Tracking the changes in the pipeline
Changes to employment equity and black economic empowerment (BEE) rules have been coming so thick and fast that many people find it difficult to keep track of them all. Summarised below, thus, are the most important shifts in:
Both the EE and BEE Bills have been approved by the National Assembly and are continuing to make their way through the parliamentary process. Once this has been completed, both Bills will need the assent of President Jacob Zuma and will then promulgated in the Government Gazette.
The revised codes were published in the Government Gazette on 11th October 2013 and are intended to replace earlier codes which came into operation in 2008. The new codes are not scheduled to come into effect until 10th October 2014, but firms may choose to have their BEE status measured under the new codes with immediate effect.
1. The Employment Equity Amendment Bill of 2012
The EE Bill not only strips away key defences for businesses battling to meet unrealistic racial quotas but also more than triples current fines. In addition, it cuts short the enforcement process so as to make prosecutions easier and faster.
Background to the EE Bill
The Employment Equity Act of 1998 (the EE Act) requires ‘designated’ employers (those with 50 employees or more, or with annual turnover above specified thresholds) to ‘achieve employment equity’ by increasing black representation at management and other levels to the point where this matches the proportion of black people (Indians, coloured people, and Africans) in the country’s economically active population (EAP).
Since Africans make up 75% of the EAP, this is the target for African representation at all management levels which employers are expected to meet. However, the African population is both youthful and, for a variety of historical and other reasons, poorly skilled and experienced. Relatively few Africans (4.1%) thus have the tertiary qualifications often appropriate for management posts, while only 25% fall within the 35-64 age cohort from which managers are usually drawn. As a result, the 75% target is virtually impossible to attain.
The EE Act partially recognises the difficulties firms face in meeting racial targets in these circumstances by allowing employers who fail to do so to cite the skills deficit in their defence. However, these provisions, which provide at least some level of protection for employers against the unrealistic expectations of the EE Act, are to be removed under the EE Bill approved by the National Assembly in October 2013.
Fewer defences
Under the current EE Act, the director general of labour or the Labour Court (or anyone else seeking to enforce fulfilment of racial quotas) must take account of the severe skills shortage in the country by noting the size of ‘the pool of suitably qualified people from designated groups from which the employer may reasonably be expected to promote or appoint employees’. They must also consider relevant economic factors in the sector, along with the financial circumstances of the employer and ‘the progress made by other designated employers operating under comparable circumstances’.
The EE Bill repeals these provisions. Instead, it puts the onus on the employer to show what ‘reasonable steps’ he has taken to appoint, promote, and train black people and implement his employment equity plan. He is also entitled to ‘raise any reasonable ground to justify his failure to comply’, but may in practice battle to convince the Department of Labour (DoL) of the salience of the skills shortage.
This may be particularly difficult for firms to do when, according to the ‘skills demand list 2012-2013’, compiled by the DoL from data supplied by Sector Education and Training Authorities (Setas), the private sector has a shortage of 128 managing directors and chief executives, 1 174 finance managers, 819 human resource managers, six financial services and bank managers, and 58 policy and planning managers. More realistically, according to the DoL, business is also short of 30 320 ‘production and specialised services managers’ and 21 492 ‘manufacturing, mining, construction, and distribution managers’. Though little credence can be attached to data of this kind, the DoL may see it differently.
Higher penalties
At present, maximum fines for the ‘offence’ of failing to meet unrealistic racial quotas at management and other skilled levels range from R500 000 for a first transgression to R900 000 for a fifth similar transgression within three years. Under the EE Bill, by contrast, maximum fines for any failure to meet specified racial targets will start, for a first contravention, either at R1.5m or 2% of annual turnover, whichever amount is the greater. For a fifth similar contravention within three years, maximum fines will be either R2.7m or 10% of annual turnover, whichever is the larger.
Fines of this magnitude will also apply to designated employers who fail to adopt successive employment equity plans, implement any measures ordered by the director general of labour, or submit their employment equity reports to the DoL each year.
