The South African Broad-Based Black Economic Empowerment (“B-BBEE”) Commission recently issued a non-binding practice guide regarding the enhanced recognition status for exempted micro-enterprises (“EMEs”) and qualifying small enterprises (“QSEs”) through the application of the modified flow-through principle. 

In terms of the current Codes of Good Practice (the “Codes”), which are promulgated under the Broad-Based Black Economic Empowerment Act, 2003, as amended (the “Act”), EMEs and QSEs benefit from the enhanced recognition status principle, in that a 51% black-owned EME or QSE will qualify as a level 2 contributor and a 100% black-owned EME or QSE will qualify as a level 1 contributor, provided that such EME or QSE has completed a sworn affidavit confirming its turnover and percentage of black ownership. The Codes set out a number of rules stipulating how entities are to measure their black ownership, including:

• the flow-through principle: when measuring ownership of black people in an entity, only the rights of natural persons are relevant.  Where the rights of natural persons pass through a juristic entity or entities, then only the ownership rights of black persons in the juristic entity or entities are measurable; and 
• the modified flow-through principle: where a company in a chain of ownership is more than 51% black owned and controlled, then once in that chain of ownership, despite the flow-through principle, that company can be treated as being 100% black owned and controlled.

In terms of the practice guide, the B-BBEE Commission is of the view that the measurement of black ownership in an EME or QSE must be calculated using the flow-through principle only (and not the modified flow-through principle) in order to benefit from the enhanced recognition status. 

Interestingly, the B-BBEE Commission acknowledges that the Codes, as currently drafted, do not provide for such limitations in claiming any enhanced recognitions status. However, and despite such acknowledgment, the B-BBEE Commission is of the view that that the effect of applying the modified flow-through principle to the enhanced recognition status undermines the objectives of the Act. 

While the practice guide is intended to be non-binding, it notes that any contrary advice would be regarded as a misrepresentation of an entity’s B-BBEE status, which is an offence in terms of section 13O(1)(a) of the Act. Accordingly, it would appear that the practice guide is more of a “ruling” than a guide, and is perhaps indicative of the manner in which the B-BBEE Commission will evaluate and investigate fronting practices in relation to EMEs and QSEs. This also brings into question the legal validity of such a “ruling”, as it purports to amend legislation. 

Furthermore, the B-BBEE status/level of an EME or QSE benefiting from the enhanced recognition status through the application of the modified flow-through principle may be adversely affected in terms of its next B-BBEE verification.

For more information, please contact:

Sanjay Kassen

Corporate Commercial Director - [email protected] - cell: +27 82 561 1509

Parusha Desai Valodia

Corporate Commercial Associate - [email protected] - cell: +27 82 560 4129