A different take on franchising
By Jerome Veldsman
B v SARS, a judgment of the Tax Court, Cape Town on 3 November 2017, dealt with section 24C of the Income Tax Act.
Under section 24C, a taxpayer may, in the determination of its taxable income for the current tax year, deduct, by way of a reserve, an amount received (in the current tax year) under a contract, which amount is to be utilised to finance future expenditure to be incurred by the taxpayer in a future tax year in the performance of its obligations under such (the same) contract.
The typical example of a section 24C deduction is a builder who receives payment upfront under a building contract, and must then over time buy building materials to construct a building in accordance with the building contract. There have been several cases in which taxpayers tried to ‘stretch’ the ambit of section 24C, but the taxpayers were seldom successful.
The appellant taxpayer is a franchisee operating several restaurants in terms of (identical) franchise agreements. Under the agreements, the franchisor has substantial control over the income generating operation of the taxpayer, including that:
- – the taxpayer must actively operate the restaurants (sell meals), as its sole business, and exactly as directed by the franchisor;
- – the taxpayer must upgrade and/or refurbish the restaurants at reasonable intervals as determined by the franchisor.
The taxpayer claimed deductions in terms of section 24C in respect of future expenditure for such refurbishing and/or upgrading (under the franchise agreements).
SARS denied the deductions, on the basis that the taxpayer received amounts (income) from contracts to provide meals to its customers, and would incur the future expenditure under the franchise agreements – very different contracts.
The taxpayers countered that it cannot provide such meals, and thereby earn its income, absent the franchise agreement; so the franchise agreement is the source and origin of the taxpayer’s income.
Somewhat surprisingly, the Judge found in favour of the taxpayer:
“To my mind what distinguishes the contractual arrangement in the present matter is the obligation imposed on the taxpayer, by necessary inference, in the franchise agreement to sell meals to its customers. Although the customers are not parties to that agreement, the proximate cause of those sales is that obligation.”
As franchising is big business in South Africa, this case could set a questionable precedent detrimental to SARS, and the latter may well appeal.