It is extraordinary that a fine of R2.7m, or 10% of turnover, if that is the larger sum, could apply for failing to submit a report. Moreover, under the Bill, all designated employers will have to report to the DoL in every year, whereas the current EE Act allows smaller companies, with between 50 and 149 employees, to submit their reports every two years.
Annual turnover is calculated on the basis of yearly revenue before expenses and taxes are taken into account. Say, thus, that a company has revenue of R100m in its 2013 financial year, but expenses of R85m, leaving it with a gross profit of R15m. Corporate tax (at 28%) is payable on this sum, amounting to R4.2m. This leaves the company with net after-tax profit (NPAT) of R10.8m. But assume that in 2013 the company also fails to meet its target for black senior management under the EE Act for the fifth time in three years. Unless it can satisfy the DoL that it did all that was reasonable to fulfil this quota, it will have to pay a maximum fine of R2.7m or 10% of turnover, whichever is the larger. Since 10% of R100m is R10m, this is the fine potentially payable. Such a fine would reduce its net profit for the year to R800 000.
In this example, a small profit would still remain. However, there could also be many instances where net after-tax profit is smaller – and the obligation to pay a fine amounting to 10% of turnover would push a company into an overall loss.
Faster enforcement
Under the current EE Act, a labour inspector must begin the enforcement process by seeking ‘an undertaking to comply’ from the relevant employer. Thereafter, the inspector may issue a compliance order, against which the employer may object to the director general of labour or appeal to the Labour Court. This compliance order cannot be executed until it has been made an order of the Labour Court.
Enforcement under the current rules thus involves a number of steps. By contrast, under the EE Bill, labour inspectors will have a choice as to whether or not to start the enforcement process by seeking an undertaking to comply from an employer. If they choose not to do so, they will instead be able to start by issuing a compliance order against an employer alleged to be in breach of the EE Act. In these circumstances, no prior consultation with the employer will be needed. In addition, employers will no longer have the power to object to a compliance order or appeal against it to the Labour Court. Moreover, if an employer fails to fulfil a compliance order, the director general of labour may immediately apply to the Labour Cost to have the department’s compliance order made an order of court.
In addition, where an employer has allegedly failed to fulfil the racial targets set out in his employment equity plan, no compliance order will be needed. Instead, the director general of labour will be able to go directly to the Labour Court to seek an order punishing him for this transgression.
National, rather than regional, demographics
The current EE Act allows employers, in setting their racial targets, to take account of ‘the demographic profile of the national and regional economically active population’. This has particular salience for coloured people in the Western Cape, who make up some 55% of the EAP in the province but only 11% of the national EAP. Hence, coloured people in the Western Cape could battle to find jobs or win promotions if employers there were to set the coloured quota at the national level of 11%.
The EE Bill retains the current EE Act provision entitling employers to take account of both national and regional demographics. However, it also undermines this by allowing the minister of labour to limit reference to regional demographics by means of regulation, outside of parliamentary scrutiny – and without public debate or even awareness.
2. Broad-Based Black Economic Empowerment Amendment Bill of 2012
The BEE Bill introduces three main changes. It lays down heavy penalties for fronting or exaggerating empowerment credentials, defines fronting in an extraordinarily broad manner, and gives the task of investigating fronting to a new BEE commission.
Background to the BEE Bill
BEE is currently mainly governed by the Broad-Based Black Economic Empowerment Act of 2003 (the BEE Act), along with the generic codes of good practice (the codes). BEE rules seek to give increased economic opportunities to ‘black’ people, defined as Africans, coloured people, and Indians.
The generic codes apply to firms in all sectors of the economy, unlike the various sectoral charters which have been negotiated by stakeholders within specific sectors and which apply solely within those spheres. The current generic codes were gazetted by the Department of Trade and Industry (DTI) in February 2007 and entered into force in August 2008. (A new version of the generic codes was gazetted in October 2013, as described below.)
