Deductibility: General Licence Fee (Franchise Agreement)

Whether a general licence fee payable under a franchise agreement is deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997).

No. The general licence fee is a capital amount and is not deductible under section 8-1 (ITAA 1997).

The taxpayer enters into a 5 year (renewable) franchise agreement with a petroleum company for the operation of a service station. The franchise agreement requires the taxpayer to pay a general licence fee by advance instalments over 5 years. The amount is refundable and is paid annually. The agreement can be renewed for a further term of 5 years and at the expiry of that time can be 'held over' by the franchisee under similar terms and conditions.

If the agreement is terminated within 3 years, a term in the agreement stipulates that the franchiser may retain that part of the general licence fee paid in advance applicable to the expired term of the agreement, but must refund to the franchisee the remainder of any of the fee.

The taxpayer suggests that, as the general licence fee is payable annually and refundable, it is akin to rental. The taxpayer argues that the amount is distinguishable from a 'once-and-for-all' capital payment and accordingly should be treated on revenue account.

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 Division 8 (ITAA 1997) allows a deduction for any losses or outgoings to the extent to which they are incurred in gaining or producing assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. However, no deduction is allowed under section 8-1 (ITAA 1997) for expenses to the extent to which they are 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).

The courts have held that expenditure is of a capital nature where it is made with a view to bringing into existence an asset or an advantage for the 'enduring benefit' of a business. In determining whether the license fee is capital, and therefore non deductible, it is necessary to consider whether the fee can properly be characterised as the price paid for the right to carry on a particular business. If this is so, then it would appear to be a non-deductible capital outgoing (see Labrilda Pty Ltd v. DFC of T 96 ATC 4304; 32 ATR 206 which is highly comparable with this particular issue). The 'enduring benefit' in this situation is essentially the right to acquire a business structure and to have access to, and use of, intellectual property.

In situations where a licence is granted to use intellectual property, relevant case law indicates that the payment may be of a capital nature. This is also the case, notwithstanding that the amount payable may be payable by way of instalments (see Trustee of Earl Haig v. IRC (1939) 22 TC 725; also see Green (H.M. Inspector of Taxes) v. Favourite Cinemas Ltd (1930) 15 TC 390).

The fact that a general licence fee (or a small part of it) is potentially refundable, is not considered to be determinative in ascertaining whether such a payment should be regarded as a 'once-and-for-all' payment (see John Fairfax & Sons Pty Ltd v . FC of T (1959) 101 CLR 30). The character of the advantage sought by the making of the expenditure is the chief, if not the critical, factor in determining the character of what is paid (see GP International Pipecoaters Pty Ltd v. FC of T (1990) 170 CLR 124).

Based on the facts, the character of the advantage sought by the payment of the general licence 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 general licence fee is properly characterised as the price paid for the right to carry on a business it is accordingly a non-deductible capital outgoing.