Call for Action: Draft Guide on the Taxation of Franchisors and Franchisees

The South African Revenue Service (SARS) has issued a draft guide on the Taxation of Franchisors and Franchisees. The guide was released on 7 January 2016 and will close for comments on 12 February 2016.

The guide is limited to the income tax consequences of franchise arrangements for resident franchisors and franchisees but covers the tax treatment of a number of payments which are made under these arrangements. A summary of the payments covered as well as the recommended treatment set out in the guide are contained in the table below:

Nature of the amount Tax treatment for Franchisors Tax treatment for Franchisees
Creation, acquisition or use of intellectual property Expenditure is capital in nature. Deductions or allowances may be available under section 11(gB), section 11(gC) and section 11(gD) of the Income Tax Act.
License fee for obtaining the right of use of the franchisor’s intellectual property. The fee could be included as part of the initial franchise fee or paid on a monthly basis in addition to the royalty payments Not specifically covered in the guide but will likely be regarded as gross income. Expenditure is capital in nature and therefore not tax deductible.
Initial franchise fees payable for obtaining the right of use of the franchisor’s intellectual property and business processes. Amounts received to be included in gross income.
Costs incurred in drafting franchise agreements are tax deductible.
Expenditure is capital in nature and therefore not tax deductible regardless of whether the amount is payable as an upfront fee or monthly fee.
Royalty payments for the ongoing use of the franchisor’s intellectual property and business processes. Amounts received to be included in gross income. Expenditure will be deductible in most instances.
Renewal Fee to extend franchise agreement. Amount is regarded as being similar to the initial franchise fee and would therefore be included in gross income. Amount is regarded as being similar to the initial franchise fee and would therefore be a non-deductible capital expense.
Compensation paid by a franchisor for early termination of a franchise agreement in order to replace the franchisee with a more competent franchisee Payment would be regarded as tax deductible. Amount received would, in most instances, be regarded as a receipt of a capital nature.

The capital gains tax consequences arising from the disposal of the franchisee’s rights under the franchise agreement must be considered.

Compensation paid by a franchisor for early termination of a franchise agreement in order to incorporate the franchisee’s operations into its own operations. Payment would be regarded as a non-deductible capital expense. Amount received would, in most instances, be regarded as a receipt of a capital nature.

The capital gains tax consequences arising from the disposal of the franchisee’s rights under the franchise agreement must be considered.

Compensation paid by a franchisee for the early termination of a franchise agreement. Tax consequences will be dependent on whether the payment is intended to compensate the franchisor for loss of royalties (the amount would be included in gross income) or to compensate the franchisor for the loss of an asset (the amount would be capital in nature). Payment would in most instances be regarded as a non-deductible capital expense.

The capital gains tax consequences arising from the disposal of the franchisee’s rights under the franchise agreement must be considered.

Penalties for breach of contract Amount received will generally be of a revenue nature and included in gross income. Amount will be deductible provided the requirements of the general deduction formula are met.
Advertisement fees Receipt of amounts will generally be included in gross income with a deduction being claimed as and when amounts are expended on promotional activities. Payments will generally be tax deductible.
On-going training fees Receipt of amounts will generally be included in gross income with a deduction being claimed as and when amounts are expended on training activities. Payments will generally be tax deductible.
Restraint of trade payments No deduction will be permitted unless the payment is made to a natural person and that payment is or will be included in that person’s income.

Any deduction which is allowed will be spread over the lesser of three years or the period over which the restraint applies.

Receipt will generally be of a capital nature.

Payments received by a natural person would, however, be included in gross income if it relates to the person’s past, present or future employment or holding of an office.

KPMG will be submitting comments on the guide along with recommendations to extend the contents of the guide to include cross-border arrangements (both inbound and outbound payments for franchisees and franchisors alike) and indirect tax considerations (such as VAT and Customs issues). It is important for the industry to make submissions on those areas which are contentious from a tax perspective, or any aspect of the draft guide which may not correctly reflect industry norm or practice. Failure to do so, could lead to the guide being issued in final.

The guide can be accessed via this link.

Should you wish to comment on any of the above or wish to have any additional aspect included in the guide, please feel free to contact us:

Muhammad Saloojee

Partner, Corporate Tax

M:  +27 (0)78 339 1454

E:  Muhammad.Saloojee@kpmg.co.za

Jenna Mason

Senior Tax Manager, Corporate Tax

M: +27 (0)63 682 1387

E: Jenna.Mason@kpmg.co.za

 

 

Lesley Isherwood

Associate Director, Corporate Tax

M: +27 (0)82 719 5523

ELesley.Isherwood@kpmg.co.za

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