• The impact of this case on ATO policy is discussed in Decision Impact Statement: Inglewood & Districts Community Enterprises Ltd and Commissioner of Taxation (Published 23 November 2011).

INGLEWOOD & DISTRICTS COMMUNITY ENTERPRISES LTD v FC of T

Tribunal:
Administrative Appeals Tribunal, Melbourne

MEDIA NEUTRAL CITATION: [2011] AATA 607

F O'Loughlin (Senior Member)

Introduction

1. This application concerns deductibility (either outright in the year incurred or over time) of three of five amounts that the applicant committed to pay to operate a Bendigo Bank branch under a community bank model. The amounts it committed to pay were provided for in an agreement (the Franchise Agreement) with Bendigo Bank Limited (Bendigo) and were:

• (a) franchise fees payable on entering the Franchise Agreement divided into two components:
  • (i) $10,000 - called a Franchise fee; and
  • (ii) $100,000 - called a Franchise establishment fee ( Franchise Establishment Fee );

  (together, Franchise Fees ) and

• (b) renewal fees payable on renewal of the Franchise Agreement divided into three components:
  • (i) $10,000 (escalated to reflect movement in the consumer price index to the time of payment) called a Franchise fee; and
  • (ii) $50,000 (also escalated to reflect movement in the consumer price index to the time of payment) called a Franchise Renewal fee;

    (together, Renewal Fees ); and

  • (iii) an unspecified amount which was a recovery fee for Bendigo's time, effort and expense, excluding certain disbursements otherwise provided for in the Franchise Agreement.

2. The applicant applied to the Commissioner for a ruling concerning the deductibility of the Franchise Establishment Fee and the Renewal Fees. The applicant contended that the Franchise Establishment Fee was deductible over a five year period pursuant to s 40-880 of the Income Tax Assessment Act 1997 (C'th) (the 1997 Assessment Act) and that the Renewal Fees were deductible pursuant to Subdivision H of Division 3 of Part III of the Income Tax Assessment Act 1936 (C'th) (the 1936 Assessment Act).

The Commissioner's ruling

3. The Commissioner did not rule in the way the applicant had sought. The Commissioner's ruling set out the Commissioner's questions and responses as follows:

"Question 1

Is the 'Franchise Establishment Fee':

• (a) Not immediately deductible in accordance with section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) on the basis that the expense incurred is capital in nature?
• (b) Deductible in accordance with section 40-880 of the ITAA 1997 (i.e. over five years) on the basis that the cost relates to the proposed carrying on of a business for income producing purposes and does not form part of the cost base of any other CGT asset or depreciating asset, nor is the expense taken into account by any other provision of the Income Tax Assessment Acts?

Answers

• (a) Yes
• (b) No

Question 2

Is the 'Renewal Fee - Franchise Fee':

Deductible over the eligible service period (broadly five years, being the term of the 'Franchise Agreement') in accordance with the prepayment provisions of Subdivision H of Div 3 of Part 111 of the ITAA 1936, on the basis that the expenditure is not excluded expenditure, is in relation to services to be provided under an agreement that is not wholly provided within the income year in which the expenditure was incurred, and would be otherwise deductible in accordance with section 8-1 of the ITAA 1997?

Answer

No

Question 3

Is the 'Franchise Renewal Fee':

Deductible over the eligible service period (broadly five years, being the term of the 'Franchise Agreement') in accordance with the prepayment provisions of Subdivision H of Div 3 of Part 111 of the ITAA 1936, on the basis that the expenditure is not excluded expenditure, is in relation to services to be provided under an agreement that is not wholly provided within the income year in which the expenditure was incurred, and would be otherwise deductible in accordance with section 8-1 of the ITAA 1997?

Answer

No"

The competing contentions

4. The bases for the Commissioner's negative answers above and the contentions in support of his decision on objection can be summarised as:

• (a) the Franchise Establishment Fee is an amount payable for the contractual franchise rights and as such forms part of the cost base of that asset attracting the terms of s 40-880(5) of the 1997 Assessment Act. The Franchise Establishment Fee is affected by ss 40-880(3)(d) to (g) (which are now represented by s 40-880(5)), and that these provisions make it clear that franchise fees and expenditure to acquire goodwill incurred in establishing a taxpayer's business are not deductible under section 40-880. The Commissioner relies on the Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 5) 2002 which states that:

  "[ijt has been suggested that expenditure incurred in relation to leases or other legal or equitable rights, franchise fees or the acquisition of goodwill could be covered by paragraph 40-880(1)(a). It was never intended that the paragraph encompass such expenditure and the amendments to the paragraph and the amendments to subsection 40-880(3) discussed in paragraphs 3.63 to 3.71 ensure that the intended outcome is achieved."

  and example 2.13 at page 56 of the Explanatory Memorandum to the Taxation Laws Amendment (2006 Measures No. 1) Bill 2006; and

• (b) both of the Renewal Fees are of a capital nature. They are not deductible under s 8-1 of the 1997 Assessment Act and therefore Subdivision H of Division 3 of Part III of the 1936 Assessment Act does not apply.

