Tax Implications For Franchisees

In Short

• Initial franchise fees are generally not tax-deductible, but ongoing fees like royalties and marketing levies are.
• Assets and equipment may be eligible for depreciation deductions over time, while consumables like office supplies are typically deductible.
• GST can be claimed on franchise-related payments, and royalty payments to non-resident franchisors require specific tax reporting.

Tips for Businesses

Franchisees should ensure they understand the tax treatments for different franchise-related expenses. Initial franchise fees are capitalised, but ongoing costs like royalties, marketing, and training fees are usually deductible. Keep track of your equipment and assets for depreciation, and be mindful of GST credits. If dealing with non-resident franchisors, consult a tax professional for proper reporting and deductions.

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Table of Contents

• Franchise Fees
• Asset Purchase and Setup
• Royalty and Marketing Fees
• Training Fees
• Goods and Services Tax
• Transfer or Termination of a Franchising Agreement 
• Non-Residents
• Key Takeaways
• Frequently Asked Questions

Franchising is a business model where the franchisor grants a franchisee a licence to use their established business name, proven procedures, and intellectual property (IP). While this ready-to-go model offers the advantage of operating under a recognised brand with established systems, it also brings unique tax implications that differ from starting an independent business.. 

This article provides a comprehensive guide to the tax obligations of franchisees in Australia, outlining which franchise-related payments are tax-deductible as business expenses.

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Franchise Fees

The initial franchise fee is the upfront payment made to the franchisor for the right to operate a franchise business under their brand and system. The Australian Tax Office (ATO) states that the initial franchise fee and transfer fees are treated by the ATO as capital expenditure used to acquire your franchise licence, which is a capital asset. Since these payments represent a capital investment in acquiring business rights rather than day-to-day operating costs, they are not tax-deductible. The total value of the cost base of the franchise business you purchase will have implications for any deductions (depreciation or amortisation) you make each year as well as the calculation for any future capital gain or capital loss when the business is sold (referred to as asset disposal).

Franchise renewal fees may have different tax treatments depending on your specific circumstances. If your franchise renewal fees form part of your cost base, they will not be deductible. Any franchise renewal fees not included in your cost base may be deductible as a business expense and subject to the prepayment rules.

Key factors affecting deductibility include the renewal period length, whether new rights are created, and the consequences of not renewing. Deductible renewal fees may be subject to prepayment rules if they cover multiple income years.

Fees paid to professional advisers, such as lawyers, accountants, or business advisers, are generally deductible. These fees are not related to the business’s value but rather to obtaining professional services in the ordinary course of establishing your business operations.

Asset Purchase and Setup

If you purchase equipment or assets, these may be deductible or capital assets depending on their nature, cost, expected lifespan and intended use.

Generally, the equipment you invest in to operate the business and receive any additional income from will depreciate over time. These write-offs are recorded as expenses in each year’s profit and loss statement and are therefore periodic tax deductions. As such, you will still get a tax deduction, just not for the initial purchase.

Consumable items or miscellaneous business expenses involved in the day-to-day operations of the business may be more likely to be tax deductible. This could include:

• third-party software (including recurring subscriptions purchased independently or through the frachisor);
• initial supplies; or 
• consumable stationery, products, merchandise and stock.

If you purchase assets from an existing business, you should check the:

• current book value and market value of an asset to determine if goodwill has been included or excluded;
• expected depreciation schedule and amounts (for example,straight-line – known as prime rate – or diminish value); and 
• any financing or security attached to the asset.

This way, you can ensure your financial records are accurate.

Royalty and Marketing Fees

Ongoing use of a franchisor’s business model, systems, operations and IP often involves payment of ongoing fees. These fees include:

• royalties; 
• interest payments; or 
• levies for advertising and marketing.

Royalty payments and marketing levies are typically based on the revenue of your franchise, although they may sometimes be fixed amounts or conditional on achieving certain performance targets or milestones. Marketing and advertising fees are often pooled with contributions from other franchisees to fund national or regional advertising campaigns, promotional materials, and brand development activities. These collective marketing efforts benefit all franchisees within the network by maintaining brand recognition and driving customer traffic.

Regardless, these payments are deductible as a business expense. Unlike the initial upfront fee, they are a continuing expense of your business that covers expenses relating to: 

• administration; 
• services from the franchisor; 
• advertising; and 
• other types of support. 

The key distinction is that these ongoing fees relate to current operational support and services rather than the initial acquisition of franchise rights. This makes them legitimate business operating expenses that can be claimed as tax deductions in the financial year they a re incurred.

It’s important to maintain detailed records of all royalty and marketing fee payments, as these will be required to substantiate your deductions during tax time or if the ATO requests documentation during an audit.

Training Fees

Training fees are charged to the franchisee to provide training in running the business. This training ensures that the managers and employees of a franchise remain up to date with business procedures. Training fees may be included in the initial franchise fee. Alternatively, you may be charged this fee separately upfront or pay it on an ongoing basis. This is dependent on the franchisor. 

Suppose the initial training is charged separately and in exchange for tangible services (particularly for third-party providers). In that case, they may be deductible and considered separate from the business’s cost base. After all, the knowledge gained from training is retained by the individual employees. 

Ongoing training fees can more readily be claimed as a business expense. This might mean that paying training fees separately and over time is a more financially viable option for franchisees. 

If the training fee is included in the initial franchising fee, then it is more likely to form part of the business cost base. However, this can change if you exercise any cooling off rights and still have to pay some fees for services provided by the franchisor.

Goods and Services Tax

Your ongoing payments to the franchisor usually include a goods and services tax (GST) component. If you are registered to pay, you will generally be able to claim a GST credit for the amounts relating to the payment of:

• initial franchise fee and ongoing fees (such as royalties);
• franchise renewal fees;
• advertising fees;
• transfer fees; and
• training fees.

Transfer or Termination of a Franchising Agreement 

You must consider both GST consequences if you transfer a franchise to someone else or terminate a franchise agreement. In addition, you will also need to consider capital gains tax for gains or losses which can differ depending on the circumstances of the transfer (to the franchisor or another franchisee) or termination (surrender). 

When you transfer or terminate your franchise, the initial fee in your cost base may be relevant in working out your net capital gain (if any). Therefore, this should be accounted for in your annual tax return.

Transferring a franchised business as a going concern removes GST applicable to the purchase price, provided conditions are met. It is important to make sure the purchaser continues under the franchise brand to ensure there are no tax surprises.

Non-Residents

You may make ongoing royalty payments to a non-resident franchisor as a franchisee. In these circumstances, tax rates paid to the ATO might be lower. This is because there may be a double-tax agreement with the franchiser’s country of residence. This would, therefore, reduce the standard amount of tax withheld, typically 30% from the gross royalty payment amount.

You must pay the ATO the amounts you withhold from royalty and interest payments and report the amount in these circumstances. Moreover, you should later report the total annual royalty, interest payments, and amounts withheld.

Key Takeaways

There are unique tax implications associated with operating as a franchisee. Speaking to a legal or financial advisor about your tax obligations can help you maximise your franchise. However, some key things to note include the following:

• the initial franchise fee you pay to the franchisor is not deductible as a business expense from your annual income tax;
• assets and equipment can have different tax treatments;
• royalty payments, advertising expenses and training fees are usually tax-deductible; and
• there are different tax obligations associated with non-resident franchisors.

If you need assistance understanding your tax obligations as a franchisee, our experienced franchise lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.

Frequently Asked Questions