By Andre van Wyk
In the past there was uncertainty if initial franchise fees could be deducted from the taxable income of a franchisee. This is a large cash outlay for a new franchise and not getting the tax benefit would be detrimental to a new franchisee. SARS have recently made a ruling which has clarified the deduction of an initial franchise fee in favour of franchisees.
Income vs Capital
One of the main principles in tax law is that only expenses in the production of income and not of a capital nature are tax deductible. The difference between capital and income is one of the most difficult tax issues and there have been many court cases over the years.
A capital item is normally consumed over a number of years and can often be sold second hand. A good example of the difference between capital and income in a food franchise is set out below:
|Tax deductible expenses||Capital expenses (not automatically deductible)|
|· Rent· Salaries and wages
· Raw food
|· Rental deposit· Shop fitting
· Kitchen equipment
In principle the cost of kitchen equipment is not tax deductible as it is of a capital nature, however, tax law has made special concessions for certain capital items where wear and tear can be claimed as a tax deduction.
Initial franchisee fee
Until now there was been confusion whether initial franchise fees could be deducted from income when determining ones tax liability. A strong argument could be made that it is capital in nature and would therefore not be tax deductible at all!
With Binding Private Ruling BPR 285, SARS have given clarity in favour of franchisees allowing them to claim the initial fee pro rata over the period of the initial agreement and renewal fees over the period of the renewal period in terms of section 11(f) of the Income Tax Act.
For example, if the franchisee paid an initial fee of R150,000 at the start of a five-year franchise agreement he can now reduce his taxable income with R30,000 each year of the agreement.
Consult a tax practitioner
Franchisees are encouraged to use registered tax practitioners when considering or applying tax issues as the above is a simplified summary of this issue.
About the author
Andre van Wyk is a chartered accountant and owns his own practice – Acrux and specialises in the accounting and tax needs of small businesses.