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How tax burdens can be reduced for franchisees

By Andre van Wyk

In November 2017 the Tax Court found in favour of a franchisee which could reduce the tax burden on many franchisees.

Two main principles in tax law

The two main principles in tax law are:

 

  1. All income received or accrued is taxable (subject to certain exceptions); and
  2. Only expenses already incurred in the production of taxable income is deductible from that income.

Why was Section 24C introduced?

The above-mentioned principles in tax law cause a dilemma in contracts which span more than one year, for example construction contracts:

  • The contractor receives an amount upfront but the expenses only arise in following years;
  • The upfront payment is fully taxable in the year it is received or invoiced, but may not have incurred expenses yet;
  • This could cause an unfair tax burden
Therefore, Section 24C was introduced to allow a taxpayer, in certain circumstances, to deduct an estimated future expense from monies received in advance.

You may now wonder how this applies to franchisees?


On 3 November 2017, the Tax Court (IT14240) found that the taxpayer (a franchisee) may apply a deduction for future refurbishment costs from current year income, where he has a contractual obligation to the franchisor to do the refurbishment in a future, by applying the terms of Section 12C.

This allowed him to:

  • calculate the cost per meal of the estimated cost to refurbish in future. For example if the cost is R1 million to refurbish in future and there is an estimated 2 million meals until refurbishment then the refurbishment cost per meal is 50 cent
  • if he sells 200,000 meals in the current year a deduction of R100,000 can be made from the current year taxable income,
  • resulting in a tax saving.

It is very important that when applying a court case that you follow the same principles

In this case the franchisee owned restaurants under a franchisee agreement and cannot operate the restaurant unless he complies with the franchise agreement. In terms of this agreement he has to upgrade the restaurants at reasonable intervals, as determined by the franchisor. The franchisee therefore has to have an obligation placed on him by the franchisor, before Section 24C applies. It cannot be optional or discretionary. The wording of the franchise agreement is therefore very important in this case.

Always consult a qualified tax practitioner

This ruling can have a tax benefit to many franchisees, but it is important to consult with a qualified tax practitioner when applying tax law and practices, as there are many factors to consider.

About the author

Andre van WykAndre van Wyk is a chartered accountant and owns his own practice - Acrux and specialises in the accounting and tax needs of small businesses.