Some considerations when defining a group structure in RSA

1. Shareholding does not necessarily entitle one to employment.

2. Directorship does not necessarily entitle one to share options/shares or profit share.

3. Incentivization of key employees and executives will usually depend upon achieving certain targets and/or KPI’s, and can include:

a. Shares (usually issued immediately)

b. Share options (delays the actual issue of shares until certain dates or criteria are met)

c. Profit share (% or value depending on definition)

d. Annual bonus like a 13th or 14th cheque (could be purely based on performance evaluations, or a combination of criteria).

4. The entity structure and the organization structure are two separate things, with the one not necessarily being a mirror or match of the other, and the one being mapped to the other based on (inter alia):

a. where the person is employed and/or

b. where work is performed and/or

c. where the person is paid from and/or

d. where costs need to be recovered from (and on what basis they are to be recovered = must be consistent and fair/sound/justifiable/reasonable).

5. In order to simplify matters, people should be employed where they work, and their incentives should be based on where they add value. Incentivisation need not be in the form of directorships or shares, as these have inter alia administrative/compliance, BBBEE and consistency implications.

6. On-charges are typically calculated based on a proportionate % of ‘contribution to overhead’ per entity (which translates into operating profit or gross profit), as this more closely determines an entity’s ability to carry and cover that overhead allocation as opposed to its turnover, as it might have lower relative gross margins. Activity-based costing allocation systems tend to be too cumbersome and contentious and costly to define, implement and maintain.

7. Organisation structures typically reflect reporting lines and areas of responsibility, whereas a group entity structure could be based on various other criteria, including:

a. Shareholding intentions

b. BBBEE considerations

c. Dividends

d. Income Tax

e. VAT

f. Regulatory compliance

g. Financing requirements

h. Asset ownership criteria

i. Geographic representation

j. Brand segregation and protection

k. Product lines

l. Business types

m. Staff and executive employment criteria, etc.

8. Directors’ and officers’ remuneration are potentially required to be disclosed at individual entity level where they are appointed, and so confidentiality is more difficult to contain when there are multiple legal entities in the group, each with their own AFS and disclosure requirements.

9. The ‘Reasonability Assessment’ is applied to all directors and officers at the time of making decisions, and so they can be held personally liable for any transaction or liability in any entity they are responsible for (the liability does not end at the legal entity level if the director or officer is found to have not applied the degree of skill, care and diligence that may reasonably be expected of a person carrying out the same functions and having the general knowledge, skill and experience of that person).

10. Assignment of authority levels and reserved matters and delegation thereof (including authorized signatories, payroll/EFT releasers and AFS signatories) needs to be carefully defined, as this does not necessarily match individual entity structures.

11. BBBEE:

a. The holding company shareholding has a waterfall effect cascading down into that of the wholly-owned subsidiaries in a group, and this is only diluted if any particular subsidiary is not wholly-owned.

b. A national holding company will use national demographics in its employment equity and training plans and measurements, whereas regional entities will use regional demographics. This can place additional administrative burdens on decentralized group entity structures.

12. Dividends:

a. Subsidiary entity PAT can be distributed to the holding company through dividends, which could attract dividends tax (exemptions apply, as well as solvency and liquidity tests).

b. Holding entity shareholders do not have access to subsidiary entity PAT unless it is paid up the line as a dividend. This creates an additional step of administration and possibly has cash flow effects.

13. Income Tax:

a. Individual entities are responsible for their own ITR14’s and provisional tax declarations, estimates and pay-overs. The greater the number of entities, the greater the possibility of human error and timing differences resulting in penalties, interest and negative cash flow implications.

b. The more complex a group structure is, the more SARS is likely to review submissions and returns to ensure that the group structure is not merely for tax optimization. This can thus result in more administrative expense (including lawyers, advisers, consultants and auditors) to (a) ensure all considerations are properly taken into account to avoid pitfalls, errors and omissions and (b) deal with the larger number of SARS queries, reviews, audits and disputes.

c. Inter-company transactions will all need to pass the test of being fully arms-length transactions by their nature, intent and value, and any markups and transfer prices are likely to be subject to SARS scrutiny. Any entity that incurs tax losses will be monitored for shifting business into it to reduce overall group tax liability, so such movements need to be properly evaluated and justified on the basis of sound commercial reasoning.

d. Any administration or management fees charged between entities need to be properly documented in agreements so as to stand up to SARS scrutiny to ensure that the details and intentions are not deemed to be tax evasion, and should include items such as incentive pay on-charges.

14. VAT:

a. Each legal entity will need to register for VAT, and the returns can be required monthly or bi-monthly, as well as annual reconciliations to tie up revenue declared to Output VAT and purchases/expenses and Input VAT. This could cause timing differences in cash flows between group subsidiaries, and additional administrative expenses.

b. The greater the number of VAT returns required to be filed, the greater the possibility of human errors that automatically attract non-refundable penalties and interest, as well as SARS reviews, queries and audits, that can attract additional costs of consultants and specialists.

c. If a person is paid through a paymaster entity, the employment contract is important in defining where the person is actually employed, as Output VAT must be raised when charging that person’s salary expense to another group entity if the person is employed in the paymaster entity (otherwise not, if he/she is employed in the charge recipient entity), and Output VAT must be charged on the paymaster entity recovering any payroll-related costs or expenses (as well as any administration or management fees if it is a shared services entity) from other group entities. These can result in timing differences in cash flows for VAT purposes, especially where the paymaster entity incurs no Input VAT on employee remuneration but raised Output VAT when charging these on (and potential VAT refund claims and queries in the entity receiving the charge)

15. Regulatory compliance:

a. Each legal entity will need to be registered with the CIPC, which attracts an annual fee and returns submission.

b. Each entity has company secretarial administrative requirements (minutes, resolutions, appointments, etc.).

c. Each entity will need a set of AFS prepared, and this will either be unaudited, reviewed or audited, depending on its public interest score, and these add administrative burdens and costs.

d. Forex and customs registration and compliance is at entity level.

e. Statistical returns (monthly, quarterly, bi-annual, annual) are required at individual entity level.

f. PAYE, UIF and SDL returns, reconciliations, submissions and payments are required at individual employment entity level.

g. Group directors and officers are responsible for compliance at all entities in the group, which places additional burden on them for corporate governance.

16. Arranging financing for individual entities can be administratively cumbersome for new entities or entities that are not cash flush, as the financing companies tend to look to the holding entity or shareholders for security accordingly.

17. Inter-company asset transfers need to be carefully considered for CGT implications as well as base cost tax deductability for tax allowances in the recipient entity.

18. Reporting requirements can be a key determination in either setting up the group structure or which ERP system to implement for the group or per entity. The ability to consolidate effectively, properly treating/eliminating and disclosing inter-company interests, balances, collaterals and transactions, as well as the ability to generate management accounts combining/with different views of entities, product lines, business types/channels/divisions and geographies can be really significant. Then, individual entity requirements also come into consideration, for example the need for MRP, budgets, forecasting, MPS, integrated costing systems, WIP accounting, cost centres, profit centres, allocations, etc.