Broad-Based Black Economic Empowerment (BBBEE) is a regime that affects almost all businesses in South Africa and for an expanding business, a good BBBEE 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 BBBEE elements, of which one may be ‘Enterprise Development’.
Enterprise Development (ED) 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 BBBEE 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 percent on the value of the grant. For ease of reference I will discuss each of these elements under separate headings.
May the 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 BBBEE 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 BBBEE 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 BBBEE 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?
Donations 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 BBBEE regime it can clearly be concluded that the grants are made with the intention of maintaining or improving a BBBEE 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.
By Erich Bell (Tax Technical)
This article first appeared on the SAIT website on June 25 2014