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Flawed perception of compliance

The general perception that corporate SA’s compliance with ESD is very good is “flawed”, say Anton Baumann and Mark Fitzjohn, executive directors of black-owned investment company, Empowerment Capital. “Often where there’s recognition, it relates to old initiatives, and in most instances old loans that are outstanding and still on the measured entity’s books,” says Fitzjohn. Furthermore, often these loans are in default and the repayment terms are just being pushed out.

Baumann says if all companies were to contribute 3% of net profit after tax annually, about R40bn would be available for small business support every year. But because of an interpretational issue in the codes, nothing close to this amount is being contributed to small business development. According to a paper recently submitted by Empowerment Capital to the Trade, Industry and Competition Department:

“A guiding principle in the codes is that there cannot be a double counting of initiatives. If an initiative counts as a contribution for one element, then it cannot count as a contribution for another element as well. Likewise, if an initiative is recognised in one year it cannot be recognised again in a subsequent year. This principle applies throughout the scorecard. Any initiative claimed for scorecard recognition must be supported by net cash flows that occur within that specific year for which a measured entity claims scorecard recognition.”

Baumann says the common interpretation means that a large company that may have provided a loan in 2007, for example, may never have to do ESD again as long as the loan is outstanding and the company’s profit hasn’t grown. If it has, say by 10%, and interest on the loan was charged at 10%, the outstanding loan balance grows accordingly and the company never has to do ESD again. “Why would a grant, which is support in the form of cash flow, only be recognisable in one year and a loan, which is “money coming back”, be recognisable in multiple years? How does that make sense?”

He says the codes include rules as well as overarching guiding principles. Such principles include “substance over form” or the general interpretation rule that any reasonable interpretation of the codes consistent with the objectives of the B-BBEE Act must take precedence. “If an interpretation does not make sense then how can it be the reasonable interpretation or even be consistent with the objectives of the act? The codes incentivise companies to support qualifying ED and SD beneficiaries annually to the value of 3% of their net profit after tax. Such annual contributions must be supported by net cash flows that occur during the year of assessment. That is the only interpretation that makes sense and that is in line with the objectives of the B-BBEE Act,” Baumann says.

In 2016, Empowerment Capital sought clarity from the BEE Commission on this issue, but the commission did not deem it necessary to issue a practice guide. This year, Empowerment Capital turned to the DTI. The company says ESD is often done in such a way that it has little impact and some practices constitute fronting. Measured entities get away with it because of “an almost malicious misinterpretation of the codes”.

Examples of such initiatives include:

 

• The claiming of an outstanding loan balance over several years;

• Support of beneficiaries without any intent of grooming the beneficiary into the supply chain;

• Standard business practices claimed as ESD, such as banks claiming loans to a black business;

• “Onboarding” of loan recipients to become suppliers in order to be able to claim for supplier development (eg, Bank A issued a standard business loan to Company X. Before financial yearend Bank A quickly procures a minor service from Company X. Company X is now a supplier and the loan can be claimed as supplier development);

• Excessive management fees charged by ESD facilitators;

• Repackaged “marketing expenses” labelled as ESD;

• Inflated cost and inaccurate time sheets supporting “contributions made in the form of human resources”; and

• Obviously low-impact initiatives.

Baumann says points for ESD are meaningless if there’s no meaningful impact. “I don’t think the idea of companies parking R50m in a wealth preservation fund is taking our country forward.”

 

[page 37 of the Sanlam Gauge Report]

 

 

Read the full report here.

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