5. The applicant contends that the Commissioner is wrong and that:

• (a) the Franchise Establishment Fee relates to services rendered prior to carrying on any business rather than securing an enduring benefit and does not form part of the cost base of any asset; and
• (b) the Renewal Fees:
  • (i) secure no additional or new rights other than the right to continue to carry on or maintain the existing franchise;
  • (ii) are not met once and for all but are recurring in nature should the applicant choose to renew the franchise for an additional term;
  • (iii) effectively reimburse Bendigo for the costs incurred in renewing the franchise; and
  • (iv) should be considered in the same light as the cost of renewing a trademark so as to maintain it, which the applicant submits is generally regarded as deductible.

The facts for the ruling

6. The Commissioner's ruling set out the facts on which he ruled. It is necessary to quote them in full.

"Bendigo Bank Limited ('Bendigo Bank') operates a 'Community Bank Model' which involves local communities owning and establishing their own Bendigo Bank branch.

Each branch operates as a corporate franchise ('the Franchisee') of Bendigo Bank, using the name, logo and various systems of Bendigo Bank. The Franchisees are appointed as authorised representatives of Bendigo Bank and manage the branch on behalf of Bendigo Bank in the local community.

The 'Franchise Agreement' governs the management of the branch and the rights and obligations of the branch and Bendigo Bank. A copy of the Franchise Agreement applicable to the taxpayer, Inglewood & Districts Community Enterprises Ltd (Inglewood), was attached as supporting information.

Under the Franchise Agreement, Bendigo Bank grants each Franchisee the non-exclusive right to use the 'System' and other intellectual property of Bendigo Bank for the purpose of managing and operating a branch of Bendigo Bank in the local community.

The System is the interior layout, design and decoration, merchandising, advertising, sales and promotional techniques, personnel training and other matters relating to the efficient and successful operation of the Franchise.

Other intellectual property of Bendigo Bank comprises the intellectual or industrial property owned, licensed or used by Bendigo Bank, including:

• • Trademarks which are the registered trademarks notified to the Franchisee by Bendigo Bank,
• • The name 'Community Bank',
• • The intellectual property attaching to the technology and the information technology materials which are provided by the Franchisees in connection with the Franchise Agreement,
• • Any intellectual property attaching to the Franchise Agreement, the Capital Raising Documents and any manuals or other documents provided by or on behalf of Bendigo Bank, and
• • Any other intellectual property of Bendigo Bank provided under the Franchise Agreement for the purposes of managing and operating the Franchise.

In accordance with the Franchise Agreement, the Franchise is entitled to certain profit, commissions and fees in respect of the branch's activities.

Inglewood & Districts Community Enterprises Ltd (Inglewood) was incorporated on 15 February 2007 and entered into the Franchise Agreement to establish the Bendigo Community Bank branch during the 2008 income year.

Inglewood commenced trading as a Bendigo Community Bank branch on or around 1 June 2007.

Franchise Agreement

The Franchise Agreement is subject to a number of conditions which govern the establishment and operation of the Franchise. The following are the more pertinent clauses extracted from the Franchise agreement for the purposes of this ruling:

• 1. Definitions and interpretation
  • 1.1 Definitions

    Bendigo Franchise means a right granted by Bendigo, or a member of the Bendigo Group, to manage and operate a branch of Bendigo.

    Commencement Date means:

    • (a) the earlier of the Anticipated Branch Opening Date and the date, set out in a notice from Bendigo to the Franchisee for the purposes of this definition, on which the Franchise Operation commences operation; or
    • (b) such other date, being not more than 6 months after the date of this Agreement, as Bendigo and the Franchisee may agree.

    Franchise means the right granted the Franchisee by Bendigo under Clause 2.1 of this agreement.

    Franchise Fees means the fees specified in Item 8 of Schedule 1.

    Initial Term commences on the Commencement Date and ends on the last day of the time period set out in Item 6 of Schedule 1.

    Intellectual Property means that part of the Bendigo Intellectual Property licensed to the Franchise under this Agreement, being:

    • (a) the Trademarks;
    • (b) the name 'Community Bank';
    • (c) the intellectual property attaching to the Technology and the IT Materials;
    • (d) the intellectual property attaching to the Agreement, the Capital Raising Documents and any manuals or other documents provided by or on behalf of Bendigo; and
    • (e) any other of the Bendigo Intellectual Property provided to the Franchisee by or on behalf of Bendigo for use by the Franchisee for the purpose of managing and operating the Franchise Operation in accordance with this agreement.

    Start-Up Costs means the costs specified in Item 10 of Schedule 1.

    [Site modifications $150,000 - $200,000 and IT establishment $Nil]

    System means the interior layout, design and decoration, merchandising, advertising, sales and promotional techniques, personnel training and other matters relating to the efficient and successful operation of a Bendigo Franchise as specified in the Manuals and elsewhere by Bendigo.

    Training Costs means the amount set out in Item 9 Schedule 1.

    [Training Costs $10,000]

• 2. Grant of Franchise
  • 2.1 Franchise

    Subject to the satisfaction of the conditions in Clause 2.3 (or the waiver in accordance with Clause 2.4 of any such condition that has not been satisfied), Bendigo grants the Franchisee the non-exclusive right to use the System and the Intellectual Property for the purpose of managing and operating a branch of Bendigo at each Location for the Term in accordance with the terms and conditions of this agreement.

