FRANCHISEES may have to pay back over R6 billion in taxes if a recent tax case which the South African Revenue Services (Sars) won against a taxpayer, who attempted to deduct royalty payments that he paid to a franchisor, becomes law.

This came to light during a Franchise Association of Southern Africa Seminar held in Cape Town recently where tax specialist Daniel Erasmus’s talk on the landmark court ruling revealed that franchisees might no longer be able to claim tax for royalty payments and might even have to pay back royalty taxes that they’ve claimed.

According to a typical franchisor and franchisee contractual agreement, franchisees must pay an initial start-up fee to acquire the rights to operate the franchise in a particular area, followed by an annual or monthly fee or royalty to maintain that right.

That right includes an exclusive use area to conduct the business in and the right to use the intellectual property including trade marks, trade name, patents and copyrights.

Erasmus, tax specialist and lawyer at Daniel Erasmus Tax Consulting, says if Sars start aggressively enforcing the principles in the judgment against all franchisees on their franchise royalties to franchisors, the franchise industry could suffer enormous losses.

Says Erasmus: “Until now royalty payments have been held to be tax deductible if paid for the use of the franchisor’s intellectual rights. This is seen as an expense which forms part of the running expenses of a franchisee and is therefore a revenue expense.”

In this case, however, the court ruled that royalty expenditure was the same as expenditure incurred in setting up a business, and was therefore capital in nature and not tax deductible, says Erasmus.

Erasmus calculates that if Sars should start claiming back royalty deductions for the last five years, based on a tax rate of 30% on average, the franchise industry that encompasses 391 franchises and 22 825 outlets will have to pay back taxes of R6,51 billion at R275 000 per franchisee.

But Erasmus says the law states that Sars cannot revise tax assessments older than three years and they also cannot re-open or change tax assessments that were the established practice at the time.

“Should the taxpayer find itself in a position where it must show on a balance of probabilities that the practice prevailing at the time was to allow a deduction for royalties, it may subpoena the relevant senior Sars official from its head office in Pretoria to attest to the practice followed by Sars during the years of assessment in question,” says Erasmus.

Contact Erasmus on 011 476 5048.