Since BEE is supposedly voluntary, no formal penalties apply for failure to meet the compliance targets laid down in the codes. However, firms with poor BEE scores are likely to be barred from government contracts and may battle to obtain necessary licences or permits from the State. In addition, since firms can earn additional BEE points by procuring goods and services from other companies with good BEE scores, all enterprises are under pressure to seek high BEE scores. Conversely, firms with low BEE scores may find themselves left out of procurement chains and battling to do business at all.
Soon after Mr Zuma came to power in 2009, the minister of trade and industry, Rob Davies, began to warn that many firms were trying to reduce or avoid their BEE obligations by ‘fronting’ or exaggerating their BEE credentials. In addition, fronting mechanisms were becoming more sophisticated and thus more difficult to detect, he said. Hence, steps would have to be taken to criminalise fronting and help bring it to an end. This is the key purpose behind the BEE Bill, even though fronting which amounts to fraud is already a crime under the common law.
Prohibition of fronting:
The BEE Bill defines fronting in extraordinarily broad terms to encompass any ‘transaction’ or ‘conduct’ that ‘directly or indirectly undermines or frustrates the achievement of the objectives’ of the 2003 BEE Act. Certain fronting practices are also expressly barred. These include:
Under this broad wording, appointing an inexperienced black manager and then failing to give him the same remuneration as a white male with long years of experience, could count as fronting. So too could a firm’s failure to incubate its BEE start-ups and turn them into successful enterprises.
Penalties for fronting
Any person who ‘knowingly’ engages in a fronting practice is ‘guilty of an offence’. The definition of ‘knowingly’ is met where a person either has ‘actual knowledge’ of a particular matter or ‘ought reasonably’ to have had actual knowledge.
Any person convicted of fronting may be punished by a fine, imprisonment for up to ten years, or both. If the person convicted is ‘not a natural person’, then ‘a fine not exceeding 10% of its annual turnover’ will apply. ‘We want to see culprits behind bars,’ says Sandile Zungu, a member of the presidential advisory council on BEE. ‘Fronting penalties should include imprisonment of both shareholders and directors.’ (The BEE Bill does not expressly refer to shareholders being punishable in this way, but its penalties apply to ‘any person’ found guilty of fronting – and this wording could perhaps be wide enough to include shareholders, as Mr Zungu recommends.)
Once the BEE Bill is enacted into law, it will be the first time since 1994 that jail sentences will be available for a failure to meet empowerment targets.
A new BEE commission
The BEE Bill also seeks to establish a Broad-Based Black Economic Empowerment Commission (the commission) to investigate fronting, among other things. (This will be a new body, in addition to the Broad-Based Black Economic Empowerment Advisory Council for which the 2003 BEE Act provided from the start, but which was not established until December 2009.)
The new commission is to operate under significant ministerial control, for its head will be appointed by the minister of trade and industry, in consultation with the relevant portfolio committee in Parliament, for a five-year term. The minister has sole discretion to re-appoint any commissioner for a further five-year period. In addition, the minister will be able to dismiss the commissioner for ‘undermining the integrity or standing of the commission’ or on ‘any other legitimate ground’, while the commission will be subject to ministerial ‘directives of a general nature’ in the performance of its functions. In practice, these provisions are likely to trump a clause stating that the commission ‘must be impartial and perform its functions without fear, favour, or prejudice’.
In investigating fronting, along with any ‘complaints relating to BEE’, the commission will be able to issue summonses, subpoena documents, and interrogate witnesses and alleged offenders. It will also be able to decide for itself on ‘the format and procedure to be followed in conducting any investigation’. The Bill is silent as to what evidentiary rules it must follow and what standard of proof it will apply. The commission’s decisions could, however, be challenged if they do not comply with the basic principles of administrative justice (such as audi alteram partem, or hear the other side) laid down in the Promotion of Administrative Justice Act of 2000.
Based on such evidence as it decides to muster, the commission will be able to ‘make a finding as to whether any BEE initiative involves a fronting practice’. This could cause firms great reputational damage, if nothing else. Since fronting is a crime under the BEE Bill, the commission will also be obliged to refer the matter to the police and the prosecuting authorities for further action.
