Tax Issues in Franchising

• Author: Frank Zaid
• Profession: Senior Partner Osler, Hoskin & Harcourt LLP
• Pages: 250-279

CHAPTER 7

TAXISSUESIN

FR ANCHISING

A. INTRODUCTION

Beginning w ith the purchase of a franchi se and lasting until or even be-

yond its sale, franchisors and franchisees are faced with important tax

considerations and chal lenges. This chapter will examine s ome of these

issues, with a particular focus on Canadian income tax, the Canada-

U.S. Tax Convention (U.S. Tax Treaty),1 and Canadian sales taxes.2

B.INCOME TAX

1) ResidentFranchisee

a) Initial Franchise Fee

i)Capital or Income Account

The initial lump-sum franchise fee is not deductible by the franchisee

if, as is generally the case, the fee is on capital account.3 Capital cost

1(1980), 91 T.N.I. 29-34; Doc. 93-31275; T.I.A.S. 11087; S. Exec. T., 96-2.

2All ba sed upon the law as of 1 October 20 04, without consideration of amend-

ments not in force on th at date.

3Smitty’s Pancake Houses Ltd.v.M.N. R. (1965), 65 D.T.C. 667 (T.A.B.) [Smitty’s].

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Tax Issues in Franchising251

allowance will be available for such a fee, however, as long as the fran-

chise is propert y described in Class 14 of Schedule II to the Regulations

of the Income Tax Act (Canada). Subject to certain exceptions, Class 14

property includes patents, franchises,4 concessions, licences, etc., but

does not include the securing of non-competition.5

Capital cost allowance is only available for property that will exist

for only a limited period of time.6 The property, even if terminable,

does not qualify if its initial term is for an indef‌inite period.7 Property

having a term of a specif‌ied length, but terminable on notice without

cause, may also be disqualif‌ied,8 although recent commentary suggest s

a contrary result.9

If the term is renewable automatically or renewal is within control

of the franchisee, the life of the franchise includes renewal periods.10 If

the term may not be extended without concurrence of the franchisor,

the life of the franchise will not include the renewal period.11 For ex-

ample, an initial franchise fee payable for a franchise for a f‌ixed f‌ive-

year term, with no renewa ls, will be depreciable on a straight-line basis

for f‌ive years. However, if the agreement provides for a renewal for

another f‌ive years at the option of the franchisee, without conditions

determined by the franchisor, the fee will be depreciable by the fran-

chisee on a ten-year straight-line basis.

4In inter preting the Regulat ions, one must give “franchi se” its ordinary mea n-

ing: The Investors Group v. M.N.R., [1965] C.T.C. 192 (Ex. Ct.).

5No. 481 v. M.N.R. (1957), 58 D.T.C. 41 (T.A.B.); No. 614 v. M.N.R. (1959), 59

D.T.C. 238 (T.A.B.).

6A limit ed period has been def‌ine d as “for a period capable of being a scertained”

at the time the f ranchise agreement i s entered into: Bowater Power Company

Limited v. M.N.R. (1971), 71 D.T.C. 5469 (F.C.T.D.) [Bowater]. See als o IT-477 at

para. 14. “IT” is the abbrev iation for an Interpretation Bul letin, which is a pub-

lication use d to outline the Canada Reve nue Agency’s administr ative position

pertain ing to the interpretation of pr ovisions of the ITA.

7Bomag (Canada) Limited v. Canada, [1984] C.T.C. 378 (F.C.A.).

8Plouff e v. M.N.R., [1964] C.T.C. 580 (Ex. Ct.) [Plouffe].

9IT-477, at para. 17, states th at some provisions relatin g to early termination

are not relevant in dete rmining whether the f ranchise is for a limited p eriod.

The reasoning i n IT-477 is preferre d to that in Plouffe,ibid. The judge in Plouffe

may have mis interpreted earlier juri sprudence, which stood for the proposit ion

that an agre ement of indef‌inite duration, but contain ing a cancellation claus e,

was not for a limited p eriod. It is arguable that a n agreement instead, of def‌inite

duration, but conta ining a cancellation or te rmination clause, cou ld be viewed

as havin g a limited period.

10 Crystal Spr ing Beverage Co. Ltd. v. M.N.R ., [1964] C.T.C. 408 (Ex. Ct.); IT-477 at

para. 15.

11 Bowater, above note 7; IT-477 at para. 15.