South African Firms Face Back Tax Claims After Landmark Ruling

by Robert Lee, Tax-News.com, London

09 November 2005

A landmark decision by the Cape Tax Court could leave franchisees in South Africa facing demands for back taxes from the authorities on deductions claimed from the payment of trademark royalties, according to a Business Day report.

The case in question involved the deduction of royalty payments made to an offshore UK holding company by its South African subsidiary, A Company of Africa Limited.

During the late 1990s, the firms entered into a trademark licence agreement which provided for the payment of a royalty for the use by the South African firm of certain trademarks, of which the UK firm was the registered owner.

However, deductions of these royalty payments from the South African firm's income were subsequently disallowed by the South African Revenue Service (SARS) on the basis that these amounts were capital in nature. A challenge to SAR's decision was rejected and appealed to the Cape Tax Court, which arrived at the same conclusion.

Despite the fact that the company operated as a manufacturer, supplier and marketer of products, the court found that the licence agreement was a vital component of its operation.

According to the court: “Its business or trading prospects are limited and there is no guarantee that it could maintain previous levels of business or survive in the market at all” without the licence agreement.

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