3. The revised generic codes
The revised generic codes restructure the existing components or ‘elements’ of BEE, while identifying three of these as ‘priority’ elements. They also require firms to put great effort and resources into developing 51% black-owned businesses. In addition, they make it much harder – especially for small businesses – to earn good BEE scores.
Background to the revised codes
The current generic codes require businesses with annual turnover exceeding R35m to comply with seven elements of BEE. Firms with annual turnover between R5m and R35m are expected to comply with four out of the seven elements, but may choose for themselves which these four should be and disregard the other three. Firms with annual turnover of less than R5m are exempt from BEE obligations.
The current generic codes have long been criticised in the media – and also by some within the ruling African National Congress (ANC) and its allies in the Congress of South African Trade Unions (Cosatu) and the South African Communist Party (SACP) – for giving too much emphasis to the ownership element of BEE. This element aims at transferring 25.1% of the equity or assets in firms to black South Africans. The BEE ownership deals done to date have been valued at some R600bn, and have helped transfer great wealth to a small group of people, many of whom have close ties to the ANC, Cosatu, or the SACP.
The current generic codes have also been castigated by several BEE proponents as being too easy to implement, like ‘an exam which is easy to pass’ (in the words of Duma Ggubule, a BEE analyst). The revised codes are thus intended to make it significantly more difficult to earn BEE points.
Seven elements reduced to five
The revised codes reduce the seven current elements of BEE to five, a shift which has been achieved by combining some of the present elements. Management control has thus been combined with employment equity to generate a single new element called management control. Similarly, preferential procurement and enterprise development have been combined into one element called ‘enterprise and supplier development’. None of the existing elements has in fact been removed, for the two ‘fewer’ elements have simply been incorporated into those that remain.
Compliance thresholds
Under the current codes, ‘exempt micro enterprises’ are defined as those having less than R5m in annual turnover and are exempt from having to comply with BEE rules. Under the revised codes, the threshold for exemption has been doubled, exempt micro enterprises now being defined as firms with annual turnover below R10m.
Under the current codes, ‘qualifying small enterprises’ are defined as those having annual turnover between R5m and R35m, while firms with annual turnover above R35m are regarded as larger enterprises. Under the revised codes, these thresholds have also changed, for qualifying small enterprises are now defined as firms having annual turnover of between R10m and R50m, while larger enterprises are those with annual turnover exceeding R50m.
Though these increases in the relevant thresholds might appear to reduce the burden of BEE compliance, they are also largely in line with inflation since 2007. In addition, qualifying small enterprises now have to comply with all five BEE elements (effectively, with all seven), rather than being able to choose four out of seven.
Priority elements
Ownership, skills development, and enterprise and supplier development are all identified as ‘priority’ elements on which firms are expected to attain at least a ‘40% sub-minimum’ of the various requirements laid down. Qualifying small enterprises must attain this 40% minimum on the ownership element, plus one of the two other priority elements, failing which their ‘level of BEE contribution’ will be reduced by one level. Larger enterprises, with annual turnover exceeding R50m, must meet the 40% minimum on all three priority elements or suffer the same penalty. (Under both the current and revised codes, there are eight levels of BEE contribution, ranging from ‘level one’, the highest – for firms with 100 or more points, a perfect score – to ‘level eight’, the lowest, for firms whose BEE compliance is minimal.)
Key requirements under each element
The key compliance requirements for each of the five elements of BEE are set out below. These elements are dealt with in the order in which they appear in the revised codes.
Ownership
Though the target remains at 25.1%, all firms, including family-owned qualifying small enterprises, must now fulfil this quota, while 40% of the net value of this stake must immediately vest in BEE beneficiaries. If these requirements are not met, firms will have their level of BEE contribution reduced by one level.
Management control
Under both the current and revised codes, firms are expected to increase black representation to 50% at board level, 60% at executive and senior management levels, and 75% in the middle management sphere. At the junior management level, the new target under the revised codes is 88%, up from 80% at present. The representation of black women is expected to increase to half of each of these targets.
