PORTFOLIO

Tax Aspects of Franchising (Portfolio 559)

Tax Management Portfolio, Tax Aspects of Franchising, No. 559-3rd, discusses the legal environment and history of franchising in the United States before analyzing the tax and legal aspects of franchising. The Portfolio examines federal and state regulation of franchises, start-up considerations, the different treatment of franchisor and franchisee, and looks at area development agreements as well as many other aspects of operating a franchise.

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DESCRIPTION

Tax Management Portfolio, Tax Aspects of Franchising, No. 559-3rd, discusses the legal environment and history of franchising in the United States before analyzing the tax and legal aspects of franchising. The Portfolio examines federal and state regulation of franchises, start-up considerations, the different treatment of franchisor and franchisee, and looks at area development agreements as well as many other aspects of operating a franchise.
The Portfolio explores in depth the tax issues involved in franchise advertising, personal holding company and S corporation considerations, state and local taxation of franchises, and succession planning for franchisees.


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AUTHORS

BRUCE S. SCHAEFFER
Bruce S. Schaeffer, Master of Laws (Taxation), New York University School of Law, 1976; J.D., Brooklyn Law School, 1975. Mr. Schaeffer is an attorney in private practice with offices in New York, N.Y. He concentrates his practice in the areas of estate planning, taxation, franchising, and securities fraud. Mr. Schaeffer is also president of Franchise Valuations Limited and is a member of the Institute of Business Appraisers.

TABLE OF CONTENTS

Detailed Analysis

I. Franchising and Its Legal Environment

A. Types of Franchise Arrangements

B. History and Development

C. Economics of a Franchise

D. Franchising in the 1980s and 1990s

E. Franchising Since 2000

F. International Franchising

G. Regulation of Franchise Sales and Disclosure

1. The FTC Franchise Disclosure Rule

2. State Regulatory Activity

H. Franchise Company Mergers and Acquisitions

II. Franchise Transfers and Retransfers

A. In General

B. Legislative History

C. Characterization and Recognition of Receipts by the Franchisor

1. Initial Franchise Fees

2. Royalties, License Fees or Service Fees

3. Master License Fees

4. Subsequent Transfer Fees

D. Deductibility of Franchise Costs by Franchisees

1. Initial Franchise Fees

a. Prior Law

b. Current Law - Present Cost of Acquisitions - Amortizable Franchise Fee

2. Present Discounted Value of Right to Deduct Initial Franchise Fee

3. Master License Fees

4. Subsequent Transfer Fees

E. Different Treatment of Franchisor and Franchisee

F. A Modest Proposal - The Overriding Royalty

G. Purchases of Existing Franchise Operations at a Premium: Goodwill or Franchise Rights?

H. Canterbury v. Comr.

1. Introduction

2. Goodwill and Going Concern Value

a. Normal Business Context

b. Normal Franchise Context

(1) Goodwill

(2) Going Concern Value

c. Unique McDonald's Facts

3. IRS Arguments in Canterbury

a. Franchisor's “Franchisee Fee” for New Franchises Establishes Amount that Can Be Amortized as “Franchise Fee”

b. Purchaser of Operating Franchise May Not Amortize Amount as a Franchise Fee Greater than Amount Original Franchisee Paid

c. Purchaser of Operating Franchise Acquires Other Nonamortizable Assets Such as Goodwill and Large Portion of Purchase Price Should Be Allocated to Those Intangibles

I. Section 1060 Requirements Regarding Transfers and Retransfers

1. Legislative History of § 1060

2. Allocation of Consideration Under the Residual Method

3. Required Reporting and Compliance

III. Multiple-Unit Transactions

A. In General

B. Subfranchising Arrangements

1. Legal and Regulatory Aspects

2. Tax Accounting

3. Financial Accounting

C. Area Development Agreements

1. Legal and Regulatory Aspects

2. Tax Accounting

3. Financial Accounting

D. Area Representative Agreements

1. Legal and Regulatory Aspects

2. Tax Accounting

3. Financial Accounting

E. Brokers

1. Legal and Regulatory Aspects

2. Tax Accounting

3. Financial Accounting

IV. Pooled Advertising Funds

A. Purpose

B. IRS Position

1. Seven-Up Company

2. Ford Dealers Advertising Fund Co. - The Issue Resurrected

3. Nonacquiescence: Rev. Ruls. 74-318, 74-319

4. Continued Litigation - Insty-Prints, etc.

C. Tax Status of Fund

1. Form of Fund Entity

2. Is Fund a Separate Taxpayer?

D. Payments to Fund

1. Includibility in Income for Tax Purposes

2. Deductibility for Tax Purposes

E. Planning Considerations

F. One-Year Deferral of Advance Payments

G. Conclusion

V. Passive “Royalty” Income: Personal Holding Company and S Corporation Considerations

A. In General

B. Personal Holding Companies

1. Statutory Requirements

2. Legislative Purpose and History

3. Case Law - Franchising

4. Case Law - “Compensation for Services” v. “Royalty Income”

5. Recommendations

C. S Corporations

VI. State and Local Tax “Nexus”

A. Background

B. Due Process

C. Commerce Clause

D. Income Tax Nexus

1. New York

a. “Doing Business”

b. Jurisdiction

c. “Employing Capital”

d. “Allocation Formula”

2. New Mexico

a. “Engaging in Business”

b. “Leasing Property”

3. South Carolina

4. New Jersey

5. Multistate Tax Commission

a. Voluntary Disclosure Process; Initial Taxpayer Contact

b. Preparing the Voluntary Disclosure Offer

c. Forwarding the Offer to the States

d. Executing the Agreements

e. Program Disclosure Policies

E. Sales Tax Nexus

1. In General

2. New York

a. Appellate Division

b. Court of Appeals

F. Other Forms of Nexus

G. Royalty Add Back Statutes - Be Careful What You Ask For

H. Conclusion

VII. Succession Planning for Franchisees

A. In General

B. Restrictions on Transfer

C. Permission to Transfer

D. Transfers to a Spouse - Overfunding the Marital Share

E. Valuation

1. Empirical Studies

2. Statutory Changes

3. Case Law

4. Discounts for Family Transfers

F. Shifting Income Tax Liabilities

G. Availability of § § 6166 and 2057


WORKING PAPERS

Working Papers

Table of Worksheets

Worksheet 1 Franchise Organizations, Information Sources & Select Bibliography

Worksheet 2 Franchisee Specific Succession Planning Checklist

Worksheet 3 Checklist for Franchise Valuations

Worksheet 4 Form 8594 - Asset Acquisition Statement Under § 1060

Worksheet 5 Sample Nexus Questionnaires

Bibliography