The Commissioner for the South African Revenue Service v Big G Restaurants (Pty) Ltd

Big G Restaurants (Pty) Ltd (the taxpayer) operated restaurants as a franchisee under franchise agreements with Spur Group (Pty) Ltd. The taxpayer was obliged to pay a monthly franchise and service fee of 5% of gross sales (less VAT) to the franchisor, with a minimum monthly fee of R25,000 escalating annually by CPIX. The franchise agreements required the taxpayer to upgrade and/or refurbish its restaurants at reasonable intervals as determined by the franchisor. For the 2011 to 2014 years of assessment, the taxpayer claimed allowances under section 24C of the Income Tax Act 58 of 1962 in relation to future expenditure to be incurred for restaurant upgrades and refurbishments. The matter came before the court as a special case under rule 42 of the tax court's rules read with rule 33 of the Uniform Rules of Court. The Commissioner for SARS disputed the taxpayer's entitlement to these allowances.

• Whether the income received by the taxpayer from operating the franchise businesses were amounts received or accrued 'in terms of' the franchise agreement as envisaged in section 24C of the Income Tax Act
• Whether the expenditure required to refurbish or upgrade restaurants was incurred 'in the performance of the taxpayer's obligations under such contract' as contemplated in section 24C
• The proper interpretation of the phrase 'in terms of' (in Afrikaans 'ingevolge') in section 24C(2) - whether it should be given a narrow or wide meaning

The appeal was upheld with costs, including costs of two counsel. The order of the court a quo was set aside and replaced with an order dismissing the appeal. This meant the Commissioner's additional assessments for the taxpayer's 2011 to 2014 years of assessment were reinstated, and the taxpayer's section 24C allowances were denied.

For purposes of section 24C(2) of the Income Tax Act 58 of 1962, income must be received or accrued 'in terms of' the same contract that creates the obligations for which future expenditure will be incurred. The phrase 'in terms of' ('ingevolge') in section 24C(2) bears its narrow meaning - requiring a direct and immediate connection between the income and the contract. Income is not earned 'in terms of' a contract merely because that contract enables or facilitates the earning of income. The actual source of income must be identified. In a franchise arrangement, income is earned from individual patron contracts (sales transactions), not from the franchise agreement itself, even though the franchise agreement enables the franchisee to operate the business. Section 24C does not allow for different income-earning and obligation-imposing contracts; both must be the same contract.

The court noted that section 24C constitutes an exception to the general prohibition in section 23(e) of the Act against deductions for income carried to reserve funds or capitalized. According to the explanatory memorandum when section 24C was introduced by section 18(1) of the Income Tax Act 104 of 1980, its purpose was to address situations where a contract (typically a construction contract) provides for advance payment to enable the recipient to finance performance of obligations under that contract (e.g., to purchase materials). The court mentioned that features generally common to franchise agreements include: the granting of the right by the franchisor to conduct business in exchange for fees; the acquisition by the franchisee of the right to conduct a franchise business within the franchisor's network; and the right and obligation of the franchisee to use the franchisor's trademarks, know-how and business methods. The court found it unnecessary to decide the second question of law (whether the expenditure was incurred 'in the performance of obligations under such contract') as the first question was dispositive of the appeal.

This case provides important guidance on the interpretation and application of section 24C of the Income Tax Act 58 of 1962, which provides for allowances in respect of future expenditure. It establishes that there must be a direct and immediate connection between income received and obligations incurred - both must originate from the same contract. The judgment clarifies that enabling or facilitating contracts (such as franchise agreements, lease agreements, or overdraft facilities) that make it possible for a taxpayer to earn income are not contracts under which income is received 'in terms of' for purposes of section 24C. The case reinforces the narrow interpretation of 'in terms of' ('ingevolge') in the tax context and emphasizes the importance of identifying the actual source of income as opposed to contracts that merely enable income generation. It limits the scope of section 24C to situations where advance payments or income under a contract are used to finance future expenditure to perform obligations under that same contract - typically construction contracts with advance payments.