• 3. Payments and receipts by Franchisee
  • 3.1 Receipts

    In consideration of the Franchisee managing and operating the branch of Bendigo at each Location, and selling, offering and marketing the Products and Services, in accordance with this Agreement, the Franchise must receive the fees described in Schedule 3. Those fees are to be paid by Bendigo to the Franchisee in the circumstances and in the manner set out in that Schedule (provided that the Franchisee has paid to Bendigo the fees and costs as contemplated by Clause 3.2).

  • 3.2 Payments

    In addition to any other obligations to make any payments (whether under this Agreement or elsewhere), the Franchisee must pay the following to Bendigo:

    • (a) by no later than 5pm on the Payment Date:
      • (i) the Franchise Fees;
      • (ii) the Training Costs; and
      • (iii) the Start-Up Costs
    • (b) prior to any Disposition, the fees and costs set out in, and in accordance with, Clause 24.9;
    • (c) upon Bendigo providing its written agreement to a Renewal, the fees and costs set out in, and in accordance with, Clause 32.2 (the written agreement to be provided by Bendigo may be conditional on the receipt by Bendigo of these fees and costs); and
    • (d) the payments referred to in Clause 5.16(b) in accordance with that clause.

  • 3.4 Payment date

    Once Bendigo becomes aware that the condition in Clause 2.3 (c) [re: the raising of the subscription amount from issue of shares] has been waived (in accordance with Clause 2.4) or satisfied, it may send an invoice to the Franchisee. The day which is three business days after the date of that invoice is the 'Payment Date' for the purpose of this Agreement (unless Bendigo and the Franchisee agree otherwise).

• 7. The Manager
  • 7.1 Appointment and training of Manager

    7.1 (c) The Franchisee must ensure that, before commencing in the role as the Manager, an individual completes Bendigo's training programmes to be held at a location determined by Bendigo to the satisfaction of Bendigo and if Bendigo is not satisfied, that person may not be, or remain appointed as, the Manager.

• 8. Staff of Franchisee and Training
  • 8.1 Approval and initial training of staff

    Paragraph 8.1(b) - 'Each member of Staff must be approved in advance by Bendigo. The Franchisee must not employ, or permit to be involved in the Franchise Operation any person:

    • (1) not approved by Bendigo; or
    • (2) who has not, to the satisfaction of Bendigo, completed a training course under Clause 8.2 which Bendigo considers to be relevant to that person.'

  • 8.2 Training courses

    Subject to the payment to Bendigo of the training costs as contemplated by Clause 9, and except to the extent that an employee of Bendigo or another Bendigo Franchisee on secondment to the Franchisee has already received the proposed training, Bendigo must provide each member of Staff with such training in relation to the provision of banking services as Bendigo provides to its own employees engaged in activities similar to that member. For this purpose, Bendigo may conduct training courses at such times and at such locations as it thinks fit. The Franchisee must use its best endeavours to ensure that each training course conducted by Bendigo is attended by those members of Staff (or those potential members of Staff) to which, in Bendigo's reasonable opinion, that course is relevant.

• 9. Training Costs
  • 9.1 Payment of Training Costs

    In consideration for the training to be provided by Bendigo under Clauses 7.1 (c) and 8.2 during the Initial Term, the Franchisee agrees to pay Bendigo the Training Costs in accordance with Clause 3.2. All other costs associated with training the Staff in their capacity as such (including living, travelling and accommodation expenses incurred by those members attending training and any costs incurred by the Franchisee in the relation to training Staff) must be borne by the Franchisee. For the avoidance of doubt, the parties agree that the Training Costs do not cover the training that the Franchisee must procure in accordance with Clauses 7.2 and 8.6.

  • 9.2 Refund of training costs

    If this Agreement is terminated for whatever reason prior to the provision of any training by Bendigo as contemplated by this agreement, Bendigo must refund the training costs to the Franchisee (to the extent paid by the Franchisee to Bendigo) within 120 days of such termination. Once any training as contemplated by this Agreement is provided by Bendigo, no such refund is payable.

  • 9.4 Training costs on renewal

    In the case of a Renewal, the Franchisee agrees to pay to Bendigo the reasonable costs of the training provided by Bendigo to the Staff, being training which relates to the time period in respect of which the term of the Franchise was extended by that Renewal.

• 21. Bendigo's general duties and obligations
  • 21.1 Opening assistance

    Bendigo must supply at least one employee to assist the Franchisee for at least five Business Days during the opening two months of operation of the Franchise Operation.

  • 21.2 Initial & Ongoing advice

    Bendigo must furnish the Franchisee with such ongoing advice in connection with the establishment and the ongoing conduct of the Franchise Operation as is, from time to time, reasonably required in Bendigo's opinion. Such ongoing advice and guidance with respect to:

    • (a) methods and procedures for the sale of products and the provision of services in the Franchise Operation;
    • (b) the formulation and implementation of advertising and promotional programmes, including assistance with the launch of the Franchise Operation;
    • (c) sales techniques and proper customer relations;
    • (d) administrative, book-keeping, accounting and general operating procedures for the proper operation of the Franchise Operation;
    • (e) security and cash logistic controls (including in relation to surveillance, monitoring and the secure transportation of cash);
    • (f) equipment and fittings necessary for the Franchise Operation; and
    • (g) general management and administrative guidance and assistance as Bendigo deems necessary to improve the operating efficiency and profitability of the Franchise Operation.

