Edited version of your written advice

Authorisation number: 1012838565530

Ruling

Subject: Deductibility of fees paid to terminate a franchise agreement

Question 1

Are payments made by the Trustee for Company A for the termination of franchises allowable as deductions in the year of payment under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

If the answer to Question 1 is no, are the payments deductible over 5 years under section 40-880 or section 25-110 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

1 July 20XX to 30 June 20XX.

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The Company A Group Limited is listed on the Australian Stock Exchange. The Company A Group indirectly owns 100% of the Company A Unit Trust (Company A) and the Company A Franchising Unit Trust (Franchising). These entities, along with others, are collectively referred to as the Company A Group.

The Company A Group is Australia's largest and leading specialist retailer of widgets. The Company A Group's trading division includes a number of corporate and commercial stores owned by Company A, and a number of franchised stores.

For convenience, a reference in this ruling to Company A is a reference to the Trustee for the Company A Unit Trust, and a reference to Franchising is a reference to the Trustee for Franchising.

The System Licence Agreement

Company A developed a 'System' representing a combination of the intellectual property assets it owned and had developed to facilitate the carrying on of its retail business. Company A licensed the System to Franchising by executing the System Licence Agreement (SLA) in exchange for a nominal annual fee. In turn, Franchising may franchise the System to third parties from time to time. Although the fee paid by Franchising to Company A under the SLA is nominal, 100% of the franchising income flows to Company A as owner of all the units in Franchising.

Franchises

A typical franchise agreement between Franchising and a franchisee (Franchise Agreement) has the following features:

• the franchisee is allocated its own territory to facilitate the soliciting of customers, advertising, marketing and promotion of products and services;

• the agreement is entered into for an initial period of 7 years, providing options to renew for a further 7 year period;

• a franchise fee, a project management fee and a shop fit out fee are all payable by the franchisee to Franchising, generally in full, on or before the date on which the franchisee signs the agreement;

• a marketing fee and management fee of an amount equal to a percentage of weekly gross revenue is also payable by the franchisee on a recurring basis;

• suitable premises for the franchisee are located by the Company A Group; franchisee stores are selected in locations that are seen as complimentary to the overall business and not in competition with other stores, and

• wherever possible, Company A elects to hold the lease in relation to the premises and grants an occupancy right to the franchisee by way of an Occupancy Agreement under which the franchisee is required to pay all expenses relating to the lease and the Occupancy Agreement.

Obtaining a franchise provides access to system and support services as detailed in the Franchise Agreement and an operations manual, as well as access to intellectual property such as Company A logos and other trademarks. Support services are provided through the state sales managers.

A franchised store operates in a similar way to Company A owned stores. Typically, Company A leases the store, with the franchisee occupying the store as an operator under an Occupancy Agreement. Under the Franchise Agreement, each franchisee is granted a franchise (being a non-exclusive licence to establish and operate one Company A business in a designated territory).

The franchisees have a trading terms agreement with Company A, and the franchisees pay a royalty and a marketing fee to Franchising based on a percentage of gross sales on a monthly basis.

Under a Franchise Agreement, the franchisee agrees that any goodwill and any other rights or interests arising in connection with the System, (including the franchisee's use of the System), belong to the Company A Group. Further, the franchisee agrees that at the end of the Franchise Agreement, the franchisee is not entitled to any payment from the Company A Group for goodwill which may exist in relation to the System.

For example, a clause of the sample Franchise Agreement states that:

The franchisee acknowledges that:

• the Company A Group is the owner of all goodwill arising in connection with the system, including from the franchisee's use of the System; and

• at the end of this agreement, the franchisee is not entitled to any payment from the Company A Group for goodwill which may exist in relation to the System.

Termination of franchises

In certain circumstances, Company A or the franchisee may initiate negotiations to terminate the Franchise Agreement before the term expires. This may occur where a franchisee no longer wants to continue in that role or where the Company A Group believe they could operate that store more effectively. This may occur where a franchisee is not operating a successful store and the Company A Group believes that the brand could be negatively impacted if that particular franchisee continued in that role.

The termination of a franchise is effected by all parties entering into a Termination Agreement.

Under a typical Termination Agreement;

• the parties agree to terminate the Franchise and Occupancy Agreements, and

• the franchisee, as beneficial owner, agrees to sell its assets (including goodwill) and stock to Company A for the 'Purchase Price'. The Purchase Price is defined as the value of the assets and the goodwill of the franchisee in relation to the franchised business.

