During 2007 Hudaco entered into a leveraged empowerment transaction that enabled empowerment shareholders to acquire a 15% unencumbered interest in the main operating subsidiary, Hudaco Trading Pty Ltd. (“Hudaco Trading”) with Hudaco Industries Ltd., (the listed company) retaining the remaining 85% interest. A key objective of the empowerment transaction was to introduce the empowerment shareholders in such a way so as to avoid the need for them to have to borrow money on onerous terms wherein their ability to repay such debt would have been dependent on the receipt of dividends from Hudaco Trading or the increase in the value of their shares in Hudaco Trading. The structure of the empowerment transaction meant that the empowerment shareholding was sustainable and was not dependent on the economy tracking upwards or a constant dividend flow to settle the purchase price.
In implementing the empowerment transaction, Hudaco Trading acquired most of the operating businesses from the old Hudaco structure. Hudaco Trading funded the purchase price through the issue of a R2.2bn subordinated debenture held by a company within the Morgan Stanley group. The proceeds of the sale were placed in a ring-fenced subsidiary, Barbara Road Investments Pty Ltd. (“BRI”), part of the old Hudaco structure, and invested in preference shares in a company within the Cadiz Financial Services group.
The corporate advisor of Hudaco to the transaction was BES. They inter alia arranged the participation by Morgan Stanley and facilitated the preference share investment that was made by BRI with the Cadiz group. The Hudaco management at the time sought extensive expert advice as to whether these transactions would stand up to tax scrutiny. They were advised by, amongst others, senior counsel that it would do so. In the process it was indicated that, whilst not fatal to the ultimate tax consequences of the transaction, round-tripping should be avoided. Pursuant to this advice, Hudaco ensured that the mandate given to the Cadiz group provided that the Cadiz group was not permitted to invest any of the funds with Morgan Stanley. In addition, BES confirmed in a letter to Hudaco that, to the best of their knowledge, there was no flow of cash arising from the money invested by BRI with the Cadiz group to any member of the Morgan Stanley group and that the cash would ultimately be used to purchase government bonds issued by the South African Government. BES received a fee from Hudaco for acting as the corporate advisor to the empowerment transaction.
To the great surprise of Hudaco, SARS informed it in November 2012 that, after extensive investigations both locally and internationally, SARS had uncovered a highly elaborate web of arrangements that were established at the time by various Bravura-related entities, individuals related to BES and its associates (“the Bravura Transactors”). The investigations of SARS revealed that the Cadiz group immediately invested the proceeds from the preference shares issued to BRI with one of the Bravura Transactors. The funds were thereafter transferred through means of a number of local and international entities such that government bonds were indeed ultimately purchased. However, these government bonds were given as out-and-out security to Morgan Stanley, which sold them on the same day that they acquired the debentures issued by Hudaco Trading. This effectively means that the funds flowed in a circular fashion and that no real external funding was introduced by any third party. These facts were not known to Hudaco at the time.
The investigation by SARS revealed that, pursuant to the role played by the Bravura Transactors, interest was effectively converted into preference dividends, apparently without significant tax being paid in any country. Had the transaction run over its intended ten-year life, the difference between the amounts that were received by these entities and the amounts they would have paid would have been approximately R300 million. Over the period that the circular structure was in place, Hudaco paid out about R180 million more than it received back. That money needs to be accounted for.
BES prepared the brief to the tax advisors at the time on behalf of Hudaco and Bravura representatives, including their executive directors, attended meetings Hudaco had with senior counsel. At no time during these meetings or in the copious briefings was any reference made to the complex structure that existed behind the investment in preference shares issued by the Cadiz group company or to the role played by the various Bravura Transactors.
During February 2013 SARS issued revised assessments against BRI for the years ended 30 November 2007 to 2011 on the basis, amongst others, of the transactions being simulated and falling foul of the general anti-avoidance rule. The basis relied upon by SARS for the revised assessments was described in detail in a SENS announcement at the time and in results announcements and integrated reports thereafter. After receiving these assessments, Hudaco took steps that resulted in the termination of the financing arrangements on 28 February 2013. At 31 May 2014 the contingent liability for the worst case scenario, including penalties and interest up to that date, was disclosed at R1.4 billion.
The Hudaco board recognised that, as a result of the role of the Bravura Transactors, which included the use of special purpose vehicles with no apparent commercial role but to effectively convert interest into exempt preference dividends and to provide cross security, there were significant risks associated with the transaction that were not apparent at the time the transaction was entered into in 2007. These included so-called round tripping and simulated transactions. Furthermore, having the tax challenge hanging over Hudaco for an extended period had been a negative factor for Hudaco in many aspects of its activities and for its shareholders. The Hudaco board believed that there was considerable value in having the matter closed.
In discussions with BES after the issuing of the assessments against BRI, the existence of the wider funding transaction was confirmed. After constructive discussions with SARS, a compromise was reached whereby the parties agreed that Hudaco would pay in full and final settlement, an amount of R312 million in respect of the tax challenge to the financing arrangements for the empowerment transaction, up to and including the termination of these financing arrangements in 2013. R120 million had already been paid under the “pay now, argue later” provisions and the balance of R192 million was paid by 31 March 2015. It is important to note that Hudaco Trading’s BEE shareholders were not affected by this settlement and that Hudaco Trading’s BEE credentials remained in place.
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