Skills development
The target for expenditure on skills development for black people is to double, from 3% of payroll under the current codes, to 6% of payroll under the revised codes. (This contribution is in addition to the skills development levy, currently set at 1% of payroll.) Firms must attain at least 40% of the points available to avoid having their level of BEE contribution reduced by one level.
Enterprise and supplier development
This element has three sub-elements: preferential procurement, supplier development, and enterprise development. On each of these sub-elements, a 40% sub-minimum requirement must be met for firms to avoid having their level of BEE contribution reduced by one level.
Preferential procurement becomes more difficult in that:
Supplier development is also more challenging in that:
Enterprise development is likewise more taxing for firms, as:
The stated aim of these requirements is to ‘help build South Africa’s industrial base’. However, the new rules are so onerous as to discourage fresh direct investment and give impetus to disinvestment by existing enterprises.
Socio-economic development
Under the revised codes, firms can score a maximum of five points for contributing 1% of net after-tax profit to socio-economic development. However, at least 75% of the targeted beneficiaries must be black, as under the current codes. In addition, contributions will have to be made ‘with the specific objective of facilitating income-generating activities for targeted beneficiaries’.
Under the current codes, qualifying small enterprises which choose to focus on this element can earn 25 points out of 100 for doing. Under the revised codes, qualifying small enterprises will at most be able to earn 5 out of 105 points for contributions which meet all the relevant requirements.
The revised scorecard
Under the current codes, a company which attains between 65 and 75 points out of the 100 points available is a ‘level four contributor’ to BEE. This gives it a ‘level of BEE recognition’ of 100%, which means that procurement from it counts in full – with every R100 spent on buying goods and services from it counting as R100 towards the BEE procurement points of the purchaser.
Under the new codes, the number of points needed to gain good BEE scores will increase significantly. Hence, a firm with a score of 65 points, which currently counts as a level four contributor with a level of BEE recognition of 100%, will drop to a ‘level seven’ contributor with a level of BEE recognition of only 50%. To regain ‘level four’ status under the new codes, such a firm will have to bring its score up to 80 points out of 105.
According to Keith Levenstein of EconoBEE, a verification agency, these changes will make it ‘100% more difficult for white-owned small businesses to maintain their current rating’. Small family businesses, in particular, will see ‘a dramatic drop in their scores’. Hence, ‘a company that was on level 3 could drop to level 8 or even into non-compliant status’, which might prompt many small companies to ‘give up on empowerment’.
Verification of BEE status
Under both the current and revised codes, an exempt micro enterprise is deemed to be a ‘level four contributor’ to BEE, thus giving it a level of BEE recognition of 100%. Under the new codes, both exempt micro enterprises and qualifying small enterprises which are 51% black owned will count as ‘level two contributors’ and will have a level of BEE recognition of 125%. This means that every R100 spent with such exempt micro enterprises and qualifying small enterprises will count as R125 in preferential procurement. In addition, exempt micro enterprises and qualifying small enterprises which are 100% black owned will be regarded as ‘level one contributors’ to BEE and will have a level of BEE recognition of 135%.
Neither exempt micro enterprises nor qualifying small enterprises will need to have their BEE status verified by an accredited ratings agency. Instead, exempt micro enterprises and qualifying small enterprises will have only to provide an annual sworn affidavit confirming their level of black ownership and their annual turnover (less than R10m in the case of an exempt micro enterprise, and between R10m and R50m as regards a qualifying small enterprise). Any misrepresentation of BEE status will be a criminal offence punishable under the BEE Bill, once this comes becomes operative.
Exempt micro enterprises and qualifying small enterprises which claim to meet these criteria will no longer have to spend money on verification and ‘proving that they are black’, as the DTI puts it. They will also have significant advantage over other firms in tendering for both state and corporate contracts. However, the new rules may also encourage enterprises to exaggerate their BEE status. Kate Moloto, chairperson of the Association of BEE Verification Agencies (Abva), says the new provisions will ‘open the floodgates to fronting’. She also questions whether the investigative commission to be established under the BEE Bill will have the capacity to probe all the cases of fronting likely to arise.
