March 2010 - How is Goods & Services Tax calculated on franchise purchases – and what difference will a rate change make to existing franchisees and franchisors? Craig Weston explains

Most of the investment levels quoted by franchisors in this magazine include the ubiquitous phrase ‘plus GST’. Many people new to business ownership can find this a little confusing. If a franchise costs $20,000 plus GST, does that mean it really costs $22,500? And if GST changes, will it actually increase in price to $23,000 after the Budget? Well, the answer is yes and no – let me explain.

GST is a tax that is charged on the end users of any product or service. The way that it works is that GST-registered businesses charge GST on the sales they make and claim back the GST on their purchases. They pay the difference to Inland Revenue, so effectively GST is a tax that business owners collect on behalf of the government.

So how does it work when it comes to buying a franchise? Well, it will vary according to whether you are buying an existing franchise business or buying a completely new one.

Existing Businesses

If you are buying an existing business then it is most likely that you will treat the purchase (and the vendor will treat the sale) as a ‘sale of a going concern.’ This means that the existing operational business is being sold lock stock and barrel to the new owner. In these circumstances the Goods and Services Tax Act allows GST to be charged at the rate of 0% (ie, it is ‘zero rated’). Practically, this means the seller does not charge a dollar amount of GST, nor does the purchaser pay a dollar amount of GST, in respect of the sale/purchase.

The documentation drawn up by the lawyers involved should clearly set out the understanding as regards GST and it is always very important to have this agreed prior to the agreement for sale and purchase being signed. Caution is needed because the phrase “plus GST if any” can hit the purchaser with GST if you don’t get it right. It is recommended that you use a lawyer experienced in franchising as they know what to look for.

New Businesses

Where you are setting up a completely new franchise as a franchisee, then in most cases GST is treated differently from the above. There is no existing business to purchase and you will most likely be paying for the right to use that territory plus some assets, training, etc.

In this case, you will pay GST at the going rate (currently 12.5%) on top of the purchase price. However, if your new business is to be GST registered then you will be able to claim back the GST paid from the Inland Revenue. Note that you must be GST-registered if your turnover exceeds $60,000, although you may choose to do so below this rate.

This means that when you are buying a new franchise it is very important that you take into account the timing of the payment, and the timing of the receipt of the GST refund. It could be that there is a gap of up to two to three months (or maybe longer) before you obtain your refund of GST. This can have a big effect on the cash flow of the business, particularly around start-up time, and you need to be sure that you have the funding in place to cope. Your accountant and banker will be able to advise you on this.

Should you register for GST?