend on whether it relates to the measured business’ income
earning operations or income earning structure. Arguments do exist that these enterprise
development grants relate to the measured business’ income earning structure as
the incentive to make these grants is to obtain a desired BEE level which in
turn would enhance the measured business’ chances of securing more business in
future. These grants are therefore made by the measured business to create a
source of future profit as opposed to working for present profit. Following
this reasoning, one can (and for that matter SARS too) draw the conclusion that
these grants are capital in nature and that they therefore do not qualify for
an income tax deduction.
On the other hand, many tax professionals have argued, that
due to the repetitive nature of these BEE payments, that these payments relate
to the measured business’ income earning operations and that they should in
fact qualify for a tax deduction. This view was also held in a recent tax court
case where it was held that empowerment costs incurred in terms of the Sullivan
Code (an American code very similar to our BEE regime) were not of a capital
nature as no capital asset was created or improved in the hands of the
taxpayer. By making use of these principles, it can be argued that these
expenses are bone fide incurred for the performance of the taxpayer’s
income earning operations as they are similar to insurance premiums which are incurred to protect the taxpayer’s
income earning structure and that a tax deduction should therefore be allowed.
One should always remember that the measured business would
have the burden of proving that the grant is deductible for income tax purposes
and that SARS may very well contest that these payments are capital in nature.
Would the grant be
subject to donations tax in the hands of the measured company?
tax must be levied on a donation as defined in the Income Tax Act. In short,
the definition of a donation requires any ‘gratuitous’ disposal of property
which basically means that the donation should have been made without any good
reason and that it should have been uncalled for. It was further held in our
case law that a donation should be motivated by ‘pure liberality’ (i.e. the quality of giving
or spending freely) or ‘disinterested benevolence’ (kindness). With the BEE regime it can clearly be concluded
that the grants are made with the intention of maintaining or improving a BEE rating
as opposed to spending on welfare which spending is motivated by kindness and
without expecting a quad pro quo (something
in return). Based on this conclusion, an extremely strong argument exists that
these grants would not constitute ‘donations’ and that it should consequently
not be subject to donations tax.
Strong arguments currently exist that grants paid in terms
of enterprise development should be allowed as an income tax deduction and that
they should not be subject to donations tax. One should however remember that
tax is supposed to follow business decisions and that it should not be the sole
consideration when making commercial decisions. The advantages of our BEE
regime far outweigh any negative tax consequences and it is our responsibility
as citizens of the Republic of South Africa to ensure that transformation takes
place in a continuous manner. For further tax implications of BEE transactions
it is strongly advised that you contact your registered SAIT tax professional.