Implications of the new codes
The raising of the thresholds at which BEE compliance is required (from R5m to R10m, for an exempt micro enterprise, for instance) might suggest a degree of liberalisation under the revised codes. However, the increases in the relevant thresholds are largely in line with inflation over the past decade.
In addition, the revised codes will increase the pressure on all firms with turnover exceeding R10m – many of which are small or family-owned businesses – to meet ambitious BEE ownership targets. All companies will also find it significantly more onerous to gain and retain good BEE scores under the new rules, while qualifying small enterprises will enjoy few benefits compared to larger companies with annual turnover exceeding R50m.
An example of potential costs and penalties
The potential costs and penalties arising from the EE Bill, the BEE Bill, and the revised codes may be estimated as follows for a qualifying small enterprise which was previously able to avoid doing a BEE ownership deal by focusing on other elements of BEE.
Assume this is the first year in which the new rules apply, and that the qualifying small enterprise operates in the catering and accommodation sector, has assets worth R10m, turnover in that year of R20m (making it also a designated employer under the EE Bill), pre-tax expenses of R18m, gross income of R2m, a tax bill of R0.56m, and net after-tax profit of R1.44m. It is also trying to maximise its BEE points to retain the government business on which it largely depends.
| Element | Potential cost or penalty |
|---|---|
| Ownership | 25.1% of assets of R10m is R2.51m, of which 40%, or R1 004 000, must immediately be discounted for the benefit of BEE investors to give them 40% net value, free from debt. |
| Management control | The costs of meeting the target of 60% black senior management are not easily quantifiable. If this target is not met, the potential fine under the EE Bill for a first offence is R1.5m or 2% of annual turnover, whichever is the greater. Up to R1.5m would thus be payable, and a fine of R450 000, for example, might be imposed. |
| Skills development | 6% of an annual payroll of R14m, amounting to R840 000. |
| Supplier and enterprise development | 3% of R1.44m, or R43 200. The compliance and opportunity costs of increasing preferential procurement to 80%, mainly from exempt micro enterprises, qualifying small enterprises, and 51% black-owned firms, are difficult to quantify. |
| Socio-economic development | 1% of R1.44m or R14 400. |
| Potential total for year 1 | R2 351 600 (including the discounted net value of the BEE ownership stake and assuming a R450 000 fine under the EE Bill). |
If the business is also found guilty of fronting – say, for appointing a black manager and not giving him the same salary as a more experienced white counterpart – a further fine of up to 10% of annual turnover (ie R2m) could be payable under the BEE Bill. In addition, jail terms of up to ten years could be imposed on any person who knew, or ought reasonably to have known, of this ‘fronting practice’.
These costs and potential penalties leave aside the management time and effort that must go, not into the running and expansion of the business, but rather into:
The only relatively simple BEE task will be in deciding where to allocate the R14 400 that must go to approved socio-economic development projects with 75% black beneficiaries and an emphasis on increasing ‘income-generating activities’.
Damaging the poor majority
Far from providing redress for apartheid’s wrongs, the pending shifts in employment equity and BEE rules will damage the poor majority by introducing fines, potential prison terms, and overall compliance costs which are high enough to drive many small firms out of operation. This will reduce jobs, add to the crisis of unemployment, and deter entrepreneurship and investment.
Like other affirmative action policies around the world, the tightening up of the rules is being pursued by a narrow elite which is effectively using the suffering of the truly disadvantaged to garner increased preferences for itself. However, even this elite would benefit far more from rapid economic growth and the huge demand that this would generate for their scarce skills. The poor majority, who suffer the most from the ongoing effects of apartheid injustices, would also be far better served if the ruling party were to abandon its fixation with redistribution and racial engineering – and focus single-mindedly on promoting economic growth for the benefit of all.
Anthea Jeffery
Head of Special Research 12 November 2013
