Cape Town - In a recent landmark case, the Tax Court upheld that a very special, and mostly under-utilised tax deduction allowed by section 24C of the Income Tax Act, may be applied to franchisee costs, according to Natasha Wilkinson, and attorney at Tax Consulting South Africa.
Section 24C permits the deduction of certain expenses in the current tax year assessment, where those expenses are not yet incurred, on the basis that these expenses will contractually be incurred in future years. Although limited in application, this tax allowance protects businesses from being taxed on earmarked funds that bloat their annual earnings.
If SARS allows the deduction, the specified amount is carried over into the new year as income rather than retained earnings. A further section 24C deduction may then be claimed until there is a matching of income and expenses.
What makes section 24C so unique, therefore, is that you can deduct future expenses now, although they have not yet been incurred. This provides a tax advantage to taxpayers who are operating a business, as it creates a correct matching between expenses and income.
Wilkinson explains that the recent landmark case not only clarifies the correct interpretation of section 24C, but also informs franchise operators on how they may declare income as financing for refurbishments.
"This is good news for all franchise holders in South Africa as it will no doubt assist them in planning their taxes better and stimulate their growth," she says.
Implications to franchisees
The court stressed that there are no hard-and-fast rules that apply across all industries and to all cases when deciding if the provisions of section 24C have been met. However, as far as franchisees are concerned, it is clear that where a franchise agreement sets out an obligation to incur future expenditure, such expenditure may very well fall within the beneficial parameters of section 24C of the act.
Franchisees are, however, encouraged to always engage the services of a qualified tax attorney to assess the validity of such deductions, especially as this is a matter of legal application and is solely dependent on the provisions of the franchise contract.
The Tax Court held that there need not be one physical contract document to give rise to section 24C’s benefit. Furthermore, while different parties were involved (the franchisor and the restaurant’s customers), the franchisee’s agreements with each were “inextricably linked” and “not legally independent and separate”.
The income deducted was, therefore, regarded as earned under the same contract as the taxpayer’s future expenditure, fulfilling the requirements of section 24C. The court also held that the upgrading of the franchisee’s restaurants were not optional.
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