Wrap Text
Initiation of legal proceedings by Hudaco for the recovery of secret profits and R312 million tax settlement
Hudaco Industries Limited
Incorporated in the Republic of South Africa
Registration number: 1985/004617/06
Share code: HDC
ISIN code: ZAE000003273
INITIATION OF LEGAL PROCEEDINGS BY HUDACO FOR THE RECOVERY OF
SECRET PROFITS AND R312 MILLION TAX SETTLEMENT RELATING TO
EMPOWERMENT TRANSACTION
1 The Hudaco group (“Hudaco”) has instituted legal proceedings against Bravura
Equity Services Proprietary Limited (“BES”) (part of the Bravura group (“Bravura”) in
South Africa), Cadiz Asset Management Proprietary Limited and certain other
entities within the Bravura and Cadiz groups as well as executives of the Bravura
group and certain former executives of the Cadiz group. These legal proceedings
are aimed at recovering alleged secret profits of R180 million and the payment
made by Hudaco to SARS in the amount of R312 million, in settlement of a
challenge under the general anti-avoidance rule, and pertaining to the financing
arrangements for Hudaco’s empowerment transaction, as announced in detail on
SENS on 23 January 2015. The grounds for the action include intentional
misrepresentation and/or negligence. The Hudaco board firmly believes that Hudaco
has been wronged, ultimately to the detriment of shareholders, and that from an
ethical perspective to seek redress is the right thing to do.
2 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 Proprietary Limited (“Hudaco Trading”)
with Hudaco Industries Limited, (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.
3 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 Proprietary Limited (“BRI”),
part of the old Hudaco structure, and invested in preference shares in a company
within the Cadiz Financial Services group.
4 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.
5 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.
6 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.
7 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.
8 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.
9 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.
10 In discussions with BES after the issuing of the assessments against BRI, the
existence of the wider funding transaction was confirmed.
11 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.
12 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.
Johannesburg
10 November 2015
Sponsor
Nedbank CIB
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