The Franchise Industry : a more complicated tax landscape than perceived at first glance

• Jurisdiction: South Africa
• Author: Jenna Mason,Lesley Isherwood
• DOI: 10.10520/EJC190600
• Published date: 01 June 2016
• Date: 01 June 2016
• Pages: 17-24
• Published By: Siber Ink

17

© SIBER INK

The Franchise Industry:

A MORE COMPLICATED TAX LANDSCAPE THAN

PERCEIVED AT FIRST GLANCE

JENNA MASON1 • LESLEY ISHERWOOD2

ABSTRACT

The South African franchise industry is growing at a rapid rate. Against this

backdrop, SARS has issued a Draft Guide on the Taxation of Franchisors and

Franchisees. 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 Draft Guide are generally well-established

and undisputed. However, in practice, often payments under franchise agree-

ments 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(f) of the Income Tax Act is discussed, specifically

in the context of what constitutes a ‘premium’ as considered by our courts.

To claim a ‘premium’ in terms of section 11(f) 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 deter-

mined 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.

1

Senior Manager, KPMG Tax & Legal.

2

Associate Director, KPMG Tax & Legal.