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HMRC internal manual

Business Income Manual

Franchising: initial fee paid by franchisee

Intangible assets regime for companies

Where a company acquires or sells a franchise, the Corporation Tax intangible assets regime applies. The regime is introduced at BIM35501, and covered more fully in the CIRD manual. Where the intangible assets regime applies then it takes precedence over the guidance here.

Trade profits treatment

The initial payment by the franchisee, whether payable in one sum or instalments, is usually capital, as are any related legal fees. Capital payments are not allowable deductions in computing the taxable profits of a trade. See generally BIM35000 onwards.

An initial fee remains capital expenditure even if it is paid by instalments over a number of years. In S Ltd v O’Sullivan (Irish Tax Cases 108), the judge held that a predetermined sum payable in instalments by an Irish company for access to an English company’s know-how for a period of 10 years was capital. Although an Irish case, the judge was following Viscount Cave’s approach in Atherton v British Insulated and Helsby Cables Ltd [1925] 10TC155, see BIM35010.

For further information about the Capital Gains Tax implications, see CG68270 - CG68280.

In some cases, the franchise agreement may show that the franchiser charged a specific part of the initial fee for an allowable expense such as the training of staff.

Whether an apportionment between revenue and capital expenditure is appropriate depends on the facts. The facts may show that no part of the initial lump sum fees can be attributed to services of a revenue nature provided by the franchiser because such services are separately charged for in the annual fees.

In practice, franchisees may put forward an apportionment without reference to the franchiser. An apportionment of this type may be difficult to justify in relation to the services provided. For instance, some franchisers are unwilling to negotiate special terms with individual franchisees and the same lump sum is payable irrespective of the actual services required from the franchiser, for example the number of staff needing training may be irrelevant.

If the agreement terms are such that no part of the initial fee is specifically attributed to revenue items then the claim for apportionment may need to be critically examined.

Generally, the annual fees which are payable by the franchisee are allowable expenses in computing the profits of the trade.