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The Modified Flow-Through Principle – Beware of getting it wrong!

The Modified Flow-through Principle is a special provision in statement 100 par 3.4.3.1 of the codes that reads: “Where in the chain of Ownership, Black People have a flow-through level of participation of at least 51%, and then only once in the entire ownership structure of the Measured Entity, such Black participation...

The Modified Flow-through Principle is a special provision in statement 100 par 3.4.3.1 of the codes that reads:

“Where in the chain of Ownership, Black People have a flow-through level of participation of at least 51%, and then only once in the entire ownership structure of the Measured Entity, such Black participation may be treated as if it were 100% black.”

This means that if a measured entity has a legal entity (other than a natural person) as part of its ownership structure and if such entity is at least 51% black-owned, such entity (and only one such entity in the entire ownership structure) may be deemed to be 100% black-owned. What many don’t realise however is that this provision has only one very specific purpose which is clear from statement 100 par 3.4.4 which reads:

“The Modified Flow-through Principle may only be applied in the calculation of the indicators in paragraphs 2.1.1 and 2.2.1 of the Ownership scorecard. In all other instances the Flow-through Principle applies.”

The sole purpose of the Modified Flow-through Principle is to enhance a measured entity’s score on two of the indicators on the ownership scorecard. It is primarily large enterprises (above R50m annual turnover) that will adopt the ownership scorecard. Most qualifying small enterprises (QSE’s) are opting to implement 51% black ownership to qualify for an automatic Level 2 status. Many such QSE’s have been wrongly advised to use the Modified Flow-through Principle to achieve 51% black ownership. It is however illegal to use this principle for anything other than its intended purpose. It would be a misrepresentation claiming to be 51% black-owned having applied the Modified Flow-through Principle. In the light of the above, many measured entities will now have to urgently rectify their ownership structures to comply with legislation. We recommend that a company that has acted in good faith on ‘professional advice’ and have incorrectly applied the Modified Flow-through Principle, should immediately take the necessary steps to rectify its structure with the necessary expert assistance.

On 31 March 2017 in its Practice Guide No 1 of 2017, the B-BBEE Commission confirmed this interpretation as follows:

“Therefore, the B-BBEE Commission in accordance with the requirements to advise on the interpretation of any provision of the Act as per section 13F(1)(a) and (3)(b) (ii) of the B-BBEE Act, hereby concludes that the modified flow through principle cannot be used to benefit from the enhanced recognition status reserved for 51% and 100% black owned EMEs and QSEs. Any contrary advice would be regarded as a misrepresentation of the entity B-BBEE status which is an offence in terms of section 13O (1) (a) of the Act.”

The Codes define a “51% black-owned” entity as an entity where a) black people hold at least 51% of the exercisable voting rights as determined under Code Series 100; b) black people hold at least 51% of the economic interest as determined under Code Series 100; and c) has earned all the points for Net Value under Code Series 100.

From the above definition it is clear that applying the Modified Flow-through Principle to achieve 51% black ownership when in fact the company will be effectively only 26% black-owned, is a serious misrepresentation.

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