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Franchising – What are your Tax Obligations?
Are you thinking about taking on a franchise? Many Australians become franchisees of large companies to leverage existing brand power and customers, whilst also giving themselves the opportunity to run their own small business. As attractive as this type of business setup might look, it is crucial to understand all the related tax obligations, fees and structures in place that govern how franchisees and franchisors must do business.
One clear distinction between opening up a franchise and starting a traditional small business is some of the fees involved, including an initial franchise fee that forms part of the cost base for the business. It is treated as a capital asset invested in the business, and therefore cannot be deducted as a business expense from the franchisee’s annual tax return. Franchise renewal fees, on the other hand, do not necessarily form part of the base cost and can be deducted, as can ongoing training costs paid by the franchisee to the franchisor.
Goods and Services Tax (GST) and Capital Gains Tax (CGT)
Payments made to the franchisor will generally include a GST component if the franchisor is registered for GST. If in turn the franchisee is GST-registered, they will generally able to claim a GST credit from the Australian Taxation Office (ATO) for the GST amount included in the following:
- Initial franchise fee
- Franchise renewal fees
- Franchise service fees or royalties
- Advertising fees
- Transfer fees
- Training fees
It is also important to note the tax obligations surrounding the sale or ending of a franchise agreement. For instance, the initial franchise fee or transfer fee may be relevant for the ATO in calculating any net capital gain (and therefore the tax that would apply to it).
Undertaking a franchise often includes some form of ongoing royalty, interest payment or levy to the franchisor. These costs are generally in place to cover head office expenses such as administration, technical support and advertising. As these royalties, interest payments and levies are part of the ongoing expenses involved in running the business they can be deducted in your annual tax return.
In some cases, the franchisor and franchisee may not share a tax jurisdiction. This is often the case when a multi-national corporation has franchises operating in many countries around the world but conducts central operations from one place. When this is the case, the franchisee must withhold a flat rate of 30% from the gross amount of a royalty payment; and 10% from the gross amount of an interest payment. Withheld amounts are paid to the ATO, and included on the franchisee’s activity statement for the relevant reporting period. It is important to note that in some cases, a double-tax arrangement with the franchisor’s country may reduce the above rates. Tax deductions in relation to the royalties and interest payments to an overseas franchisor can only be claimed if the appropriate amount of tax has been reported, withheld and paid to the ATO.
In addition to understanding your tax obligations we suggest you also become familiar with the federal Franchising Code of Conduct, which is the primary piece of legislation covering the franchising area. Furthermore, if you’re looking for professional advice on all things tax-related, contact McKinley Plowman today on 9301 2200 or visit www.mckinleyplowman.com.au.
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