Taxation and Franchisees
The taxation treatment of franchise fees and the proceeds of sale of a franchise business can cause problems for franchisees if they are not advised of the special rules that apply to them.
Normally it is possible to apportion the initial payment by a franchisee to the franchisor between capital and revenue. The amount of revenue expenditure will depend on the facts, but usually includes a revenue service such as the training of staff. If, however, the agreement terms are such that no part of the initial lump sum fee is specifically attributed to revenue items, then claims for apportionment will be resisted by the Inland Revenue.In practice, apportionments for which franchisees contend may be made without reference to the franchisor and may be difficult to justify in relation to the services provided. For instance, some franchisors are unwilling to negotiate special terms with individual franchisees and the same lump sum is payable irrespective of the actual services required from the franchisor. For example, the number of staff needing training may be irrelevant. The facts may also show that no part of the initial lump sum fees can be attributed to services of a revenue nature provided by the franchisor because such services are separately charged for in the annual fees.
Where the initial fee is accepted as capital, it may be possible to seek capital allowances under ICTA88/S530(2) as industrial know how, but the statutory definition defines “know how” to include “any industrial information and techniques likely to assist in the manufacture or processing of goods or materials” and this indicates that the definition excludes commercial know how. If the franchisee can demonstrate that a reasonable part of the total payment was for the acquisition of “industrial” know how, then a just and reasonable apportionment can be negotiated.
Any part of the initial fee payable that has not obtained relief as a revenue expense or by way of capital allowances for “know how” is essentially a license to operate a business in a certain manner and as such no tax relief against income is available for individuals and partnerships. However, The Finance Act 2002 Section 84 and Schedules 29 and 30 introduced new rules for obtaining tax relief on the cost of “Intangible Assets” such as the cost of buying a franchise. Previously the cost of buying a franchise was only allowable against a subsequent sale. The new position is somewhat complicated, but for a Limited Company it should be possible to obtain tax relief on the amount written off in the accounts in accordance with Financial Reporting Standard 10.
It is important to remember that the asset the franchisee is acquiring is a license to operate the business and not goodwill as it is often described. This is important because if the franchise is re-sold then any Capital Gain arising on the sale of the “license to trade” is not a qualifying asset for the purpose of Capital Gains Tax Rollover Relief.
