Private ruling: Termination of franchise - CGT - small business CGT concessions
Date of advice: 23 July 2025
Published: 22 September 2025
Ruling period: Year ended 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Will the payments received by the company in respect to the termination and release of its rights to operate under the franchise agreement be treated as capital gains tax (CGT) event C2 under section 104-25 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes | Q2: If the answer to Question 1 is "Yes', will the company satisfy the basic conditions for small business CGT concessions in section 152-10 of the ITAA? | A2: Yes

Relevant facts and circumstances: The company carries on a business of mortgage brokering, acting as a financial intermediary who would match potential borrowers with potential lenders to obtain the best possible mortgage terms for the borrower. The franchisor distributes financial products and services through a network of franchisees. The franchisor is a subsidiary of company X, which is the credit provider of the financial products supplied by the franchisor. The company entered into a franchise agreement with the franchisor. The company's assessable income primarily consisted of accrued commission payments known as trailer income. Under the franchise agreement: • The company was granted a non-exclusive licence (without the right to sub-license) to operate the franchise within the approved marketing area. • The company was entitled to accrued commission payments known as trailer income. • The franchisor owns all the goodwill which the company develops, or which arises as a result of or in connection with the operation of the company's business, and the customer relationship in respect of its customers. • Upon termination, the company is required to provide the franchisor with a list of all customers with whom it had any dealings or contact in the course of operating it business. The company's business turnover for the relevant income year was less than $2 million. The company has no connected or affiliated entities. In the relevant year, the franchisor made a decision to terminate the franchise agreement with the company. A termination deed was executed between the franchisor and the company where the company agreed to the termination of its commission payments in exchange for an upfront payment of active trail commission and ex-gratia payment from the franchisor. Following the termination of the franchise agreement, the company was not entitled to receive any further payments from the franchisor in respect of the franchise agreement. The receipt of the active trail commission payment and the ex-gratia payment resulted in a gain.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 section 102-20 | Income Tax Assessment Act 1997 section 104-25 | Income Tax Assessment Act 1997 section 108-5 | Income Tax Assessment Act 1997 section116-20 | Income Tax Assessment Act 1997 Subdivision 152-A | Income Tax Assessment Act 1997 section 152-10 | Income Tax Assessment Act 1997 section 152-35 | Income Tax Assessment Act 1997 section 152-40 | Income Tax Assessment Act 1997 section 328-110 | Income Tax Assessment Act 1997 section 328-115 | Income Tax Assessment Act 1997 section 328-120

Reasons for decision: Summary: The first category of payment detailed in the termination deed is an 'active trail commission payment' and it is considered a capital receipt for the loss of the company's rights to continue its profit-yielding activity under the franchise agreement. Utilising a look through approach, the active trail commission payment constituted compensation for the cancellation of the company's intangible rights associated with the operation of the franchise. The second category of payment detailed in the termination deed is an ex-gratia payment and it is considered a capital receipt for compensation for the loss of the company's right to continue its business operations under the franchise agreement. On execution of the termination deed the company's entitlement to operate the franchise business under the terms of the franchise agreement ceased, hence CGT event C2 happened pursuant to subsection 104-25(1) of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Your assessable income includes income according to ordinary concepts, which is called ordinary income (section 6-5 of the ITAA 1997). Ordinary income has generally been held to include 3 categories, namely, income from rendering personal services, income from property, and income from carrying on a business. Other characteristics of income that have evolved from case law include receipts that: • are earned • are expected • are relied upon, and • have an element of periodicity, recurrence or regularity. An amount received in connection with the cancellation of a contract, or an agreement made in the course of carrying on a business is usually of an income nature if the amount which it replaces would have been income. On the other hand, if the cancellation affects the framework of the business or causes a substantial part of the business to be lost then the amount received will be of a capital nature. Commrs of Inland Revenue v. Fleming & Co. (Machinery), Ltd. (1951) 33 T.C. 57 illustrates how to apply these principles to determine whether a business continues in largely the same form or otherwise: The sum received by a commercial firm as compensation for the loss sustained by the cancellation of a trading contract or the premature termination of an agency agreement may in the recipient's hands be regarded either as a capital receipt or as a trading profit... When the rights and advantages surrendered on cancellation are such as to destroy or materially to cripple the whole structure of the recipient's profitmaking apparatus, involving the serious dislocation of the normal commercial organisation and resulting perhaps in the cutting down of ...staff previously required, the recipient of the compensation may properly affirm that the compensation represents the price paid for the loss or sterilisation of a capital asset and is therefore a capital and not a revenue receipt... On the other hand when the benefit surrendered on cancellation does not represent the loss of an enduring asset in circumstances such as those above mentioned - where for example the structure of the recipient's business is so fashioned as to absorb the shock as one of the normal incidents to be looked for and where it appears that the compensation received is no more than a surrogatum for the future profits surrendered - the compensation received is in use to be treated as a revenue receipt and not a capital receipt. Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts (TR 95/35) provides the Commissioner's view on the CGT consequences for recipients of compensation amounts received. Paragraph 70 of TR 95/35 provides that in determining the most relevant asset in respect of which the compensation has been received, it is often appropriate to adopt a 'look-through' approach to the transaction which generates the compensation receipt. The 'look-through' approach is defined in paragraph 3 of TR 95/35 as follows: The 'look-through' approach is the process of identifying the most relevant asset. It requires an analysis of all of the possible assets of the taxpayer in order to determine the asset to which the compensation amount is most directly related. It is also referred to in this Ruling as the underlying asset approach. 'Underlying asset' is also defined in paragraph 3 of TR 95/35 as follows: The underlying asset is the asset that, using the 'look-through' approach, is disposed of or has suffered permanent damage or has been permanently reduced in value because of some act, happening, transaction, occurrence or event which has resulted in a right to seek compensation from the person or entity causing that damage or loss in value or against any other person or entity. Taxation Ruling TR 2000/1 Income tax: insurance registers (TR 2000/1) provides guidelines on the taxation consequences of acquiring or disposing of an insurance register. For the purpose of this ruling, an insurance register is a record of the rights of an insurance agent to future commissions and a record of policyholders that an agent has an exclusive right to deal with on behalf of the agency. TR 2000/1 considers that an insurance register is a capital asset where it is held as part of the profit-making structure of a business. Whilst TR 2000/1 is about insurance registers, the ruling has application to the company's circumstances. The rights to trailing commissions are comparable to insurance registers, in that the company is entitled to trail commissions from its customers who have taken out RAMS home loans. CGT event C2 Subsection 108-5(1) of the ITAA 1997 defines CGT as any kind of property, or a legal or equitable right that is not property. The capital proceeds from a CGT event include the money you have received, or are entitled to receive, in respect of the event happening (subsection 116-20(1) of the ITAA 1997). Section 102-20 of the ITAA 1997 provides that you make a capital gain or capital loss as a result of a CGT event happening to an asset in which you have an ownership interest. Subsection 104-25(1) of the ITAA 1997 provides that CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset: (a) being redeemed or cancelled; or (b) being released, discharged or satisfied; or (c) expiring; or (d) being abandoned, surrendered or forfeited; or (e) if the asset is an option - being exercised; or (f) if the asset is a convertible interest - being converted. The time of the event is when you enter into the contract that results in the asset ending, or if there is no contract, when the asset ends (subsection 104-25(2) of the ITAA 1997). Application to your circumstances Under the franchise agreement, the company was granted a non-exclusive licence (without the right to sub-license) to operate a franchise business within the approved marketing area. On entering the franchise agreement, the company acquired the right to operate the business and receive income in the form of trailer commissions for offering the franchisor's financial products to its customers. The franchise business was a significant part of the company's profit earning structure. Under the franchise agreement, all customers and all customer information the company has collected or otherwise obtained is franchisor's exclusive property. On termination of the franchise, the company was required to provide the franchisor with a list of all its customers and was not permitted to use customer data acquired during the course of its business nor offer to supply same or similar products, to any person who is a customer. Similar to insurance registers as explained in TR 2000/1, the trailer income the company received under the franchise agreement form part of the profit-yielding structure business. When the company entered into the franchise agreement with the franchisor, it acquired a legal chose of action giving it the right to receive a sum of money in the form of trailer income for offering its customers the franchisor's financial products or third-party supplied products. Accordingly, we consider it to be CGT asset. The first category of payment detailed in the termination deed is an 'active trail commission payment' and it is considered a capital receipt for the loss of the company's rights to continue your profit yielding activity under the franchise agreement. Utilising a look through approach, the active trail commission payment constituted compensation for the cancellation of your intangible rights associated with the operation of the franchise. The second category of payment detailed in the termination deed is an ex-gratia payment and is also considered a capital receipt for compensation for the loss of the company's right to continue its business operations under the franchise agreement. On execution of the termination deed the company's entitlement to continue operate the franchise pursuant to the terms of the franchise agreement ceased, hence CGT event C2 happened pursuant to subsection 104-25(1) of the ITAA 1997. Accordingly, the payment received is the capital proceeds from CGT event C2 happening. | Summary: The company has satisfied all the basic conditions for the small business CGT concessions as outline in section 152-10 of the ITAA 1997 in relation to CGT event C2, as detailed in Question 1. | Detailed Reasoning - Detailed reasoning: Basic conditions for small business concessions To qualify for any of the CGT small business concessions, an entity must satisfy several conditions that are common to all the concessions, known as the basic conditions. The basic conditions are contained in Subdivision 152-A of the ITAA 1997. Subsection 152-10(1) states: A capital gain (except a capital gain from CGT event K7) you make may be reduced or disregarded under this Division if the following basic conditions are satisfied for the gain: (a) a CGT event happens in relation to a CGT asset of yours in an income year; (b) Note: This condition does not apply in the case of CGT event D1 (c) the event would (apart from this Division) have resulted in the gain; (d) at least one