Under both termination scenarios contemplated above, the franchisee and Company A negotiate the Purchase Price and how it is to be allocated between the assets and goodwill.

Relevant legislative provisions

The relevant provisions dealt with in this Ruling are:

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 25-110

Income Tax Assessment Act 1997 section 40-880

Reasons for decision

Summary

Payments made by Company A to a franchisee to terminate a Franchise Agreement are not deductible under section 8-1 of the ITAA 1997.

Detailed reasoning

All legislative references in this Ruling are to the ITAA 1997 unless otherwise stated.

Section 8-1 allows for an immediate deduction for expenses incurred in the carrying on of a business provided that the expenses are not capital in nature.

Judicial precedent for distinguishing between capital and revenue was established by the High Court in Sun Newspapers Ltd and Associated Newspapers Ltd v. FC of T (1938) 61 CLR 337; (1938) 45 ALR 10; (1938) 1 AITR 403; 5 ATD 97 (Sun Newspapers). At 359, Dixon J stated:

The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure or organisation set up or established for the earning of profit and the process by which such an organisation operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss.

Justice Dixon stated that assessing the character of the expenditure was another relevant consideration (at 363):

There are, I think, these matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical outlay to cover its use or enjoyment for periods commensurate with the payment by making a final provisions or payment so as to secure future use or enjoyment.

In these reasons for decision we will first consider what constitutes Company A's business and its profit yielding structure. We will then consider the character of the expenditure in terms of the above factors.

What is Company A's business?

A franchise is an arrangement which allows the franchisee to use the intellectual property, goodwill and business system that is owned by the franchisor. The term 'franchising' covers various forms of co-operation between different entities.

Company A utilises the System it has developed in two ways. Firstly it uses the System to help operate the corporate stores whereby it sells products and services to customers, earning 100% of the gross revenue and incurring all expenditure in relation to these sales.

Secondly, Company A generates income from licensing the System to Franchising, which in turn licences the System to franchisees. Its revenue from this part of the business is mainly derived by receiving ongoing royalty payments paid by each franchisee to Franchising, which are then on paid to Company A, as holder of 100% of the units in Franchising.

What is Company A's profit yielding structure?

In identifying the structure established by Company A for the earning of profit, assistance may be garnered from the statements of Dixon J in Sun Newspapers (at 359):

The business structure or entity or organization may assume any of an almost infinite variety of shapes and it may be difficult to comprehend under one description all the forms in which it may be manifested. In a trade or pursuit where little or no plant is required, it may be represented by no more than the intangible elements constituting what is commonly called goodwill, that is, widespread or general reputation, habitual patronage by clients or customers and an organized method of serving their needs.

The Commissioner considers that franchising is an enterprise that is within the scope of the above statement of Dixon J, in that it comprises a low proportion of physical assets and a high proportion of intangible assets, including goodwill.

Goodwill

In FC of T v. Murry (1998) HCA 42; 98 ATC 4585; (1998) 39 ATR 129, the majority of the High Court (at paragraph 20) stated that the attraction of custom still remains central to the legal concept of goodwill, and further that:

• for legal purposes, goodwill is the attractive force that brings in custom and adds to the value of the business. It may be site, personality, service, price or habit that obtains custom (paragraph 68).

• the goodwill of a business is the product of combining and using the tangible, intangible and human assets of a business for such purposes and in such ways that custom is drawn to it (paragraph 24).

• it may be site, personality, service, price or habit that obtains custom (paragraph 68).

• goodwill is a quality or attribute that derives, among other things, from using or applying other assets of a business, for example, use of a trade mark or a particular site, or from selling at competitive prices (paragraph 24).

• it is more accurate to refer to goodwill as having sources than it is to refer to it as being composed of elements (paragraph 24).

• many of the sources of goodwill are not themselves property. Nor are they assets for accounting purposes. Examples include manufacturing and distribution techniques, the efficient use of the assets of a business, superior management practices and good industrial relations (paragraph 25).

• other examples are location of the business, a lack of competition resulting from an enforceable restrictive covenant, and statutory monopolies in respect of products of a business such as patents or trademarks (paragraph 26).

