Private ruling: Franchise fees
Date of advice: 29 July 2016
Published: August 2016
Ruling period: Year ended 30 June 2016
Date scheme commenced: 1 July 2016

Ruling: Q1: Are you entitled to an immediate deduction for the payment of a franchise fee under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No. | Q2: Is the franchise fee deductible over the term of the franchise agreement under the prepayment provisions? | A2: No.

Relevant facts and circumstances: The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of, and are to be read with, this description. The relevant documents are: • your application for a private ruling • further information received • franchise schedule 1 and • Tax invoice. You purchased a franchise and paid an initial franchise fee, which included a Business Assets Rent fee. The Business asset fee gave you the right to use the kiosk and business equipment for the next 5 years. This fee does not include rent paid to the landlord.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 8-1 Division 8

Reasons for decision: Summary: Subdivision H of Division 3 of Part III of the Income Tax Assessment Act 1936 (ITAA 1936) applies to expenditure incurred by a taxpayer in a year of income that cannot be wholly deducted in the expenditure year. Instead the taxpayer can deduct, for each year of income during which part of the eligible service period for the expenditure occurs, an amount worked out using the formal in paragraph 82KZMF(1)(b) of the ITAA 1936. In your case, the franchise fee is considered to be capital in nature and not deductible under section 8-1 of the ITAA 1997. The prepayment provisions do not apply.

Reasons for decision: For the payment of the general licence fee to be deductible, it must fall under the provisions of Division 8 (ITAA 1997). Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for any loss or outgoing to the extent that it is incurred in gaining or producing assessable income or it is necessarily incurred in carrying on a business for the purposes of gaining or producing assessable income. However, no deduction is available for outgoings of a capital, private or domestic nature. | In determining the essential character of the general licence fee it is first necessary to clarify what the payment actually represents. Based on the facts, the general license fee is regarded as a fee paid by the taxpayer in exchange for permission from the franchiser to operate a business under the franchiser's name and on the franchiser's premises (see Labrilda Pty Ltd v DFC of T 96 ATC 4304; 32 ATR 206). | An initial franchise fee is generally charged for the right to market or sell a product or service. Generally costs connected with an acquisition, set-up, establishment, enlargement of a business, or with the acquisition of fixed capital assets are capital in nature and not deductible. The costs of acquiring a business would not be considered as a cost of carrying on a business for the purpose of gaining assessable income, unless it is an operating expense. To be deductible an outlay must be part of the cost of trading operations to produce income, that is, it must have the character of a working expense. | Based on the facts, the character of the advantage sought by the payment of the franchise fee is the creation, enlargement and enhancement of the business structure of the taxpayer's specific business. It is not part of the process by which the taxpayer operates to obtain regular returns by means of regular outlay. As the franchise fee is properly characterised as the price paid for the right to carry on a business it is accordingly a non-deductible capital outgoing. | In your case you paid a franchise fee for a five year franchise arrangement. The franchise fee included a Business Assets Rent Fee. | The essential character of the advantage gained by you was the right to operate using the franchisor's trade mark, systems and for the provision of technical assistance. These are of enduring benefit to you and therefore the franchise fee is considered capital in nature. The franchise fee was paid in a single payment for the future enjoyment of these benefits. | The payment is not regarded as an operating or working expense of the business. The rights obtained in relation to this payment have an enduring benefit and are regarded as being capital in nature. Therefore, no deduction is allowable under section 8-1 of the ITAA 1997.