• 32. Renewal
  • 32.1 Renewal

    If:

    • (a) there are no existing breaches of any of the terms of this Agreement (or any other agreement between the Franchisee and Bendigo or a member of the Bendigo Group);
    • (b) the Franchisee secures the rights (to the satisfaction of Bendigo) to the possession and use of each Location for the purposes of carrying out the Franchise Operation for any renewal period;
    • (c) the Franchisee refurbishes each Location where the Franchise Operation is conducted to meet the then current standards and specifications for Bendigo Franchises;
    • (d) the Franchisee provides a statement in the form of Schedule 4 and complies with any requirement imposed by the Code; and
    • (e) no earlier than six, but no later than three, months prior to the expiration of the Initial Term, the Franchisee provides a written request for renewal or extension.

    Bendigo will, subject to the payment of the fees and costs by the Franchisee as required by Clause 32.2, extend the term of the Franchise (a Renewal), for the first Renewal Period and the Franchisee must accept such renewal upon the terms and conditions set out in this Agreement (other than payment of the amounts in Clause 3.2(a))[see above]. (Emphasis added.)

  • 32.2 Payments of Costs

    If there is to be a Renewal in accordance with Clause 32.1, Bendigo will provide a written notice to the Franchisee that it has agreed to the Renewal, subject to the payment of the fees and costs specified in Clause 32.2. Upon receipt of such notice, the Franchisee must pay to Bendigo:

    • (a) the Renewal Fee; and
    • (b) Bendigo's reasonable out of pocket expenses (including any legal and other adviser's fees, stamp duty on any necessary documents) on renewing the Franchisee's Franchise, as specified in the notice.

  Schedule 1

  • 6. Initial Term - 5 years from the Commencement Date
  • 8. Franchise Fees: comprising $100,000 (being a Franchise establishment fee); and

    $10,000 (being a Franchise fee)

  • 9. Training Costs $10,000
  • 11. Renewal Fee comprising: $10,000 (being a Franchise fee); and

    $50,000 (being a Franchise Renewal fee)

    Each to be escalated at CPI at the time of each payment.

    * This fee is a cost recovery fee for Bendigo's time, effort and expertise. It does not cover any disbursements contemplated by clause 32.2(b).(sic)

  • 12. Renewal Periods

    (First Renewal Period 5 years; (sic)

    (b) Second Renewal Period 5 years.

  Other information.

  As part of the branch establishment and launch process, Bendigo Bank incurred expenditure on initial staff recruitment, training and uniforms, and on the marketing campaign and promotion of the launch of the new franchise.

  As part of its obligations under the Franchise Agreement, the taxpayer made a payment of $100,000 to Bendigo for 'start-up assistance'.

  A letter is provided to the Board prior to payment of the franchise establishment fee of $100,000 and establishment of the community bank.

  Extract from the letter:

  Many of the formal steps in establishing your local branch have now been completed, and we would now like to commence formalising the process by requesting payment of the up-front fees.

  Attached is an authority request, which once signed by two of your account signatories would allow us to withdraw the following amount from your company trading account:
  

  Franchise Fee	$ 10,000.00
  Establishment Process Fee	$ 100,000.00
  Training Costs	$ 10,000.00
  	$ 12,000.00 GST
  	$ 32,000.00 Total

  A breakdown of the Establishment Process fee and Training costs follows:

  • • Establishment Process Fee
  • • Staff Time and Travel: Community Bank Development Manager/Support Officer, supporting staff, Mentors, Recruitment, Staff Uniforms, IT Installation, Branch Support, staff pre-opening and post opening and launch.
  • • Advertising for recruitment and launch.
  • • Travel, meals and accommodation for branch staff training.
  • • Production of legal documentation.

  Training Costs

  • • All professional training prior to opening
  • • All future training post opening for the term of the agreement.

  Summary of costs

  The following is a summary of the costs that have been extracted from the Franchise Agreement and other available information.
  

