Guide on the taxation of franchisors and franchisees

A comprehensive guide on the Taxation of Franchisors and Franchisees issued by SARS considers the income tax implications of specified income received and specified expenditure incurred by franchisors and franchisees.

It is not an “official publication” as defined in section 1 of the Tax Administration Act 28 of 2011 and accordingly does not create a practice generally prevailing under section 5 of that Act. It is also not a binding general ruling under section 89 of Chapter 7 of the Tax Administration Act. Should an advance tax ruling be required, visit the SARS website for details of the application procedure.

This guide is based on the legislation as at date of issue. All guides, interpretation notes, forms, returns and tables referred to are available on the SARS website at www.sars.gov.za. Unless indicated otherwise, the latest issues of these documents should be consulted.
For more information you may –

  •  visit the SARS website at www.sars.gov.za;
  • visit your nearest SARS branch after making an appointment via the SARS website;
  • have a virtual consultation with a SARS consultant by making an appointment via the SARS website;
  • contact your own tax advisor or tax practitioner; or
  • contact the SARS National Call Centre –
    • if calling locally, on 0800 00 7277; or
    • if calling from abroad, on +27 11 602 2093 (only between 8am and 4.30pm South African time).
      Comments on this guide may be emailed to policycomments@sars.gov.za

Introduction

The franchise industry in South Africa is a major contributor to the South African economy. There is a need for clarity concerning the tax implications that arise in relation to franchise arrangements, in particular, the income tax treatment of specified income received or accrued and specified expenditure incurred by franchisors and franchisees under franchise agreements. The aim of SARS taxation guide is thus to assist in clarifying uncertainties that may arise on the application of the income tax laws to a franchise agreement.

This guide focuses mainly on transactions between franchisors and franchisees that are resident in South Africa.

The Franchise arrangement

In order to facilitate a better understanding of the franchising industry, some of the most commonly used terms relating to franchises, as defined by the International Franchise Association are:

  1. Business format franchise: This type of franchise includes not only a product, service and trademark, but also the complete method to conduct the business itself, such as the marketing plan and operations manuals.
  2. Franchise: A license that describes the relationship between the franchisor and franchisee, including the use of trade marks, fees, support and control.
  3. Franchising: A method of business expansion characterized by a trade mark license, payment of fees and significant assistance and/or control.
  4. Franchisor: The person or company that grants the franchisee the right to do business under its trade mark or trade name.
  5. Franchisee: The person or company that acquires the right from the franchisor to do business under the franchisor’s trade mark or trade name.
  6. Franchise agreement: The legal, written contract between the franchisor and franchisee which tells each party what each is supposed to do.
  7. Product distribution franchisee: A franchise in which the franchisee simply sells the franchisor’s products without using the franchisor’s method of conducting business.
  8. Royalty: The regular payment made by the franchisee to the franchisor, usually based on a percentage of the franchisee’s gross sales.
  9. Trademark: The marks, brand name and logo that identify a franchisor which is licensed to the franchisee.

A franchise agreement will usually enable a franchisee to operate a business under specific licensing conditions. As noted above, a business format franchise arrangement provides the franchisee with a strong brand (intellectual property) and “the complete method to conduct the business itself, such as the marketing plan and operations manuals” (business processes). By contrast, a product distribution franchise arrangement enables the franchisee to sell the franchisor’s products but does not involve the franchisor providing the franchisee with its method of conducting business. The SARS guide is focused on the business format franchise arrangement, however, many of the concepts examined in the guide will often also apply to a product distribution franchise arrangement and other variations of franchise agreements.

The franchisor that establishes or develops a concept normally uses franchisees to duplicate and distribute the concept on a large scale. The success of a franchise chain lies in the effective implementation of basic, but clearly defined, business principles that have been established by the franchisor.

General principles in the taxation of franchisors and franchisees

A franchisor’s income and franchisee’s expenditure can, respectively, include a wide range of amounts received or accrued, and incurred, which are stipulated in the franchise agreement. A franchisor, for example, may receive payments such as initial fees, renewal fees and royalties from a franchisee. In exchange, the franchisor has to provide the necessary intellectual property and business processes to enable the franchisee to operate the franchise.

The franchisee incurs initial expenditure in setting up the franchise outlet, as well as expenditure relating to the day-to-day running of the franchise, which can either be in the form of once-off or recurring payments.

This Taxation guide provides commentary on some of the general principles and sections which underlie the taxability or tax deductibility of many amounts that are received by or accrue to, or are paid or incurred by, franchisors and franchisees Some of these principles and sections explain the tax treatment of specified types of income and expenses relevant to franchisors, franchisees and franchise agreements.

Conclusion

This guide is intended to provide clarity regarding some of the general issues pertaining to franchisors and franchisees in South Africa. Note that each case has to be considered on its own merits when determining the taxability of a franchisor and a franchisee. The terms and conditions of the franchise agreement, as well as the manner in which payments are construed, will be important in determining the tax implications of the different types of amounts received, or expenses incurred, by franchisors and franchisees.

Read the full guide on the Taxation of Franchisors and Franchisees

FASA Franchise Association South Africa
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