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Edited version of your written advice
Authorisation Number: 1012878627955
Date of advice: 17 September 2015
Ruling
Subject: Capital Loss
Question
Is the amount by which the refund you received on the termination of the franchise agreement was less than the payment you made to enter into the franchise agreement a capital loss?
Answer
Yes.
This ruling applies for the following period
Year ended 30 June 2015
The scheme commenced on
1 July 2014
Relevant facts
You entered into a franchise agreement with the agreement to run for a period of several years. You made a payment to secure the agreement to operate the franchise business. Your agreement included a short 'cooling off' period.
During the 'cooling off' period you withdrew from the franchise agreement and returned the rights attached to the franchise to the franchisor.
You were refunded a portion of your payment less an amount withheld by the franchisor to cover certain expenses incurred by them.
Relevant legislative provisions
Income Tax Assessment Act 1997 section 8-1.
Income Tax Assessment Act 1997 section 100-35.
Income Tax Assessment Act 1997 section 100-40.
Income Tax Assessment Act 1997 section 100-45.
Income Tax Assessment Act 1997 section 108-5.
Reasons for decision
Generally, the costs connected with an acquisition, establishment, enlargement of a business or the acquisitions of fix capital assets are considered to be capital expenses.
The decision in Associated Newspapers Ltd and Sun Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337; (1938) 5 ATD 87 provides guidelines for distinguishing between capital and revenue expenditure. This case considered the issue of whether expenditure in establishing, replacing and enlarging the profit-yielding structure itself was capital. The test laid down in this case involved three elements:
• the nature of the advantage sought;
• the way it is to be used or enjoyed; and
• the means adopted to get it.
In regard to the first two elements, the courts have held that, in the absence of special circumstances, expenditure is capital in nature where it is made with the view to brining into existence an asset or an advantage for the enduring benefit of the trade or business.
In Labrilda Pty Ltd v. Deputy Federal Commissioner of Taxation (1996) 65 FCR 119; (1996) 96 ATC 4303; (1996) 32 ATR 206, the taxpayer paid an up-front accreditation fee for participation in the Team Pak Program conducted by the principal, Mobil Oil. Under that program Mobil granted the right to the taxpayer to carry on its service station business using the 'Mobil System'. The specific program was designed to provide its participants with necessary training, marketing advice, advertising, promotion and other such assistance in setting up the business.
The majority in that case concluded that the taxpayer's expenses in relation to the above were of a capital nature and not deductible as outgoings incurred in carrying on of the business. The expenses were more concerned with the business structure and characterised as expenditure which established the profit-yielding subject of the taxpayer's business.
In your case, you paid a franchise fee for a franchise arrangement that was to operate for several years. The essential character of the advantage gained by you was the right to operate the franchise business. This would have been an enduring benefit to you and therefore the franchise fee is considered capital in nature.
Your right to operate the franchise business is a CGT asset (section 108-5 of the Income Tax Assessment Act 1997) and the franchise fee you paid is included in the cost base of that CGT asset.
A CGT event happened when you terminated the agreement and your ownership of the right to operate the franchise business ended.
The capital proceeds that you received when your ownership of the CGT asset ended was less than the cost base of that asset, that is, the amount you were refunded was less than the franchise fee that you originally paid.
Therefore, you made a capital loss when you terminated the franchise agreement.
You offset the capital loss against capital gains in the same income year and if any loss remains, this can be carried forward to be offset against future capital gains.