  1.	$25,000 to $35,000	- Legal and accounting costs in relation to feasibility study (not paid to Bendigo)
  2.	$5,000	- Non refundable amount
  3.	$110,000	- Franchise fee - Franchise Fee - $10,000 - Franchise Establishment Fee - $100,000
  4.	$10,000	- Training costs Clause 7.1 Initial training of manager before they can commence the position. All costs of other training to be met by Franchise (Clause 7.2). - Clause 8.1 Approval and initial training of staff and some ongoing training. All costs of other training to be met by Franchisee (Clause 9.1)
  5.	$60,000	- Renewal cost recovery fee. This fee is a cost recovery fee for Bendigo's time, effort and expertise. It does not cover any disbursements contemplated by clause 32.2(b). - Franchise Fee - $10,000 - Franchise Renewal Fee - $50,000 - Clause 32.2(b) Bendigo's out of pocket expenses (including any legal and other adviser's fees, stamp duty on any necessary documents and all other disbursements). The Franchisee refurbishes each location.
  6.	$150,000-$200,000	- Start up Items - Site modifications - $150,000 - $200,000 - IT establishment - $Nil (The Note to Clause 22.3 stipulates that start up costs do not include Franchise Fees set out in Item 8 of Schedule 1).
  7.	$	- Clause 5.16 Ongoing services from Bendigo - cheque clearing services - computer software and hardware (per invoices)
  8.	$	- Clause 5.11 Uniforms - expense to be met by Franchisee.
  9.	$	- Clause 5.17 Costs of running Franchise - to be met by Franchise
  10.	$	- Clauses 7.2 and 8.6 Other training - Clause 9.1 Payment of training costs to be met by franchisee not covered by "Training Costs".
  11.	$	- Clause 8.4 Costs of employing staff - met by Franchisee.
  12.	$	- Clause 9.4 Training costs on renewal - met by Franchisee.
  13.	$	- Clause 12.7 Costs of Lease - Franchisee solely responsible for all costs.
  14.	$	- Clause 12.8 Maintenance of Premises - Franchisee at its own cost.
  15.	$	- Clause 12.10 Layout and colour scheme, construction remodelling. Franchisee's cost.
  16.	$	- Clause 12.14 Rates taxes and other outgoings the Franchisee is solely responsible for these expenses
  17.	$	- Clause 16.1 the Franchisee must regularly advertise at its cost.
  18.	$	- Clause 18.1 the Franchisee must take out and maintain insurances at their cost.
  19.	$	- Clause 49 Costs and Stamp Duty.
  20.	$	- Clause 50 Additional fees and charges"

7. Notwithstanding the facts stated in the Commissioner's ruling only included extracts of the Franchise Agreement, the entire Franchise Agreement forms part of the facts ruled on. Additional aspects of the Franchise Agreement that were not separately extracted in the ruling bear upon the proper ruling to be made. They are as follows:

• (a) Bendigo remains entitled to establish a competitor business to that of the applicant anywhere;^[1] Clause 2.2.
• (b) the relationship between Bendigo and the applicant is described in various ways in the Franchise Agreement. The applicant is said to be an independent proprietor conducting the business and not a joint proprietor, partner, joint venturer with or agent of Bendigo.^[2] Clauses 5.12 and 48. However, in offering, marketing, providing, promoting or selling the products and services the applicant acts on Bendigo's behalf and all transactions in relation to those products and services were transactions between the customer and Bendigo as principal.^[3] Clause 5.14. The facts that the applicant provides, promotes and/or sells the products and services on Bendigo's behalf and that all transactions in relation to those products and services are transactions between the customer and Bendigo as principal must mean that in relation to insurance products for example, the applicant is not assuming any indemnity or underwriting obligations, and in relation to loans the applicant is not lending any of its money. In a very real sense the Franchise Agreement is an agreement which facilitates the conduct of Bendigo's business;
• (c) during the term of the Franchise Agreement the applicant and its employees are restrained from engaging in other businesses in competition with Bendigo's business and/or Bendigo's products and services.^[4] Clauses 10.1, 11.1. There are also similar constraints for a period after the Franchise Agreement is terminated;^[5] Clauses 8.7 and 19.1–19.3.
• (d) the fees referred to in clause 3.1 of the Franchise Agreement were:
  • (i) 50% of the Gross Margin calculated in accordance with Part 1 of Schedule 3;
  • (ii) the commissions set out in Part 2 of Schedule 3; and
  • (iii) the fee income set out in Part 3 of Schedule 3; and
• (e) the fee structure for the amounts payable to the applicant for conducting the business of providing financial products and services specified or approved by Bendigo under the Bendigo name and logo allows a sharing of the profitability of those activities between Bendigo and the applicant. The profit sharing appears to be the only other return Bendigo's reward for entering agreements transacted by the applicant pursuant to the Franchise Agreement. As such the Franchise Fees (including the Franchise Establishment Fee) and the Renewal Fees paid is payable to Bendigo are consideration, at least in part, for the rights conferred on the applicant to use the Bendigo system and intellectual property and to conclude transactions that form part of Bendigo's business.

Analysis of the competing contentions

8. The competing contentions, at least in part, focus on determining the nature of the financial obligations borne by the applicant by reference to the badges assigned to them and/or the manner in which they were calculated. The Commissioner contends that franchise fees were specifically excluded from the scope of s 40-880, as they are franchise fees and form part of the cost base of an asset. The applicant contends that the Franchise Establishment Fee was a fee for services provided independently of the Franchise Agreement and broadly represented the cost of those services. Neither the label (or nomenclature) nor the manner in which the fee is calculated is necessarily determinative.

9. The appropriate principles concerning the extent to which nomenclature and labels govern characterization of payments and obligations have been described in the following terms:^[6] M M Gordon, Principles of Deductibility of Interest, Presentation to the Tax Institute, 12 June 2003, http://www.taxinstitute.com.au/seminar-papers/principles-of-deductibility-of-interest-seminar-paper at 4 August 2011.

