SARS has recently issued Binding Class Ruling 72 (“BCR 72“), on 07 August 2020, in which it ruled on the tax deductibility of contributions by a group of employer companies to fund an employees’ ownership trust to enable the trust to participate as a part shareholder of a newly established black-owned and controlled property entity.
The transaction had a dual purpose – to obtain a favourable broad-based black economic empowerment (“B-BBEE“) status, and to incentivise employees.
SARS summarised it as follows:
“This ruling determines the deductibility of contributions by employer companies (class members) to fund an employees’ trust to enable the trust to participate as a part shareholder of a newly established black-owned and controlled property entity (B-BBEE company). The ruling also confirms that the advance of an interest-free loan by the listed holding company (listco) of the applicant and class members to a managers’ trust destined to hold a percentage of the B-BBEE company, would not constitute a taxable benefit, with the effect that no PAYE withholding obligation would arise in respect thereof.”
In other words: SARS has ruled that 50% of the employer contribution by each group company is not tax deductible because it is of a capital nature. Note that the reference to “listed” is that of the JSE. The reason for 50% is given later in the article.
Relevant tax laws
- Income Tax Act 58 of 1962.
- section 11(a), read with section 23(g);
- section 23H(1)(ii);
- paragraph 1 of the Fourth Schedule – definition of “remuneration”;
- paragraph 2 of the Fourth Schedule; and
- paragraph 2(f) read with paragraphs 4 and 16(1)(b) of the Seventh Schedule.
SARS has previously granted rulings that acknowledge the deductibility of social responsibility expenditure incurred in order to improve a taxpayer’s B-BBEE scorecard, such as Binding Class Ruling 2. In principle, there is no difference between the types of expenditure that are incurred in order to improve a taxpayer’s B-BBEE scorecard. However, one factor that may have been taken into account by SARS is that the expenditure is incurred on a one-off basis, and may provide an enduring benefit to the group companies, especially bearing in mind that the contribution received was used to subscribe for shares in the holding company of each employer company.
Detail relevant to the ruling:
Applicant: A private company and a resident
Employer companies: The group companies that employ the participating employees and managers and who are, together with the applicant, wholly-owned subsidiaries of “listco”, forming a group of companies
Listco: A holding company of the applicant and class members and listed on the JSE
Quoting from the transaction reviewed by SARS:
“The group is in the process of implementing a B-BBEE transaction in terms of which immovable property, previously owned by the group, is transferred to the B-BBEE company.
The shareholders of this entity include the employees’ trust and the managers’ trust, as well as members of the broader public who are black. The B-BBEE points earned by the group will contribute to the B-BBEE status of the applicant and each group company, including the employer companies. It is important to note that the B-BBEE status of the group prior to the transaction is already at the maximum level, due to previous equity-based B-BBEE transactions.
However, this status is at risk, mainly due to uncertainty relating to the mandated investment by black shareholders who may sell the equity at any time. Therefore, the group seeks a more sustainable solution to ensure that the group remains black owned. The objects of both the employees’ trust and managers’ trust comprise the creation of an employee incentive scheme, as well as the implementation of the B-BBEE transaction.
These objects are set out in the various founding documents and may be summarised as the incentivising of employees of group companies by affording them the opportunity to become beneficiaries of trusts that participate in the equity of the B-BBEE entity, thereby contributing to the sustained unencumbered B-BBEE ownership profile of the group.
Neither the managers’ trust nor the employees’ trust will be “connected persons” as defined by section 1(1) in relation to the applicant, any employer company, or listco.
Listco does not have any employees – all the South African based employees within the group are employed by the employer companies. It is intended that the employees’ trust be funded directly by contributions from the employer companies, whilst listco will make an interest-free loan available to the managers’ trust and invoice each employer company for its proportional share (the recovery amount).
Each recovery amount is calculated with reference to the number of participatory units to be offered to the employees of each employer company, proportional to total units available to employees of the group. Units are allocated to employees in proportion to the national economically active population targets published by the Department of Labour.
Although the recovery amount for each employer company is calculated using employment-related criteria, each employer company also benefits from the more robust BEE credentials achieved in consequence of the B-BBEE transaction in which the trust plays an essential part.”
In understanding this ruling it must be noted that the important aspect of this transaction hinges on the planned purpose.
For each employer company, the recovery amount serves a dual purpose.
The implementation of the B-BBEE transaction is facilitated and,
The employees are incentivised.
For SARS, these two purposes are achieved equally. Therefore, 50% of the recovery amount relates to the staff incentive and 50% relates to the B-BBEE status, of each employer company.
The participating employees and managers will be taxed on the value of the shares in the B-BBEE company under section 8C, upon vesting, as governed by the scheme rules. Listco will not claim a deduction in relation to the expenditure it incurs and will also not include the recovery amounts in its gross income. The tax consequences for the employees, managers and listco fall outside the scope of the binding class ruling.
“Fifty percent (50%) of each employer company’s recovery amount is not deductible, because it relates to the implementation of the B-BBEE transaction and is capital in nature. However, fifty percent (50%) of each employer company’s recovery amount relates to incentivising employees and will be deductible in terms of section 11(a), read with section 23(g).
Section 23H(1) will apply to this portion, with the effect that that amount must be deducted proportionally over the period for which staff is incentivised.
The advance by listco of an interest-free loan to the managers’ trust does not result in a taxable benefit contemplated under paragraph 2 of the Seventh Schedule and in consequence there is no PAYE withholding obligation in the hands of the employer companies in relation to the
beneficiaries of the managers’ trust.”
This ruling has been made valid for 3 years from 24 April 2020.
Note that Binding Class Rulings are typically binding between SARS and the applicant, any co-applicant(s) and the class members only and published for general information. It does not constitute a practice generally prevailing and is published for purposes of information only.
In closing, businesses seeking to achieve B-BBEE and Tax compliance should utilise the services of professional B-BBEE Consultants and Tax Practitioners at all times.
Author Craig Tonkin