Licence To Be Recognised
03 June 2006
Posted by: Author: Michelle Swart
Licence To Be Recognised
By the time South Africa started to toy with the idea of franchising, the United States was already well under way with this concept and the success of such business ventures internationally was starting to appear more enticing to South African business owners.
Modern franchising, as we know it, became a legitimate business format with the emergence of a recognisable brand among consumers.Famous brands are recognised as symbols of quality, consistency, service and value.The continued success of franchising has become one of the dominant organisational forms of our times.
The ingenious aspect of the franchise system lies in its flexibility and adaptability to suit every continent, every lifestyle and any socio-economic situation.Previously international brands were the franchise giants, but today modest-sized, local businesses such as sandwich bars and cleaning services are all around us.Although the most popular franchise businesses are generally fast food industries, the trend has caught on to anything from the print industry to the car industry; from health services to business-to-business services.
It is worth noting that South Africa offers a business environment similar to that found in other top franchising countries.Local business owners can operate a branch office, a wholly owned subsidiary franchisor,a joint venture, or licence a master franchising agreement with a local partner.
Growing at a steady 13% annually in South Africa, the franchising sector is expanding into numerous business categories and it is predicted that franchising will soon account for 50% of all retail sales worldwide, making it a vital economic force and one of the dominant organisational forms of our time. Food franchising is still one of the most popular forms of franchising with brands ranging from the likes of Scooters Pizza,Fish Aways, King Pie and Butterfield to concepts like newly franchised Fruit & Veg City, Maxi’s and the revamped Ola Milky Lane and Juicy Lucy franchises.New concepts like Mozart Ice Cream, Mini Melts,Anat, Sandwich Baron and new pubs like The Brazen Head are also now franchising.
The inception of the Franchise Association of Southern Africa (FASA) came about 26 years ago, and the association has since represented franchisors, franchisees and the professional organisations that service the franchise industry.
As the only recognised, official representative body of the rapidly growing franchise industry, FASA’s aim is to ensure that its members practice ethical franchising and that it continues to develop and expand the business environment for franchising in South Africa.FASA is also a full member of the World Franchise Council.Membership is granted and controlled through a Code of Ethics and Business Practices to which all members subscribe.
In order to obtain franchisor membership, a thorough assessment of each applicant company is made before membership is granted.This would typically include a look at the viability of the concept as well as the presence of appropriate documentation,with the minimum requirements being a disclosure document that complies with FASA’s stringent specifications, a fair and reasonable franchise agreement that clearly reflects the character of FASA’s Code of Ethics and Business Practices and a comprehensive operations and procedures manual.The franchised concept must have also been in operation successfully for at least one year in South Africa.
The submission documents for membership must include a completed membership application form for franchisors, a franchise agreement, operations manual and disclosure document including financial statements of existing franchised outlets so that prospective franchisees can evaluate the financial viability of your concept.
A guideline on the required inclusions and format of an ideal Disclosure Document is available in the 2006 Franchise Directory,which can be purchased from the FASA offices.Also required is a member's declaration form, which must be printed on the applicant company's letterhead, duly completed and signed by the correct or relevant representative of the applicant's company.
The supplier/service provider membership is open to professional practices that wish to provide professional services of high ethical standards to the participants in the franchise sector.These include law firms,6 banks, insurance companies, franchise consultants, brand and marketing companies, IT companies, suppliers and many others.In order to complete your membership application, a service provider application form has to be completed,signed and submitted together with a member's declaration document.
All applications are forwarded to FASA's membership committee for comments and final approval, where applicable.The entire approval process takes between four and six weeks from date of submission depending on the number of questions or suggested amendments raised by the membership committee and the applicant's response time.The FASA website states that annual membership fees are R8200 plus VAT as well as a once-of f legal fee of R1800 plus VAT in respect of franchisor membership applications only.
Franchising is acknowledged globally as one of the most aggressive forms of business expansion. Potential franchisees open their businesses up to the same high profile benefits that some of the world’s most renowned brands enjoy.Some of the benefits of owning a franchise include use of the FASA logo and all relevant collateral, an entry into the Franchise Directory, members will be promoted among FASA’s existing member base and there are several networking opportunities for all members. Members will also participate in print campaigns undertaken by FASA and be provided credibility with banks, prospective franchisees, the public in general and the government.
Promotion of members will include Exhibitions in Johannesburg, Durban and Cape Town, member details are carried on the FASA web site and if a member has a web site, the FASA web site is linked to the member site.Furthermore, FASA is the mouthpiece for the Franchise industry and as such has close dealings with the Department of Trade and Industry, seda,SETA’s, the press and other bodies important to the franchise sector.
