“Any time you can get the government to share in an investment, which this does—it’s very good news,” says Dusty Profumo, CFO of Church’s Chicken. His is one of many franchise brands mandating remodeling programs for its franchisees, but this year it has an incentive to offer, courtesy of an unlikely source—the Internal Revenue Service.
That’s right, after at least three years of heavy negotiating and a big effort by the National Restaurant Association, among others, the IRS has finalized what’s known as the remodel safe harbor rule. It allows qualified restaurant operators and retailers to deduct a big chunk of certain remodeling costs in the first year—rather than spreading those out over years and years. Thus their tax bill is lowered and the remodeling program becomes much more attractive. Plus, operators don’t have to ask their accounting firms to conduct expensive and complicated cost segregation studies to get the benefits, although some may continue to do so, anyway, to maximize their return.
Another change makes permanent shorter depreciation times, to 15 years in some cases compared with the former 39. Shorter depreciation times have been a temporary feature of the tax law in recent years, but the PATH act, otherwise known as Protecting Americans from Tax Hikes, lent certainty by making them permanent in December.
“It’s very good news for the restaurant industry,” says Profumo, who was busy this spring working with his accounting firm to provide examples to franchisees about what their return on investment would be before and after these changes. One of the chain’s largest franchisees has contacted him, he says, to get details about what he expected to be significant benefits.
Here’s a disclaimer right off the bat, which Profumo and everyone else we talked to for this story emphasized: Each person’s individual situation is different, and so of course careful consultation with tax advisers is imperative.
That being said, accountants and franchisors are expecting a sweeter time urging their franchisees to complete remodeling programs. “Maybe this is the year to get them on board,” says Charles Bailey, referring to the often-resistant multi-unit operators who are mandated to do remodels. Bailey is an audit partner with Warren Averett CPAs and Advisors in Atlanta.
To qualify for the remodel safe harbor rule, Bailey emphasizes, operators must either be publicly traded or have audited financial statements, something a single- or few-unit operator is unlikely to find worthwhile. But for those with five, 10 or many more units, it’s a boon.
Bailey offers a rough example, for an operator with a 41 percent combined federal and state tax rate who will be spending $10 million on qualified renovations (and setting aside any tax elections that need to be made.) In the past, that operator would get a $660,000 deduction, for tax savings of $273,000 that would be spread over 15 years. Under the new rules, the operator who spends $10 million gets a 75 percent or $7.5 million deduction the first year. “So you just saved $3.1 million off your tax bill” in year one, Bailey explains, and then that operator can deduct the rest of the savings over 15 years.
Bone of contention
Mandated remodel programs, particularly for legacy operators with many, many units owned for years, can be a bone of contention between franchisors and franchisees. The most visible example today is between Wendy’s and DavCo, Wendy’s fourth-largest franchisee who balked at completing the remodels, only to be sued last year by the franchisor. At the time, a Wendy’s spokesman said it is “confident in our position and had no other choice but to file suit,” to compel DavCo to comply. “We believe the vast majority of franchisees support our initiatives to grow the Wendy’s brand.”
In a countersuit, DavCo said franchisees “stand to make little or no return on their investment” from the mandated remodeling program, and estimated its own costs would be “at least $55 million in present dollars for the first 60 percent of its restaurants,” and “at least $20 million or more” for the remaining 40 percent. In other words, remodels can cost big money and cause big problems. Of course, these tax rule changes won’t fix all the disputes, but they may help smooth the way.
At Church’s Chicken, for example, Profumo says its mandated re-imaging program costs a relatively modest $100,000 to $125,000, with a few items such as a digital image board that are optional. Under the new rules, “you can write a large share of that off immediately,” he points out, making for lower tax payments. Church’s has remodeled about 30 percent of its corporate-owned restaurants, which total 250, “so we have a good feeling for what it’s going to cost. We’ve always tried to lead the system and do things first, and now the 2016 focus will be to get the franchisees to catch up with us,” he says. Church’s has about 950 franchised units.
“This is a big, big help to any franchisees that are required to do reimage projects over the next several years.”You’ve heard that old joke: “I’m from the government and I’m here to help you.” In this case, and likely to the surprise of many restaurant operators, it may just be true.
Five things to know about the new tax rules
(Source: Franchise Times; by Beth Ewen)
Need financial assistance to make those mandatory franchise updates? We have affordable and easy to obtain working capital products to meet your needs! Click here to receive a free, no-obligation quote.