n Business Tax and Company Law Quarterly - The Franchise Industry : a more complicated tax landscape than perceived at first glance

Volume 7, Issue 2
  • ISSN : 2219-1585


The South African franchise industry is growing at a rapid rate. Against this backdrop, SARS has issued a . This article summarises the character of payments under franchise agreements as well as the recommended treatment as set out in the guide. The tax principles as set out in the are generally well-established and undisputed. However, in practice, often payments under franchise agreements are composite payments which are not broken down into the categories designated in the guide. This, coupled with the generic nature of the analysis within the guide, is discussed in this article, as well as the concerns raised from industry stakeholders that the tax implications as summarised in the guide are in reality far more complex than presented.

The article then goes on to highlight certain of the complexities not explored within the guide. Firstly, the deduction of initial franchise fees by franchisees under section 11() of the Income Tax Act is discussed, specifically in the context of what constitutes a 'premium' as considered by our courts. To claim a '' in terms of section 11() of the Income Tax Act, the franchisee would in the first instance need to evidence from the agreement what portion of the initial franchise payments relate to the ongoing right of use of the franchisors' intellectual property. Often franchise fees are not itemised in the standard agreement templates used by franchisors. To the extent such itemisation is agreed to by the franchisor, the franchisee would also be required to prove that the amount to be deducted is over and above the payments being made by the franchisee for the ongoing right of use of the intellectual property. This would require valuation and benchmarking exercises which the franchisee would again be reliant on the franchisors to provide. The ability of the franchisee to obtain the required information would therefore be determined by the franchisee's ability to place the matter on the agenda with the franchisor and the franchisor's appetite to support the franchisee in this regard, which it is submitted may prove unlikely. The article concludes that whilst there may be a foundational basis for such a deduction by a franchisee, in practice, the ability of the franchisee to obtain the required information and influence the terms and structure of the underlying franchise agreements to claim such a deduction may be difficult.
The deduction of royalty payments by franchisees is then discussed, again having regard to case law. It is concluded that whilst there may be a basis for the deduction, this will depend on the nature of the payment as evidenced in the underlying franchise agreements. A franchisee's ability to have the franchise agreement drafted to specifically itemise the composition of payments made in terms thereof and to reflect the true intention of the payment is questioned.
In addition, this article considers the need for tax incentives within the franchise industry and how such incentives may be structured, including deductions for franchisees of franchise payments or access by franchisees and franchisors alike to learnership allowances.

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