"The law has been and remains clear: it is not what you call something that counts, it is "what it really is" that matters. A mere label is not sufficient and never will be.

In Commissioner of Taxation v BHP, the Full Federal Court said:

'The true position is that the label that a party uses to characterise payment, in the present case the word "interest", will not be determinative, although it may have some relevance: cf NM Superannuation Pty Ltd v Young, referred to by the learned trial Judge in this context. What that relevance may be will depend on the particular circumstances of the case. A licence does not become a lease because the parties chose to call it one, if it is in truth a licence: Radaich v Smith. A person does not cease to be an employee and become an independent contractor because the parties use the latter description: Hannan & Allen v Australian Mutual Provident Society. So, it may be said that an amount payable does not become interest, if the parties chose to adopt that word, if in law it is not'.

Really this is no more than a particular example of the law's preference for substance over form. As Hill J said in Commissioner of Taxation v BHP:

'I would wish to say something about the issue of substance and form. While, no doubt, questions such as whether a covenanted payment is an annuity will, having regard to historical matters, depend to some, perhaps a considerable, extent on the form which the parties have adopted: Australia and New Zealand Savings Bank Ltd v Commissioner of Taxation, referred to with approval on this point on appeal: Australia and New Zealand Savings Bank Ltd v Commissioner of Taxation and Commissioner of Taxation v Australia and New Zealand Savings Bank Ltd; it is not assumed that form must always prevail over substance. The law has moved somewhat from the rather rigid adherence to form to be found in cases such as Inland Revenue Commissioners v Duke of Westminster. This is merely to emphasise that the Courts will always consider the substance of a transaction in characterising the character of the advantage which is sought to be obtained in determining whether an outgoing is on revenue account or whether on capital account and thus excluded from deductibility '. (Citations omitted and emphasis added.)

10. Further:

• (a) debiting the amount of a payment obligation to revenue account in the books of the payer;^[7] Colonial Mutual Life Assurance Society Ltd v Federal Commissioner of Taxation (1953) 89 CLR 428 at 447 per Williams ACJ. or
• (b) measuring or calculating the amount of a payment obligation^[8] Colonial Mutual Life Assurance Society Ltd, above, at 451 and 454 per Fullagar J, with whom Kitto and Taylor JJ agreed. by reference to features of a business on revenue account,

do not necessarily determine the character of the payment obligation. In a setting where the loss or outgoing involves a payment to secure rights, the test, 'what is the loss or outgoing really for?'^[9] Colonial Mutual Life Assurance Society Ltd , above, at 454 per Fullagar J, with whom Kitto and Taylor JJ agreed; City Link Melbourne Ltd v Commissioner of Taxation 2004 ATC 4945 ; (2004) 141 FCR 69 at 83[41] and 90[55] per Hill, Stone and Allsop JJ. translates to, 'what rights were conferred on the payer in return for the payment?'^[10] City Link Melbourne Ltd , above, at 91[55] per Hill, Stone and Allsop JJ.

The franchise establishment fee

11. The first ruling that the applicant sought and the Commissioner refused was that the Franchise Establishment Fee was deductible over time pursuant to s 40-880. The applicant accepted that these fees were of a capital nature.

12. The applicant contends that the Franchise Establishment Fee, while capital in nature:

• (a) was separate and distinct from the Franchise;
• (b) was for separately identified services rendered prior to the carrying on of the business rather than a payment to secure an enduring benefit; and
• (c) did not relate to the securing of any rights pertaining to the franchise.

13. In the lead up to becoming the operator of a community bank under the Bendigo model, the applicant (or its sponsors) and Bendigo did considerable work. The work that Bendigo did would undoubtedly have cost it money. Had this work not led to the opening of a community bank business, Bendigo would not have recovered its cost. From Bendigo's perspective, there may well have been a recovery of the cost it bore for the preliminary work that it did and communicating the amounts it typically spends on preliminary work to new franchisees would possibly serve as a means of justifying the amount of the Franchise Establishment Fee. The applicant's focus on these facts and the propositions it advances based on them confuse the measure or calculation of an obligation with what the obligation secures.

14. The Franchise Agreement provides that amounts were payable by the applicant to secure the non-exclusive right to:

"… use the System and the Intellectual Property for the purpose of managing and operating a branch of Bendigo at each Location for the Term in accordance with the terms and conditions of this Agreement."

15. Whatever motivated the calculation of the amount, the test that applies is what the payment in fact secured. The fact that the amount of a payment obligation might be measured or calculated by reference to another factor, e.g. a revenue receipt or the quantum of work done, is not determinative.^[11] Colonial Mutual Life Assurance Society Ltd , above, at 451 and 454 per Fullagar J, with whom Kitto and Taylor JJ agreed.

16. The only reason that the Franchise Establishment Fee was payable at all was that the applicant and Bendigo entered the Franchise Agreement. The benefits secured by the Franchise Agreement were the right to use Bendigo Bank business systems and other intellectual property. With that came the right to be paid fees linked to the performance of the business and the many and varied obligations and restrictions on the manner in which the applicant conducted the business. Accordingly, these rights to be enjoyed pursuant to the Franchise Agreement are the reference points by which the Franchise Establishment Fee is to be characterised to determine whether or not that fee meets the terms of s 40-880.