The Commissioner considers that Company A's business structure relies on the intellectual property it has developed, and that this intellectual property is the main component that makes up the goodwill of the business.

You state in your contentions that despite accounting for a portion of the termination payment as goodwill:

[T]he 'goodwill' portion is a convenient categorisation of the residual purchase price after allocation to plant and equipment and stock. No goodwill is acquired.

You further state that:

…[B]y terminating an agreement with a franchisee, Company A Group is not making a fundamental change to the structure of its business. Instead, Company A Group is reorganising its management of a particular store by switching from an arrangement under which it receives a percentage of sales via a royalty, to one which is undertakes (sic) full risk and receives a full retail margin.

The Commissioner acknowledges that the Franchise Agreements result in the franchisee not owning the goodwill of the business, however what the franchisee does acquire is a non-exclusive licence to operate a certain store and utilise goodwill developed by the Company A Group, provided the franchisee complies with the terms and conditions of the Franchise Agreement.

Therefore whilst the Commissioner agrees that no goodwill belongs to the franchisee, Company A effectively gives up its right to operate a store in the area using the franchise system that it has developed when it grants a franchise. When Company A makes a payment to terminate a franchise, it is effectively cancelling the licence so that the full use of the goodwill as it relates to the particular store reverts back to the Company A Group.

Operation of Corporate Stores

The Commissioner considers that the corporate stores from which Company A operates itself, form part of Company A's profit yielding structure.

Granting and termination of a franchise

The granting of a non-exclusive licence to the franchisee allows the franchisee to operate its own business subject to the terms and conditions in the Franchise Agreement for the franchise term. The relevant clauses which support that the franchisee operates its own business (in the sample Franchise Agreement) include:

• The Business Name is listed as Company A - and the Proprietor is listed as the franchisee.

• Relationship of the Parties is described as 'The Franchisee owns the Franchise and conducts the Franchised Business as an independent contractor (and will represent itself as such at the Site, on all documentation and in all detailing with others as required by Company A) and not as a partner, joint venturer, agent, representative or employee of Company A.

• Franchised Business is defined as the 'retail outlet of the Business to be owned and conducted by the Franchisee on their terms set out in this Agreement'.

• No Representation - the Franchisee acknowledges that the inclusion of the Minimum Business Requirements in this Agreement is not a representation by Company A that the Minimum Business Requirements will be achieved.

From the above terms and conditions it is evident that the granting of the franchise results in Company A disposing of part of its profit yielding structure by issuing the non-exclusive licence to operate its business in a certain location.

The Commissioner considers that by terminating a franchise Company A is agreeing to accept the surrender of the franchise (a non-exclusive licence) such that it will be able to operate the particular store itself.

You support your contention that by terminating the franchise, Company A is not making any fundamental change to the structure of its business but is reorganising its management of a particular store, on the basis of the decision in Anglo Persian Oil Co v. Dale [1932] 1 KB 124, [1931] All ER 725, (1931) 47 TLR 487, (Anglo Persian).

In the Anglo Persian case, the company had contracts with agents for the conduct of its business in remote parts of the world. The agents were renumerated by commission at specified rates. As the business developed, the company from time to time dispensed with the services of such agents, finding itself able to carry on the business more economically directly by its own servants.

In concluding that the payments made to dispense with the agents' services were revenue in nature, Lawrence J stated that (at 141):

[T]he Company by cancelling the agency agreement, and itself undertaking the future management of its business in Persia, neither enlarged the area of its operations, nor improved its goodwill, nor embarked upon a new enterprise; it merely effected a change in its business method and internal organisation, leaving its fixed capital untouched.

The Commissioner considers that the Anglo Persian case should be distinguished from the Company A Group's circumstances on the basis that the contractual relationship between Anglo Persian and its agents was one of agency, with Anglo Persian contracting its agents to represent it in its dealings with its customers in remote areas. In doing so, Anglo Persian retained its relationship as the principal in dealings with its customers.

In the circumstances of the Company A Group, Company A granted a non-exclusive right to enable a franchise to operate using the System, so it could service its own customers. Whilst the franchisee was required to operate its franchise under strict terms and conditions as outlined in the Franchise Agreement, this does not change the fact that the right provided by Company A requires the franchisee to operate the business as their own and on the basis that they earn all profits and bear all of the risks which are normally associated with running a business.

