Private ruling: Business - deductions
Published: October 2013
Ruling period: Year ended 30 June 2017
Date scheme commenced: 1 July 2012

Ruling: Q1: Is the franchise fee you incurred deductible over the term of the franchise agreement? | A1: No.

Relevant facts and circumstances: You purchased a franchise during the relevant financial year. As part of the franchise agreement, you had to pay franchise fees of $X (incl GST) for a five year period.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1.

Reasons for decision: Summary: Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature. Generally, the costs connected with an acquisition, establishment, enlargement of a business or the acquisitions of fix capital assets are 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. The decision in Associated Newspapers Ltd and Sun Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337; (1938) 5 ATD 87 provides guidelines for distinguishing between capital and revenue expenditure. This case considered the issue of whether expenditure in establishing, replacing and enlarging the profit-yielding structure itself was capital. The test laid down in this case involved three elements: · the nature of the advantage sought; · the way it is to be used or enjoyed; and · the means adopted to get it. In regard to the first two elements, the courts have held that, in the absence of special circumstances, expenditure is capital in nature where it is made with the view to brining into existence an asset or an advantage for the enduring benefit of the trade or business. This principle was followed in United Energy Limited v. Federal Commissioner of Taxation (1997) 78 FCR 169; 97 ATC 4796; (1997) 37 ATR 1, where the Full Federal Court held that franchise fees charged by the Victorian government in respect of electricity distribution companies, were not deductible. The Court said that the essential character of the advantage gained by the franchise fee was immunity from competition for a specified period from other distribution companies for customers in the licence area. The immunity was of enduring benefit to the taxpayer and the fee was therefore of a capital nature. The third element involves consideration of the way the outlay is made, that is, is it a periodical payment covering the use of the asset or advantage, or a single and final payment made for the future enjoyment of the asset. In Labrilda Pty Ltd v. Deputy Federal Commissioner of Taxation (1996) 65 FCR 119; (1996) 96 ATC 4303; (1996) 32 ATR 206, the taxpayer paid an up-front accreditation fee for participation in the Team Pak Program conducted by the principal, Mobil Oil. Under that program Mobil granted the right to the taxpayer to carry on its service station business using the 'Mobil System'. The specific program was designed to provide its participants with necessary training, marketing advice, advertising, promotion and other such assistance in setting up the business. The majority in that case concluded that the taxpayer's expenses in relation to the above were of a capital nature and not deductible as outgoings incurred in carrying on of the business. The expenses were more concerned with the business structure and characterised as expenditure which established the profit-yielding subject of the taxpayer's business. In your case you paid a franchise fee for a franchise arrangement. 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.