17. It follows, therefore, that the applicant's foundation for deduction entitlements pursuant to s 40-880, namely that the Franchise Establishment Fee was a payment for services provided, fails. In that circumstance, it is necessary to determine whether there is any other foundation for a deduction to be allowable pursuant to that section.

18. Section 40-880 was not intended to allow deductions for amounts that are deductible under other sections or form part of the cost base of an asset. While the Franchise Establishment Fee satisfies s 40-880(2), and ss 40-880(3) and (4) do not apply to deny or limit the deduction, s 40-880(5) applies to deny the deduction. Sections 40-880(5)(b), (d) and (f) provide:

"You cannot deduct anything under this section for an amount of expenditure you incur to the extent that:

• …
• (b) you can deduct an amount for it under a provision of this Act other than this section; or
• …
• (d) it is in relation to a lease or other legal or equitable right; or
• (f) it could, apart from this section, be taken into account in working out the amount of a * capital gain or * capital loss from a * CGT event;"

19. One of s 40-880(5)(b), (d) or (f) has a role to play.

20. With a lease, there can be a premium paid or payable upon its grant and rent which is the consideration payable under the lease for the right of use and occupation of the leased premises during the term of the lease.^[12] See Commissioner of Taxation v Krakos Investments Pty Ltd 96 ATC 4063 ; (1995) 61 FCR 489 at 503 per Hill J, with whom von Doussa and O‘Loughlin JJ agreed, and the cases there cited. Similarly, for a franchise styled agreement, there can be payments for the grant of the rights conferred and payments for rights to use various property and other rights.

21. If the amounts paid or payable pursuant to a franchise styled agreement are properly regarded as rights for use and are on revenue account, then deductions would be allowed under either s 8-1 of the 1997 Assessment Act or over the eligible service period in accordance with Subdivision H of Division 3 of Part III of the 1936 Assessment Act. In these circumstances, s 44-880(5)(d) of the 1997 Assessment Act is enlivened.

22. If the amounts paid or payable are properly regarded as consideration for the grant of the franchise rights and are on capital account then either s 40-880(5)(d) or (f), or both, could have a role to play. The rights conferred by the Franchise Agreement were either legal and/or equitable rights. Legal or equitable rights that are not property are CGT assets within the meaning of s 108-5(1)(b) of the 1997 Assessment Act. Legal or equitable rights that are property are CGT assets within the meaning of s 108-5(1)(a). Amounts payable to acquire those rights, or the consideration for the conferral of those rights, meet the description of expenditure incurred in relation to those rights and will be part of (or all of) the first element of cost base provided for by s 110-25(2). Upon extinguishment (or other CGT event happening to the rights) they will be taken into account in working out a capital gain or loss.

23. Accordingly, s 40-880 cannot operate to allow any deduction for these fees. In these circumstances it is not necessary to resort to the explanatory memorandum to the predecessor to s 40-880(5). If resort is had to that document it should be noted that the references to expenditure incurred in relation to leases or other legal or equitable rights, franchise fees or the acquisition of goodwill not being intended to be covered by s 40-880 must only be referable to such amounts as are of a capital nature and/or not otherwise deductible, for example lease premiums and equivalent amounts.

The renewal fees

24. The Renewal Fees must be characterised. If they are on revenue account, the applicant succeeds. If they are on capital account the applicant does not.

25. As indicated earlier, to characterise these fees it is necessary to determine what the obligations were or are really for, or what rights were or are secured. Recognising that the distinction between a payment made for use of property for a term and a payment made for conferral of a lease can be a difficult one,^[13] Krakos Investments , above, at 503. and that the equivalent payments made under a franchise styled agreement are not materially different, resolution of the disputed income tax treatment of the Renewal Fees does not turn on whether the fees are given a particular label. Rather the resolution turns on whether these fees are on capital account or revenue account: the Sun Newspapers^[14] Sun Newspapers Ltd and Associated Newspapers Ltd v Commissioner of Taxation (C’th) (1938) 61 CLR 337 at 363 per Dixon J. principles govern the outcome. Under these principles long standing authorities suggest that:

• (a) payments to preserve, as opposed to payments to exploit, structural rights are seen as affairs of capital;^[15] Federal Commissioner of Taxation v Duro Travel Goods Pty Ltd (1953) 87 CLR 524 is an illustration of these principles.
• (b) expenditure to establish the profit-yielding structure of a business is incurred at a time that suggests it is of a capital nature;^[16] Labrilda Pty Ltd v Deputy Federal Commissioner of Taxation 96 ATC 4303 ; (1996) 65 FCR 119 at 139 per Ryan J, with whom Spender J agreed. and
• (c) the time at which expenditure is incurred can be a determinative feature in the characterisation process.^[17] Labrilda Pty Ltd , above, at 138 per Ryan J, with whom Spender J agreed.

26. Because the authorities suggest that establishing, replacing and enlarging the profit-yielding subject are affairs of capital,^[18] For example see Sun Newspapers Ltd and Associated Newspapers Ltd, above, at 359 per Dixon J. renewal or extension of arrangements that form the profit-yielding subject that would otherwise be extinguished are to be treated on the same footing.

