Addressing the Paradox of Broad-Based Black Economic Empowerment (BEE) through ESOP Trusts

1. The 2005 Budget&Black Economic EmpowermentProf RC WilliamswilliamsR@ukzn.ac.za

2. Everyone agrees that - • BEE is vital to the political & economic future of the country • BEE should be broad-based • the best (perhaps the only) way of achieving broad-based BEE is via Employee Share Ownership Plans (“ESOPs”)

3. COMPANY employee shareholders

4. The 2005 Budget Review is silent on new BEE initiatives other than company restructuring. The Revenue Laws Amendment Act 32 of 2004, promulgated in January 2005, introduced significant tax relief for certain BEE arrangements

5. Namely a new section 8B by which • the employer company gets a tax deduction for the market value of shares issued in a qualifying BEE share plan • the recipient employee is not subject to income tax on the value of the shares if he keeps them for at least five years

6. Section 8B is a move in the right direction; for it accepts that - • ESOPs are a valuable means of achieving broad-based BEE • tax incentives have a part to play in encouraging such BEE-ESOPs

7. BUTsection 8B does not accommodate the paradoxes inherent in BEE – ESOPsandthe 2005 Budget foreshadows no remedial action in this regard

8. The paradoxes of BEE - ESOPs • BEE focuses (though not exclusively) on putting ownership of business assets in the hands of black persons • BEE – ESOPs seek to achieve this by giving the ordinary worker shares in the employer company

9. BUT • the ordinary worker does not want shares • he / she desperately needs more cash in their pocket • and will in all likelihood sell the shares as soon as possible, or at least as soon as the prescribed 5 year period is over

10. Workers may well try to convert the section 8B shares into cash immediately • if the recipient worker is on a low marginal rate of income tax, the income tax bite on sale will be small; tax is no deterrent to sale • the Income Tax Act does not prevent the shares from being immediately pledged to money-lenders, or attached by creditors

11. Once the recipient worker sells the share • the BEE objective of the share issue is nullified • except in the (unlikely) event that the worker sells the share to another worker

12. It’s no use trying to “educate” workers to hold onto their BEE shares because - • for a poor person, selling (and getting cash in hand) is a sensible, rational decision because - • he/she needs cash now for the necessities of life and the support of the family

13. If BEE ESOPs are to succeed in keeping “ownership” of equity in the hands of workers in the long-term, then - • the shares will have to be held, for the workers’ benefit, in a trust • with the workers being paid out the value of the shares on retirement, retrenchment, disability, death, etc

14. This may seem patronising But it is the only way of resolving the paradox • that BEE requires that workers own shares, • but that workers do not actually want shares

15. If BEE – ESOP shares could be held in trust, then over a period of time, the snow-balling effect of regular new share issues would mean that these trusts would come to hold assets of very substantial value

16. and trustees could utilise the trust’s dividend and other income to provide many “empowering” benefits to the workers collectively such as - • health clinics • creches and pre-schools • recreational facilities • bursaries

17. As section 8B of the Income Tax Act stands at present, however, the tax benefits of shares in BEE ESOPS areavailable only in respect of shares which - • are “acquired by the employee” [which rules out their being held in trust]

18. Further legislative amendments are thus required to - • allow shares in a BEE ESOP to be held for the workers’ benefit in a discretionary (non-vesting) trust; • provide for the direct issuing of such shares to qualifying trusts; • provide that the cash value of the shares held in trust is to be paid to workers only in the long term, ie on retirement, retrenchment, disability, death,etc

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