The termination of the licence will result in the profit yielding structure of Company A's business expanding, as it will now be able to operate the business in the franchise area that is being surrendered.

Prior to termination of the franchise, the franchisee was able to use Company A's System to service its own customers. Company A's role was to maintain and develop that System to assist the franchisee increase sales and profitability. In return for this, Company A was entitled to receive royalty payments from the franchisee through Franchising. The customers of the franchise were those of the franchisee and not Company A. Company A's contractual obligations were with the franchisee and not with the customers who purchased goods and services from the franchised store.

The Commissioner considers that granting of a franchise would result in Company A reducing its profit yielding structure and the subsequent termination would result in the expansion of its profit yielding structure.

Character of the expenditure

As mentioned previously, in Sun Newspapers Dixon J stated that when distinguishing between capital and revenue, assessing the character of the expenditure was also a relevant consideration, and articulated three matters to be considered being the character of the advantage sought by the expenditure, the manner in which the expenditure is to be used, relied upon or enjoyed and the means adopted to obtain the benefit.

Character of the advantage sought

In relation to the first matter, the character of the advantage sought by the expenditure, it is necessary to examine whether the expenditure secures an enduring benefit for the business. This test was outlined by Viscount Cave in British Insulated and Helsby Cables Ltd v Atherton [1962] AC 205 at 213 - 214:

But when an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital.

The character of the advantage sought by the making of the expenditure is the chief, if not the critical, factor in determining the character of what is paid. The nature or character of the expenditure will therefore follow the advantage that is sought to be gained by incurring the expenditure. If the advantage to be gained is of a capital nature, then the expenditure incurred in gaining the advantage will also be of a capital nature.

The Commissioner has considered the commercial reality of the transactions against the requirements of the contractual terms such that neither is the sole deciding factor, but a factor to be considered. As such, the Commissioner has focussed on what Company A got in return for the expenditure, in accordance with the comments of Windeyer J in BP Australia Ltd v Federal Commissioner of Taxation [1965] ALR 381 [8]:

Regard ought therefore to be had to what it was sought to acquire and to the relation of that to the taxpayer's undertaking or business. These, rather than the form of the transaction or the mechanics of the acquisition, are what appear to me to be deciding factors. In other words, it is what the particular taxpayer got for his money, rather than how he got it that is important.

In considering the nature of the advantage sought, you contend that:

[i]t is considered that the fee paid in terminating a franchise agreement is not associated with the [Company A Group] embarking upon a new enterprise. It is continuing to operate a store which was already part of the Company A business. It is merely changing the method by which it operates that store because it believes it will prove more profitable to do so, yet the change in business methods leaves the company's fixed capital untouched.

From the above statement it is clear that the nature of the advantage sought is to terminate the Franchise Agreement so that Company A can operate a particular store in such a way as to maximise its profits. The following factors indicate that the termination of the franchise provides Company A with an enduring benefit:

1. the one-off termination payment allows Company A to operate the store as a corporate store for an indefinite period of time. Had Company A not paid the termination fee, the franchisee may have been granted a franchise renewal for a further 7 years;

2. in practice, following termination of a Franchise Agreement, Company A has taken over the leased premises and continued to run the stores with its own employees - the stores in question have not been re-franchised; and

3. clause 22.2 of the Termination Agreement states that the parties agree that the Deed provides for the supply of a going concern - that is, by terminating the franchise, Company A acquires a going concern and will operate it as one of its corporate stores.

The Commissioner is therefore of the view that Company A's main purpose for terminating the agreements with the franchised stores was so that it could maximise profits for an indefinite period of time and that it could do this by terminating the agreements with the franchised stores.

Manner in which the expenditure is to be used, relied upon or enjoyed

In relation to the second matter to be considered when assessing the character of the expenditure, the manner in which the expenditure is to be used, relied upon or enjoyed, regard must be had to the recurrent nature of the returns it produces.

From the above analysis it is evident that what Company A acquired upon terminating a Franchise Agreement, was a going concern by virtue of the fact that the franchisee no longer held the licence to operate the franchise and that now Company A could operate the store as its own corporate store.

By terminating the franchise Company A was successful in acquiring a business structure that would result in increased profits as compared with receiving its income by way of royalties.