27. More contemporary authority, however, is to the effect that payments for the use of or the right to conduct business operations in periods commensurate with the obligation to make payment should …be seen to be periodical and recurrent and thus a cost of conducting the business operations rather than a cost of acquiring a profit-making enterprise^[19] City Link Melbourne Ltd , above, at 93[70] per Hill, Stone and Allsop JJ. and lack of permanent ownership of any enduring asset has a role to play in characterising these payments.^[20] Commissioner of Taxation of Commonwealth of Australia v CityLink Melbourne Ltd (formerly known as Transurban City Link Ltd) 2006 ATC 4404 ; (2006) 228 CLR 1 at 44 per Crennan J, with whom Gleeson CJ and Gummow, Callinan and Heydon JJ agreed.

28. Applying these principles to the present circumstances, the Renewal Fees might be seen as an affair of capital by reference to some benchmarks, and as an affair on revenue account by reference to others.

29. The first consideration under the Sun Newspapers principles is the character of the advantage sought, incorporating the length of the period for which the rights under the Franchise Agreement were secured upon the renewal, namely five years. The authorities suggest that payments to secure rights that could be enjoyed for five year periods have been regarded as referrable to periods sufficiently short to be characterised as on revenue account.^[21] BP Australia Ltd v Commissioner of Taxation of the Commonwealth of Australia (1965) 112 CLR 386 at 399 per Lord Pearce; Labrilda Pty Ltd , above, at 138 per Ryan J, with whom Spender J agreed. Contracts for periods of two and three years have been described as … not lasting assets … of a relatively short term nature and subject to renewal,^[22] Spriggs and Riddell v Commissioner of Taxation of the Commonwealth of Australia (2009) 239 CLR 1 at 25[82] per French CJ, Gummow, Heydon, Crennan, Kiefel and Bell JJ. even if it is assumed that the relevant contract is the only contract that produced income.^[23] Spriggs and Riddell , above, at 25[81] per French CJ, Gummow, Heydon, Crennan, Kiefel and Bell JJ.

30. The second consideration under the Sun Newspapers principles is the manner in which the advantage is to be enjoyed. The exclusivity provisions in the Franchise Agreement^[24] Clauses 11.1, 10.1, 8.7 and 19.1–19.3 observed above. have the effect that the community bank styled business was, and upon renewal will be, the applicant's only relevant business activity.^[25] Cf Fanmac Ltd (formerly First Australian National Mortgage Acceptance Corporation Ltd) v Federal Commissioner of Taxation (1991) 91 ATC 4703 at 4709 per Beaumont J. In these circumstances, the manner in which the Franchise Agreement is enjoyed would be as an important, if not fundamental, element of the structure of the business rather than a contract made in the course of carrying on the business. Absent a renewal (in reality, an extension of the term), the applicant would not have its business at all.^[26] Cf Hallstroms Pty Ltd v Federal Commissioner of Taxation (1946) 72 CLR 634 per Latham CJ, Starke and Williams JJ; Dixon and McTiernan JJ dissenting. This suggests that the renewal of the Franchise Agreement is a renewal of the structure of the business.

31. Given that five years is considered to be a relatively short period for the purposes of the character of the advantage sought test, and that at the end of the five years the applicant would have nothing, and any renewal will involve recurrence of outgoings, it follows that the Renewal Fees would not be on capital account. Accordingly, these fees will be eligible to be deducted over the life of the service period pursuant to Subdivision H of Division 3 of Part III of the 1936 Assessment Act, on the basis that it would be otherwise deductible under s 8-1 of the 1997 Assessment Act.

32. This finding is consistent with the conclusion in
Federal Commissioner of Taxation v Chapman.^[27] (1989) 89 ATC 4246 . There, in a parallel setting to the applicant's circumstances, namely, a renewal of an arrangement that enabled a business to be carried on, Pincus J said:

"It could hardly be contended that the ordinary recurring expenses of obtaining renewal of council consent every five years in order to continue carrying on the business were on capital account."^[28] (1989) 89 ATC 4246 at 4248 .

33. The two authorities that the Commissioner relied on,
Labrilda Pty Ltd v Deputy Federal Commissioner of Taxation and Case S24,^[29] (1995) 17 NZTC 7, 169 . are distinguishable. In Labrilda the fact that the expenditure was incurred at the outset, or before commencement of business activity, was influential in Ryan J's decision on which the Commissioner relied. Labrilda is an illustration of the marginal nature of some characterisation conclusions. Over the course of the Tribunal and Federal Court processes in Labrilda, three decision makers took the view that the expenditure was of a revenue account character and three took the opposite view. Case S24 involved an outlay to acquire exclusive rights for a minimum of 10 years and possibly 15 years, with no further payment required for the additional five years. The present circumstances involve a much shorter period and do not involve exclusive rights or exclusive territory.

Conclusion

34. The Commissioner's objection decision in relation to the Renewal Fees referred to at paragraph 1(b) above is set aside and in substitution the Tribunal decides that those fees are deductible pursuant to Subdivision H of Division 3 of Part III of the 1936 Assessment Act.

35. The objection decision is otherwise confirmed.