Annual franchise fee not linked to income earning
Re Leggett & Ors and FCT (2007) 69 ATC 678
Deductions were disallowed for a franchise fee paid to gain entry to a franchise system which was marketed to accountants. The franchisees were obliged to engage a subfranchisee related to the franchisor to undertake the actual marketing. They received income from the subfranchisee's activity.
The franchisees were treated as being passive investors who acquired for their payment the right to participate in the income of another person. The arrangement did not have a business-like structure or a profit making purpose and nor was there the regularity of activity usually associated with derivation of business income.
In reality the franchisees made their money out of subfranchising as the system required them to engage subfranchisees to "do the work". Their franchise payment was in the nature of a capital outlay to acquire the assets that could then be made available to the subfranchisees.
This case is a reminder of the need to analyse carefully the purpose for which expenditure is outlaid in order to establish the necessary nexus with income earning and to avoid the prohibition on deducting capital expenditure. Simply because the share of subfranchisee income in which the franchisees shared was taxable did not mean that funds they paid to the franchisor were incurred in deriving that income.
On another analysis of the case the franchise fees were arguably contributions of capital to the franchisor whose associate was the subfranchisee doing the work. Franchisees got a share of the subfranchisee's revenues as a return on their capital contribution. The contribution itself was sunk in anticipation of the income share but was not deductible.