How do I treat the payment of a franchise fee for tax purposes?
21 April 2015
Posted by: Author: SAIT Technical
Author: SAIT Technical
Q1: I have a
client that bought a franchise and paid a R300 000 franchise fee.
Part of the franchise agreement is that the contract it for
5 years and must be renewed after the 5 year period.
The initial R300 000 fee is not refundable and
excludes any software or equipment, in other words, it is for the right to run
the franchise in a particular area
After the 5 year period, the principal can
choose if they want to renew the contract with the franchise branch or not.
If the contract is renewed, another fee will
have to be paid and will be determined at the time of renewal.
My question is: Am I right that the R300 000 fee must be
written off over the 5 year period (or 60 months) and can thus be deducted for
income tax purposes. The franchise holder trade is a sole proprietor.
A1: Note that the
service offered by SAIT is limited to guidance only.
The expense for the right to run the franchise in a
particular area would more than likely be capital in nature. As was stated by Judge Ponnan (in BPSA (Pty)
Ltd v C:SARS) "the true nature of each transaction must be examined in order to
determine whether the expenditure in question is capital...” If it is capital in nature it will not
qualify to be deducted under section 11(a), and the apportioned over 5 years in
terms of section 23H of the Income tax Act.
According to Judge Ponnan it "a distinction is thus drawn between
expenditure made to acquire an income-producing concern (in respect of which
the outlay is usually non-recurrent) and money spent '...in working the concern
for the present production of profit'...”
There are two other possible deductions that may be
If the ‘franchise fee’ is a ‘premium or consideration in the
nature of a premium paid by a taxpayer for … the imparting of or the
undertaking to impart any knowledge directly or indirectly connected with the
use of such ... advertising matter, patent, design, trade mark, copyright or
other property as aforesaid…” the allowance in terms of section 11(f) will
therefore be applicable.
Section 11(gC) of the Act is available where any if the
following was acquired:
•an invention or patent (as defined in the Patents Act 57 of
•a design (as defined in the Designs Act 195 of 1993),
•a copyright (as defined in the Copyright Act 98 of 1978),
•other similar property (but not a trade mark as defined in
the Trade Marks Act 194 of 1993) and
•knowledge essential to the use of any of these assets or
the right to have such knowledge imparted.
We accept that none of the first three applies and it would
therefore be necessary to determine if the "right to operate the franchise”
constitutes "other similar property”. It
doesn’t appear that the payment is in respect of knowledge (the last one)
either. In deciding that issue, the
following comment by Judge Heher (in the SA Silicone case) may be
relevant. The Judge said that a licence
"… is not ‘property similar in nature’ to a trade mark. The licence is not
intellectual property. It is merely the grant of a temporary right of use,
conferring no monopoly in the hands of the licensee and neither proprietary
interest nor the protection accorded by law to such an interest.” Essentially the franchise fee should do more
than give a right of use to qualify under this section.
Our guidance basically says that if the franchise fee is not
capital in nature and therefore qualifies under section 11(a), the deduction
will indeed be allowed over the period of the contract (the 5 years) as section
23H would apply. This of course assumes
that the expense is not capital in nature.
We then mentioned when the expense may be capital in nature and if it
was then said that section 11(f) or section 11(gC) would then be only other
sections that would provide a deduction.
If section 11(f) applies the deduction would also be over 5 years, but
section 11(gC) would not give an allowance over 5 years – the deduction would
We consider that adequate guidance, but agree that the
ultimate answer depends on the nature of the expense (and we referred to that
in our guidance). You didn’t request
guidance on that issue, but we also didn’t have enough information to comment
on that. You mentioned that the "client
bought a franchise and paid a R300 000 franchise fee” and also that the
franchise fee "excludes any software or equipment” and that "is for the right
to run the franchise in a particular area”.
This was what prompted us to comment on the licence issue as a licence
typically will have the features described.
You may want to consult another tax practitioner if you
require an answer to the question. If
you need more guidance on the exact nature of the expense you are welcome to
ask for guidance in that respect from SAIT.
Note that it may well need legal assistance if it is not clear from the
Disclaimer: Nothing in this query and answer should be construed as
constituting tax advice or a tax opinion. An expert should be consulted for
advice based on the facts and circumstances of each transaction/case. Even
though great care has been taken to ensure the accuracy of the answer, SAIT do
not accept any responsibility for consequences of decisions taken based on this
query and answer. It remains your own responsibility to consult the relevant
primary resources when taking a decision.