Always with the members best interests at heart, FASA acts as a watchdog on all new and planned regulations and/or legislation and amendments and evaluates its impact on its members in particular and the industry in general.
A new addition to FASA, according to the official web site, is the launched franchise funding partnership in conjunction with the African Development Bank (ADB).Piloted by ABSA, this partnership will have extensive benefits to both franchisor members and potential franchisees.Designed to promote franchising and facilitate the transfer of skills among entrepreneurs in the SME sector, it makes available R45-million in the form of deferred loans to prospective previously disadvantaged individuals (PDI) franchisees, while providing training and mentoring of the participating franchisees.
In South Africa there are 22 825 outlets with a total turnover per annum R 129,2bn (10.7%of GDP). (source: March 2006)
The total franchise fees payable (estimated 5% of turnover) is in approximately. R 6,46bn per annum. Going back five years (and adjusting the sum by 20% per annum), the total is approximately of R 21.71bn (average for the whole industry) franchise fees.According to tax lawyer Daniel Erasmus (see and the FASA Tax Seminar), if SARS start aggressively pursuing the principles in the very recent unreported ITC 11454 judgment (discussed below and at the FASA tax seminar) against all franchisees on their franchise fee payments, assuming they go back five years, (30% average tax rate), the franchise industry will suffer the following losses:
· R 6,51bn in back taxes to be repaid to SARS (R 275 000 per franchisee);
· R 13,02bn in 200% penalties(R 550 000 per franchisee);
· R 8,18bn in tax interest (R 360 000per franchisee);
· An estimated total of arrear taxes of R 1,185m per franchisee.
(Calculations based on estimates for illustrative purposes only.)
Erasmus intimates there will be great incentive for SARS to pursue the above course of action, and there is very good reason for the franchise industry to be prepared for this.He suggests that the franchise industry prepare themselves by answering certain questions created for this purpose on www.taxtalk.co.za.
The "rights” arrangements between franchisor and franchisee are as follows:
The franchisee will pay an initial start-up fee to acquire "the rights” to operate the franchise in a particular area (a lump sum),followed by an annual or monthly fee to maintain that right, based on turnover.There are variations on this theme.Some are structured so that there is no initial start-up fee, but a higher annual or monthly fee.Then there is the question of what is meant by "the rights”.These will include the exclusive right to operate in a particular area."The rights” are a bundle of rights made up of the following components:
An exclusive use area to conduct the business;
· The right to use the intellectual property;
· Other sundry items.
The acquisition fees are often specified as a lump sum, without saying what portion is allocated to the exclusive use area (similar to a restraint payment), and what portion is allocated to the initial fee for the right to use the trademarks and other intellectual property.
In summary, Erasmus states:
· There is an initial start-up fee payable for the exclusive use area;
· There is an initial start-up fee payable for the right to use the intellectual property such as trademarks, as opposed to just for the actual use of the trademarks;
· There is an ongoing fee payable to maintain the use of the exclusive use area and the use of the intellectual property (such as franchise fees or royalties).
The exclusive use area fee is arguably an expense of a capital nature.It is made to create a new business.The initial fee paid for the exclusive use area will not be tax deductible.The initial fee paid for the right to use the intellectual property (if clearly specified as such in the agreements and separately identifiable) is an expense of a capital nature,as it is made to create a new business.Section11(f) of the Income Tax Act is, however,available to the franchisee to claim a deduction.Erasmus, however, suggests that professional advice should be sought before attempting to apply any of these provisions, to ensure that the facts fall squarely within these provisions.
The ongoing fees payable to maintain the use of the exclusive use area and the use of the intellectual property (such as franchise fees or royalties) is the expense which is now the subject of uncertainty in light of the recent unreported tax case ITC 11454 which SARS won against a taxpayer who attempted to deduct royalty payments to the grantor of the rights situated in the UK.
Until now, Erasmus states, royalty payments have been seen as an expense which forms part of the day to day running expenses of a taxpayer and a revenue expense.A bit like the rental paid for your premises.
In ITC 11454 the court did not believe the comparison between rentals and royalties is a good one, as the payment of a royalty for the intellectual property use gives structure and goodwill, essential for the business’s operations.The court went on to find that that the royalty expenditure was like expenditure incurred in setting up a business(like franchise fees) and was therefore capital in nature and not tax deductible.The court held that the right of use was a valuable asset.
Erasmus says that the judgment has been widely criticised as being incorrect.It is also going on appeal.This will not deter SARS disallowing expenditure similar to royalty payments such as franchise fees in the meantime.
Source: By Michelle Swart (TaxTalk)