of the following applies: you are a CGT small business entity for the income year; you satisfy the maximum net asset value test (see section 152-15); you are a partner in a partnership that is a CGT small business entity for the income year and the CGT asset is an interest in an asset of the partnership; the conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year; the CGT asset satisfies the active asset test (see section 152-35). Note: This condition does not apply in the case of CGT event D1. To be eligible to apply the small business CGT concessions all four of the basic conditions must be satisfied. CGT small business entity A CGT small business entity is defined in section 152-10(1AA) of the ITAA 1997: You are a CGT small business entity for an income year if: (a) you are a small business entity for the income year; and (b) you would be a small business entity for the income year if each reference in section 328-110 to $10 million were a reference to $2 million. Taking into account the definition of a small business entity in section 328-110 of the ITAA 1997, a CGT small business entity is an entity that carries on business in the current year and either: • it carried on business in the previous year and its aggregated turnover for the previous year was less than $2 million, or • its aggregated turnover for the current year is likely to be less than $2 million (this test is not applicable where the entity has carried on business in each of the last 2 income years and the aggregated turnover for each of those years was more than $2 million), or • its aggregated turnover for the current year, worked out as at the end of the year is less than $2 million. Section 328-115 of the ITAA 1997 provides that an entity's aggregated turnover for an income year includes the annual turnovers for the income year of: • the entity • any other entities connected with the entity at any time during the income year, and • any other entities that is an affiliate of the entity at any time during the income year. Subsection 328-120 of the ITAA 1997 defines annual turnover and states: An entity's annual turnover for an income year is the total ordinary income that the entity derives in the income year in the ordinary course of carrying on a business. Active asset test The active asset test is outlined in section 152-35 of the ITAA 1997. The active asset test is satisfied if: • you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the test period detailed below, or • you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of at least 7.5 years during the test period. The test period begins when you acquired the asset, and end at the earlier of: • the CGT event, and • when the business ceased, if the business in question ceased in the 12 months before the CGT event (or such longer time as the Commissioner allows). Active asset For a CGT asset of a business to be an active asset for the purposes of Division 152 of the ITAA 1997 it must satisfy one of the 'positive tests' in subsection 152-40(1) of the ITAA 1997 and then also not be excluded by one of the exceptions in subsection 152-40(4) of the ITAA 1997. Section 152-40 defines an active asset and subsection 152-40(1) states, in part, the following: (1) A CGT asset is an active asset at a time if, at that time: (a) you own the asset... and: (i) you, use it, or hold it ready for use, in the course of carrying on a business; or (ii) it is used, or held ready for use, in the course of carrying on a business by your affiliate, or by another entity that is connected with you (b) if the asset is an intangible asset - you own it and it is inherently connected with a business that is carried on (whether alone or in partnership) by you, your affiliate, or another entity that is connected with you. Application to your circumstances In the present case: • CGT event C2 happened when the company executed the termination deed for the termination of the franchise agreement. On execution of the deed, the company's right to operate the franchise has ceased, therefore paragraph 152-10(1)(a) of the ITAA 1997 is satisfied. • The receipt of the active trail commission payment and ex-gratia payment resulted in a gain. The company advised that the receipt of these payments resulted in a gain, therefore paragraph 152-10(1)(b) of ITAA 1997 is satisfied. • The company is carrying on a business of mortgage brokering and had a business turnover of less than $2 million in the relevant financial year. The company has no connected entities nor affiliated with any other entities. Hence, the company is considered a small business entity for the purpose of paragraph 152-10(1)(c) of the ITAA 1997. • The company's right to operate the franchise under the franchise agreement is an intangible CGT asset which was inherently connected with it business. This right was fundamental to the business structure for which the company earned its income. As such, it is an active asset under section 152-40 of the ITAA 1997. • The company entered into a franchise agreement on XX Month 20XX in respect of rights to trail commission, and that agreement was terminated on XX Month 20XX. In respect of the active asset test pursuant to section 152-35 of the ITAA 1997, the test period commences when you acquired the asset and end when CGT event occurred. In your situation the company owned the asset for less than 15 years and the asset was an active asset of the company for a total of at least half of the test period. As a result, the active asset test is satisfied per section 152-35 of the ITAA 1997. Further the company used the asset, in the course of carrying on a business, therefore paragraph 152-10(1)(d) of the ITAA 1997 is satisfied. Considering the above, the company has satisfied the basic conditions for the small business CGT concessions outlined in section 152-10 of the ITAA 1997.

Does IVA apply to this private ruling?: Part IVA of the Income Tax Assessment Act 1936 contains anti-avoidance rules that can apply in certain circumstances where you or another taxpayer obtains a tax benefit, imputation benefit or diverted profits tax benefit in connection with an arrangement. | If Part IVA applies, the tax benefit or imputation benefit can be cancelled (for example, by disallowing a deduction that was otherwise allowable) or you or another taxpayer could be liable to the diverted profits tax. | We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part. | If you want us to rule on whether Part IVA applies, we will need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply. | For more information on Part IVA, go to our website ato.gov.au/gaar .