Edited version of private advice

Authorisation Number: 1052157175063

Date of advice: 30 August 2023

Ruling

Subject: Income or capital

Question 1

Are the amounts received from the sale of a franchise assessable as ordinary income?

Answer

Yes.

Question 2

Are the amounts received from the sale of a franchise assessable under the capital gains tax (CGT) provisions?

Answer

No.

Question 3

Do you satisfy the basic conditions for the small business CGT concessions in relation to the sale of a franchise?

Answer

No.

This private ruling applies for the following period:

Year ended 20 June 2022

Year ended 20 June 2023

The scheme commenced on:

1 July 2021

Relevant facts and circumstances

The Trust purchased a business in 20XX.

The Trust acquired the rights to:

•         Use the name and trademarks; and

•         Sell franchises and operate any existing franchises.

The purchase included the right to future yearly amounts owed by current franchisees.

The Trust, as franchisor, seeks new franchisees by advertising.

The Trust sold a franchise in the 2022 financial year and another in the 2023 financial year.

The Trust expects to sell 1 or 2 franchises each year.

The Trust derives income from the sale of goods and the receipt of ongoing franchise fees.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 118-20

Income Tax Assessment Act 1997 section 152-10

Reasons for decision

Ordinary income

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a taxpayer includes income according to ordinary concepts (ordinary income). Ordinary income has generally been held to include 3 categories, namely income from rendering personal services, income from property and income from carrying on a business.

The ordinary course of business covers the usual transactions, customs and practices of a certain business; a term for activities that are necessary, normal and incidental to the business.

Capital gains tax (CGT)

CGT event D1 occurs when you create contractual or other rights. The time of the event is when the contract is entered into or the right is created.

Section 118-20 of the ITAA 1997 primarily exists to ensure that amounts which are assessable income outside of the CGT provisions are not also taxed as capital gains. In the absence of such a provision, it is conceivable that a receipt properly characterised as ordinary income and which has also been derived as a result of a CGT event could result in the receipt being taxed twice.

Small business CGT concessions

The small business CGT concessions allow you to reduce, disregard or defer some or all of a capital gain from an active asset used in a small business. One of the basic conditions, which must be satisfied to be eligible for the concessions, is that a CGT event happens and the event results in gain.

Application to your circumstances

In this case we consider that the Trust's business activities, as franchisor, included the selling of new franchise opportunities. Therefore, the income earned from this activity is derived in the ordinary course of carrying on the business. This income will therefore be assessable as ordinary income to the Trust under section 6-5 of the ITAA 1997.

While a CGT event may occur when the franchise agreement is executed, any capital gain will be disregarded to the extent of the amount already included as ordinary assessable income of the Trust under section 6-5 of the ITAA 1997.

Given the payments received are assessable as ordinary income the Trust will not make a capital gain and is therefore not eligible to apply the small business CGT concessions.