Treatment of the fees paid
Scenario:
Our company paid an initial franchise fee of $179,000 to a franchisor under a gym's sub-franchise agreement. Our company did not proceed with the gym franchise business but it was not due to the fault of the franchisee and is currently still in a legal dispute. Our company was unable to claim the refund of the initial franchise fee paid. The questions are:
- Will the initial franchise fee of $179,000 qualify as blackhole expenditure to be amortised for five years under s 40-880 of ITAA 1997?
- Can the initial franchise fee and the legal expenses incurred during the legal dispute be claimed as a capital loss?
Explanation:
The blackhole expenditure may not be available. This is because of a specific exclusion in s 40-880(5)(d) for expenditure that "is in relation to a lease or other legal or equitable right" (see also Taxation Ruling TR 2011/6, paragraphs 46 and 47 and Example 12 in paragraphs 118 to 121). As noted at the end of paragraph 47, the exclusion is not limited to rights associated with the land. Classically, a franchise right is one that allows the franchisee to exploit the intellectual property of the franchisor such that they have been "out" as per the discussion in the ruling.
Yes, franchise fees are part of the capital cost of establishing a business and can give rise to a capital loss. As the legal dispute is most likely about the granting or refusal to grant the franchise, the subject matter of that dispute is of a capital nature and therefore, the legal fees can also give rise to a capital loss. Specifically:
- the franchise fee or part fee that was not refunded would be an increment to cost base pursuant to s 110-25(2), and
- the legal fees would be an increment to cost base pursuant to s 110-25(6)