Therefore it can be concluded that the manner in which the expenditure was to be used and relied upon or enjoyed was by effectively acquiring a going concern that would result in regular returns in the way of sale of goods and services from the running of the particular store.

Means adopted to obtain the benefit

The final matter to be considered when assessing the character of the expenditure, as described in Sun Newspapers by Dixon J, requires analysis of the means adopted to obtain the benefit and whether this payment related to the expansion of the profit yielding structure, or whether the outlay was more akin to an ordinary business expense that could be matched with regular returns.

You argue that the facts in National Australia Bank Ltd v Federal Commissioner of Taxation (1997) 37 ATR 378 (NAB) supports the contention that the termination payment is immediately deductible:

Applying this to the [Company A] Group, the payments made in terminating individual franchises are incurred as part of the [Company A] Group's ordinary business activities in organising its method of operating existing stores. Those payments cannot be said to enlarge the existing framework within which the [Company A] Group carries on its business.

You also state in respect of the lump sum payment:

In Re: Allied Mills Industries Pty Limited And: (sic) the Commissioner of Taxation of the Commonwealth of Australia (1987) 20 FCR 288, Gummow J in the Federal court said that the significance of periodicity, regularity and recurrence of a receipt "is diminished when the receipt in question is generated in the course of carrying on a business".

We therefore believe, in determining that the termination fee is revenue in nature, it is not necessary for the fee to be characterised as periodic payments. A more important factor is that the termination fee was incurred by [Company A] in the course of carrying on its business of the retail sale of [Company A] products.

The Commissioner does not agree with your reasoning that the payment is part of Company A's ordinary business activities in organising its method of operating existing stores, for the reasons outlined in the profit yielding structure section above.

In Labrilda Pty Ltd v. DFC of T 96 ATC 4303, the taxpayer was a Mobil dealer, who bought the business of a petrol station and entered into several agreements with Mobil. These agreements allowed him to access a Mobil business package, comprising new and improved products, methods of marketing, merchandising and promotion and a new and improved means of customer service (collectively called the 'Team Pak Programme'). In consideration, the taxpayer paid Mobil an upfront accreditation fee.

Justices Spender and Ryan concluded that the taxpayer's expenses in relation to the accreditation fee were capital in nature and not deductible as outgoings incurred in the carrying on of the business. They ruled that the expense was more concerned with establishing the profit-yielding structure of the taxpayer's business.

The Commissioner considers that the payment of a lump sum clearly relates to the termination of the Franchise Agreement, which enables Company A to expand its profit yielding structure to an area where it does not have the right to operate a store. Furthermore, whilst not determinative, the fact that the payment is made as a lump sum indicates that the payment was made as a 'once and for all' payment, more akin to a capital purpose.

Conclusion

From analysing the above factors, the Commissioner considers that the payment to terminate a franchise is not deductible under section 8-1 on the basis that the character of the expenditure is capital in nature.

Question 2

If not, are the payments deductible over 5 years under section 40-880 or section 25-110?

Summary

The termination payments made by Company A are deductible over a five year period under section 25-110, to the extent that each payment relates to the termination of a licence to use intellectual property and under section 40-880 to the extent that the payment does not relate to the termination of a licence to use intellectual property.

Detailed reasoning

Section 25-110

Subsection 25-110(1) provides for a five year write off for capital expenditure incurred to terminate a lease or licence (including an authority, permit or quota), which;

... results in the termination of the lease or licence if the expenditure is incurred:

(a) in the course of *carrying on a *business; or

(b) in connection with ceasing to carry on a business.

The deduction is subject to certain exceptions contained in subsections 25-110(3) to 25-110(6).

The payment of a termination fee incurred by the Company A secures the termination of a Franchise Agreement. The payment enables Company A to operate the franchise as one of its own corporate stores.

A Franchise Agreement entered into between Franchising and the franchisee confers contractual rights and obligations on both the franchisor and the franchisee. The nature of a franchise prescribes that a termination payment terminates the various rights and obligations that collectively constitute what the franchisee acquired under the franchise agreement; the right to use the intellectual property in operating the franchise during the term of the agreement, the contractual right to use the services of the franchisor for purposes of advertising and marketing of their products, and management assistance and training.

In short, a franchise may include but be wider than a licence, which would appear to be the case here. See Bob Jane T-Marts v. FC of T 99 ATC 4437 and the definition of 'franchise agreement' in Competition and Consumer (Industry Codes-Franchising) Regulation 2014, clause 4.

