28 April 1989 Income Tax Severed Letter 5-7758 - [Tax Treatment Franchise Cost Sharing]

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

XXXX

D. Turner 957-2094

Dear Sirs:

Re: Tax Treatment Franchise Cost Sharing

We are writing in response to your letter of March 27, 1989, in which you raised certain questions related to the application of paragraph 12(1)(x) and subsections 13(7.4) and 246(1) of the Income Tax Act (the "Act").

In your hypothetical situation, a franchisor purchases equipment for a franchise which is then sold to the franchisee at 50% of the franchisor's cost. The franchisor and the franchisee deal at arm's length with each other. The franchisee attains full title to the equipment, however, the franchisor has a right of first refusal to take over the location should the franchisee sell out, including the right to buy the equipment at the franchisee's net book value.

You have requested our opinion on the following:

1) Whether paragraph 12(1)(x) of the Act applies to the transaction to require the franchisee to include the full amount of assistance in income in the year in which the transaction occurs.

2) If paragraph 12(1)(x) of the Act does not apply, whether subsection 246(1) of the Act requires that the indirect assistance be included in the income of the franchisee.

3) If paragraph 12(1)(x) of the Act does not apply above, whether it applies if the equipment were sold at cost to the franchisee and a cash payment was given to the franchisee equal to 50% of the franchisee's cost.

4) If paragraph 12(1)(x) of the Act applies to the assistance and the franchisee makes the election in subsection 13(7.4) of the Act, whether subsection 246(1) still applies to the transaction.

Our Comments

We offer the following opinions related to the above questions:

1) Paragraph 12(1)(x) of the Act would not apply to the above hypothetical situation. Subparagraph 12(1)(x)(vi) of the Act provides that an amount received would not be added to income to the extent that the amount reduced the capital cost of property for the purposes of the Act. As by virtue of the assistance received the capital cost of the equipment is reduced, paragraph 12(1)(x) will not apply.

2) In the above situation subsection 246(1) of the Act may apply as had a payment been made directly to the franchisee it would have been included in its income pursuant to paragraph 12(1)(x) of the Act. It is unlikely that subsection 246(2) of the Act would provide any relief as the transaction could be considered as being pursuant to or part of the purchase of the franchise by the franchisee and future rights of first refusal granted to the franchisor.

3) If the equipment were sold to the franchisee at the franchisor's cost and a cash payment were then made to the franchisee, paragraph 12(1)(x) of the Act would apply. However, an election could be made pursuant to subsection 13(7.4) of the Act in order to reduce the capital cost of the equipment for purposes of the Act rather than including the amount in income as required by paragraph 12(1)(x) of the Act.

4) If paragraph 12(1)(x) and subsection 13(7.4) of the Act apply to a form of assistance, subsection 246(1) of the Act will generally not be applicable. Section 246 of the Act is generally considered only after the possible application of other provisions of the Act have first been considered.

The above comments are based on the assumption that the franchisor and franchisee deal at arm's length. However, that is a question of fact to be determined by the specifics of a given situation.

We trust our comments will be of assistance.

for Director Small Business and General Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch