Which franchise charges were taxable rent when a franchisor retained title to machines that franchisees had to return at termination?

Plain-English summary

A redacted business manufactured machines and accessories and transferred them to territorial franchisees. Each franchisee paid $350 to join and obtain equipment use. Afterward, the source says the franchisee usually “purchase[d]” certain redacted equipment for manufactured cost plus reasonable profit, yet title remained with the franchisor and machines had to be returned if the franchise ended. No agreement or equipment record is included.

Section 6006.3 included rental, hire or license within “lease.” Former Civil Code section 1925 defined hiring as temporary possession and use of property for reward with an agreement to return it. Retained title and required return made the arrangement a lump-sum hiring despite the transaction's purchase wording and the franchisor's claim that return served only trademark concerns.

The initial fee was taxable rent because the franchisee could not use the machines without paying it. Counsel compared excluding that fee to splitting a true sale into “advertising allowance” and purchase price to tax only one part. The separate lump-sum “payment fee” was also taxable because it paid directly for machine use; its amount is absent.

An additional monthly franchise fee was $25 per 50,000 of territory population. It was not rent because it bore no relationship to machine count. Two comparable-area examples each paid $65 monthly even though one used 13 machines and the other six. No population or machine-use records appear.

For agreements entered on or after August 1, 1965, tax was measured by the initial and machine-use fees, with an offset for tax already paid. Pre-August 1 agreements owed no additional tax because the franchisor had paid tax on machine cost. The source supplies no agreements or tax calculation.

Counsel requested clarification of an undefined “transfer fee,” specifically whether it substituted for the initial fee, and did not decide it. Live Annotation 330.3330 publishes only that the initial and machine-use fees were taxable; it omits the monthly-fee exclusion, amounts, hiring analysis, timing/offset branches, transfer-fee gap and missing records.

Common questions

Did calling the contract a franchise prevent lease treatment?

No. Retained title and required return made it a lump-sum hiring despite the franchise and purchase language.

Was the $350 initial franchise fee taxable?

Yes. A franchisee could not obtain machine use without paying it.

Was the lump-sum machine payment taxable?

Yes. It directly paid for use of the machine, though the source gives no amount.

Was the monthly population fee taxable rent?

No under the stated facts. It depended on population, not units used; two $65 examples had 13 and six machines.

Did the letter decide a transfer fee?

No. Counsel asked whether it substituted for the initial fee and received no answer in the source.

Did the source call equipment transfers purchases or leases?

It says franchisees usually purchased equipment, but also says title remained with the franchisor and return was mandatory. Counsel classified the latter arrangement as hiring.

How did the August 1, 1965 date matter?

Later agreements were taxed on initial and machine-use fees with an acquisition-tax offset; earlier agreements owed no additional tax because machine cost had been taxed.

Was the scanned text checked?

Yes. All three pages were visually checked. There are no case citations requiring citation verification.

Citations and references

• Cal. Rev. & Tax. Code § 6006.3 — lease definition applied by the opinion
• Former Cal. Civ. Code § 1925 — historical definition of hiring quoted in the source
• Live Annotation 330.3330 — initial-franchise and machine-use fee result only
• Every franchise, equipment, cost, fee, population, tax and outcome record — absent

Source

• Annotated Legal Opinions collection: https://cdtfa.ca.gov/taxes-and-fees/annotations-menu.htm
• Annotation page: Annotation 330.3330
• Original scanned supporting opinion: 330.3330 PDF

Original ruling text

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December 2, 1969
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Attention:

President
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Dear Mr •

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Because your problem was somewhat unique, it has taken somewhat longer t o de t ~rmin~ wha t we think is the proper appli­ cation of the California 3ales and Use Tax Law to your business operations. Basically, it is our understanding the following facts exist: You are in the business of manufacturing machines and accessories and transferring them to your fran­ chisees. In order to become a f ranchisee and in turn use the e quipment, each franchisee must pay a franchise fee of $350 . After this n~y~ent, the franch1s~e can and usual ly does purchase certa in equipment •. The cost of the equipment equals your manufactured cost plus a re asonable p rofit. The contrac t signed by the franchisee 1s a territorial franchise, which allows him to use the equipment in his designated area. The contract also provides that the machines are ~o remain the proper t y of · anci must be re turned i f the fr a:1c~i se agreement is cancelled. In addition to the initial franchise fee end the payment for the use of the machine (hereinafter ref erred to as 11 p aymen t fee ") the franc hi see _pays an addi tiona 1 monthly franchise fee of $25 per 50,000 popula t i on. It 1s your opi nion that you do not rent the machines to anyone. We respectfully disagree. A lease 1s defined in section 6006.3 of the ~ales and Use Tax Law as a rental, hire, or license. A hiring is defined in section 1925 of the California Civil Code as 11 • • • a contract by which on~ gives to a~o ther the temporary pcsse ssion E!Ild use

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December 2, 1969

of property, other than money, for reward, and the latter agrees to return the same to the former at a future time." In view of ·the fact that title to the machines remains in
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upon cancellation
termination of the franchise, it is our opinion that you .are making a lump-sum hiring of those machines. our decision is not altered by the fact that you contend that the only reason you wish the machines back 1s because of the trademark problems. The fact still remains that they are to be returned and they remain your property.

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We next turn to the question of what 1s the proper measure of the tax. It is my opinion that both the ini tial franchise fee and payment fee are part of the ·rental receipts. The monthly franchise fees are not. To my way of thinking, the i n itial franchisee fee must be considered as part of the rnntal re~eipts because without such payment t he franchisee could not acquire the use of the property. To hold otherwise would l~ad to the conclusion that 1n a true sale situation a retailer could split the purchase price i nto two distinct items such as adve rti sing allowance and purchase price and only charge tax on the purchase price. Such a procedure would not be of any force .and effect for sales tax purposes. There does not appear to be any question that the payment fee should be subject to tax, even though it is a lump­ sum charge. SUch charge is clearly for the use of the machine. Our reason for concluding that the monthly franchise fee 1s not part of the renta l receipts is that you have shovm that the fee has no relation to the number of units the fran­ chisee has in. use. It is purely based on population. As you indicated in one of your examples in two areas of comparable size, one franchisee payd $6~ per month and had thirteen machines and the other paid ~65 and had six machines. In conclusion, it i s our opinion that you are leasing the
·- machines and accordingly any agreement entered into on or after August 1, 1965, is subject to tax measured by the initial franchise fee and payment fee. You would, of course, have an offset against the amount of tax you already paid. As for the agreements entered into before August 1, 1965 , no additional tax would be due as you have paid tax on the cost of the machines.

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..December 2, 1969

One further point which I would like clarification on and that is what is the "transfer fee" paid for, 1.e., is it a substitute for the initial:'~franchise fee.

Very truly yours,
Glenn L. Rigby
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Tax Counsel

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Out-of-State
Chicago

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