Hamilton Pratt

Tax Aspects

There  are  no  specific  rules  which deal  with  the  tax  aspects  of franchising  and,  accordingly,  general tax principles have  to  be  applied. Further,  all  franchise  agreements  are  different   and  as  a  result  the observations  contained in this part of the guide may not be applicable to all franchise agreements.

Essentially, a franchisee will have to make two types of payment.  First he will  have  to  make an initial payment on taking  up  the  franchise  and secondly  he will have to pay a fee to the franchisor based on his turnover or a  mark up on the goods he purchases.  Clearly franchisees will wish to obtain as favourable tax treatment as possible in relation to both these payments. The  least  favourable  position for the franchisee would be for  the  initial franchise  fee  to  be  treated as a capital payment in respect  of  which  no capital  allowances are available and the continuing payments to be treated as a royalty which is payable subject to deduction of tax.

Usually the franchisor will be agreeable to the allocation of the initial fee  in  the  most  tax beneficial way for  the  franchisee  because  whatever payments  the franchisor receives are likely to be treated as trading receipts in  its  hands.   Further the franchisor has an interest in ensuring that franchisees are successful and, clearly, favourable tax breaks will assist in this.

Usually, the initial franchise fee relates to a large number of items which can include the provision of know how, but will frequently include the supply of equipment, training, stock, advice etc.  Clearly, the apportionment of the initial fee amongst these items must be commercially defensible but, with this proviso, the franchisee's interest should be borne in mind.  As a rough guide it will be to the franchisee’s advantage to have as much of the initial fee attributed to stock and as little as possible to items of capital expenditure in respect of which capital allowances are not available.

Usually, continuing franchise fees and any mark up on goods or services supplied  by  the  franchisor are deductible as a  trading expense of the franchisee  but it is advisable for the franchisee to obtain confirmation from the Inland Revenue that tax need not be deducted from such payments.

Generally speaking VAT is payable on both the initial franchise fee and the continuing payments insofar as such payments relate to the provision of services and goods.  The VAT liability of the franchisee will usually be fully recoverable.