Tax Implications - Franchising
Franchising does not have any specific tax implications; only general tax principles are applicable. All franchise agreements differ from each other in terms of the nature of business activity involved therein.
A franchisee is usually required to make two kinds of payment. First, he has to pay an initial fee amount for starting up the franchise business, and second, he has to pay a certain fee on the basis of his turnover or a mark-up for the goods purchased by him, to the franchisor. A franchisee always tries to make it a point that he has to make the least amount as possible in tax in regards to these two payments. However, the least favourable position for the franchisee would be when his payment for the initial franchisee fee is considered a capital payment, due to which no capital allowances would be available and further payments would be treated as a royalty, payable in accordance with tax deduction.
The franchisor usually agrees to initial fee allocation in the tax beneficial way for the franchisee, since all received payments by the franchisor are treated as trading receipts.
The initial franchisee fee also includes items related to the provision of know how, equipment supply, training, advice, and so on. While the apportionment of these items is commercially sound, the franchisee’s interest should also be taken care of. Apart from that, the continual franchise fees and mark up on goods or services as supplied by the franchisor are deductible as a trading expenditure of the franchisee.
VAT is generally payable on these two kinds of payments, as they usually relate to the provision of goods and services, which is again fully recoverable by the franchisee.