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.
Principal Issues: 1. Is a fee to acquire a franchise treated as a cost of a depreciable property in Class 14 or as an Eligible Capital Expenditure? 2. Is a depreciable property in Class 14 subject to the half-year rule and/or the short year rule?
Position: 1. Depends 2. No, franchise for a limited period is not subject to half year rule nor short year rule.
Reasons: 1. Cost of franchise for a limited period is included in Class 14 whereas cost of franchise that is for an indefinite period is included as an eligible capital expenditure. 2. Regulations 1100(2) and 1100(3).
2010-036577
XXXXXXXXXX S. Kim
(613) 952-1506
May 25, 2010
Dear XXXXXXXXXX :
Re: Franchise and Capital Cost Allowance ("CCA")
This is in response to your email of April 30, 2010, concerning CCA on a franchise.
As we understand it, in order to carry on a proprietorship business, you entered into a franchise agreement in XXXXXXXXXX of 2009, for which you paid a franchise fee of $XXXXXXXXXX . The term of the franchise is XXXXXXXXXX years and you have the right to renew the franchise at the end of XXXXXXXXXX years.
You enquired whether the franchise fee represents the cost of a depreciable property that is included in Class 14 of Schedule II of the Income Tax Regulations (the "Regulations") or is an eligible capital expenditure ("ECE") as defined in subsection 14(5) of the Income Tax Act (the "Act") and also about the maximum income deduction in respect of the franchise fee that you can claim in computing your business income in 2009.
Our Comments
Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5. Where the particular transactions are completed, the inquiry should be addressed to the relevant tax services office. However, we are prepared to provide you with some general comments which may be of assistance.
Interpretation Bulletin IT-477 (Consolidated) - Capital Cost Allowance - Patents, Franchises, Concessions and Licences, discusses CCA on property that is a franchise.
The word "franchise" is not defined in the Act. Accordingly, the term should be given its plain, ordinary and literal meaning. A "franchise", broadly speaking, is an arrangement whereby a franchisee will have the right to sell a product or service using the franchisor's system and the right to use the franchisor's name, in exchange for a fee and royalties.As stated in paragraph 14 of IT-477, property that is a franchise qualifies under Class 14 only if it is for a "limited period". That is, it must be for a period capable of being ascertained at the time the cost was incurred. In order to determine the life of the franchise and whether or not the franchise is for a limited period, the original term of a franchise agreement (i.e., XXXXXXXXXX years in your situation) must be considered together with the provisions of the franchise concerning renewals or extensions following the original term. Where such renewals or extensions are automatic or within the control of the taxpayer, that is they do not require any further negotiation with or the concurrence or consent of the grantor, the life of the property includes such additional periods. For instance, where a franchise with an initial term of 5 years can be renewed at the option of the franchisee for one further 3-year period, the life of the franchise is 8 years.
However, we would mention that where renewal or extension periods are considered part of the life of the franchise, as discussed in the above paragraph, and where the number of such renewals or extensions is indefinite, the franchise is not for a limited period and would not be included in Class 14. In such a case, the franchise cost would be considered an ECE, which would be subject to depreciation through the cumulative eligible capital account ("CEC"). The subject of ECE is discussed in Interpretation Bulletin IT-123R6 - Transaction Involving Eligible Capital Property (also known as ECE). Only 3/4 of the amount that qualifies as ECE is added to CEC. In computing business income, the taxpayer may claim, pursuant to paragraph 20(1)(b) of the Act, up to 7% of the balance in the CEC using the declining balance method for the computation. Examples illustrating the mechanics of the CEC can be found in chapter 5 of Guide T4002 - Business and Professional Income.
If it is determined based on the agreement that the franchise is for a limited period and the cost of the property is included in Class 14, then pursuant to paragraph 1100(1)(c) of the Regulations, the maximum CCA available to a taxpayer in any year is the lesser of:
(a) the aggregate of the amounts obtained by apportioning the capital cost of the property over the life of the property remaining at the time the cost was incurred, and
(b) the undepreciated capital cost of the class as of the end of the taxation year.
Pursuant to subsection 1100(2) of the Regulations, the so-called half-year rule on claiming CCA is inapplicable to Class 14 property. In addition, as stated in paragraph 6 of IT-477, pursuant to subsection 1100(3) of the Regulations, the short-year rule would not apply to Class 14 property.
We trust that our comments will be of assistance.
Sandy Parnanzone
Manager
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy & Regulatory Affairs Branch
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