Special Commissioners decision changes view on Franchises Goodwill

In 1996, 32 Pizza Express franchisees sold their businesses back to the franchisor Pizza Express.

Two of these businesses claimed capital gains tax rollover relief in respect of the gain on goodwill under TCGA 1992, s. 152. The claim was subsequently refused by HMRC and the tax payers appealed.

HMRC’s argument was that there was no saleable goodwill as the franchisees merely had a licence to trade and therefore no business asset to be rolled over. They claimed the amount allocated to goodwill should be reallocated to ‘early termination of franchise agreement!’

The 2 businesses involved appealed on the following grounds:

The consideration apportionment should not be changed as it was reached honestly and at arm’s length.

HMRC’s letter advising of the reapportionment was issued after the closure notice and was therefore unlawful.

As a matter of law, the goodwill belonged to the franchisor, not the franchisee.

The consideration paid was for goodwill, not early termination.

The Commissioner considered that what was goodwill, had to be determined in accordance with legal rather than accountancy principles. It was a question of fact and would include whatever was added to the value of a business by virtue of situation, name and reputation, connection, introduction to old customers and absence of competition.

The Commissioner also questioned the approach of HMRC as set out in the Capital Gains Manual and as there was a covenant restricting the trade of the vendor in the area, felt that this was indicative that the goodwill belonged to the vendor.

The Commissioner found that the appellants invested capital and time into their businesses and Pizza Express had no direct interest in their profitability, simply, taking a percentage of turnover as their franchise fee.

Whilst the franchisor owned the goodwill in the name of ‘Pizza Express’, the franchisee agreement did not give the franchisor ownership of the goodwill in the business itself. The appellants also undertook their own advertising and customers returned because of the service etc. provided in their restaurants rather than because they traded under the name Pizza Express. As such the appellants, rather than Pizza Express, would be responsible for the quality of the product.

The accountants had complied with standard accountancy practice in ‘allocating’ part of the consideration to goodwill, being the excess over the true and fair value of the tangible assets. The appeals were therefore allowed in principle