The words 'to terminate a lease or a licence' in subsection 25-110(1) entails a direct link between the incurrence of the expenditure and the termination of the lease or licence. In other words, expenditure which has been incurred for the purposes of causing or inducing the termination of the lease or licence and has the consequence of having done so, is deductible. However, a termination payment incurred by Company A terminates all of the rights and obligations under the Franchise Agreement. Accordingly, the termination payment is incurred to terminate not only the licence to use the intellectual property, but also the contractual obligations under the Franchise Agreement.

In these circumstances, it is reasonable for only that part of the payment that can be said to be paid 'to' terminate the licence to use the intellectual property and result in its termination to be eligible for deduction under section 25-110. Apportionment of the payment would therefore be required.

In making an apportionment of the payment, the method used must be reasonable and what is reasonable will often depend on the particular circumstances.

Based on the information supplied by you, the Commissioner considers that none of the exceptions contained in subsections 25-110(3) to 25-110(6) of the ITAA 1997 will apply in this case.

Section 40-880

Subject to the limitations and exceptions contained in subsections 40-880(3) to (9), subsection 40-880(2) provides that you can deduct, in equal proportions over a period of five income years starting in the year in which you incur it, capital expenditure you incur:

e. in relation to your business; or

f. in relation to a business that used to be carried on; or

g. in relation to a business proposed to be carried on; or

h. to liquidate or deregister a company of which you were a member, to wind up a partnership of which you were a partner or to wind up a trust of which you were a beneficiary, that carried on a business.

Paragraph 40-880(5)(b) provides that you cannot deduct anything under section 40-880 for an amount of expenditure you incur to the extent that you can deduct an amount for it under any other provision of this Act. Accordingly, any portion of the termination payment that is deductible under section 25-110 is not eligible for deduction under subsection 40-880(2). It is necessary to consider however, whether the balance of the termination payment ('the remaining portion of the payment') may be deductible under this section.

It is not in dispute that the remaining portion of the payment is capital expenditure, and that it was incurred in relation to Company A business (see question 1).

To the extent that a payment is business-related capital expenditure, any deduction available under subsection 40-880(2) is subject to the exceptions and limitations in subsections 40-880(3), 40-880(4), 40-880(5), 40-880(6), 40-880(7), 40-880(8) and 40-880(9). Of these, subsection 40-880(5) contains the only exception that may be relevant in Company A's circumstances. Paragraph 40-880(5)(d) provides:

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

a) …

d) it is in relation to a lease or other legal or equitable right…

The expression 'in relation to a lease or other legal or equitable right', or any part of the expression, is not defined in legislation. However, the Commissioner's view on its meaning is explored in TR 2011/6 Income tax:  business related capital expenditure - section 40-880 of the Income Tax Assessment Act 1997 core issues, which states that it has limited practical application. Specifically, paragraph 47 provides that:

The existence of paragraphs 40-880(5)(a) and 40-880(5)(f) and section 25-110 mean that paragraph 40-880(5)(d) has limited practical application. It applies to expenditure incurred on or after 1 July 2005 that has a sufficient and relevant connection to a lease or right held by an entity other than the taxpayer. The 'rights' in question do not include all legal rights but only those similar to leases in that they give the taxpayer a right to exploit the asset with which the right is associated. In other words, the right is carved out of an asset but falls short of full ownership of the asset. Examples of such rights include profits à prendre, easements and other rights of access to land. The rights however are not limited to rights associated with land. (emphasis added).

The Commissioner has established that a portion of the termination payment is indeed in relation to a lease or other legal or equitable right (a licence). That portion of the termination payment is deductible under section 25-110. As a consequence of the apportionment of the termination payment, the remaining portion of the payment will be that portion which is not in relation to a lease or other legal or equitable right. Accordingly, subsection 40-880(5)(d) will not apply to limit any deduction available to Company A under section 40-880, in relation to the remaining portion of the payment.

Conclusion

For the reasons provided above, the Commissioner accepts that the payments made by Company A to terminate Franchise Agreements are eligible for deduction under:

• section 25-110, to the extent that they relate to the termination of a licence to use intellectual property; or

• section 40-880, to the extent that they do not relate to the termination of a licence to use intellectual property.