Understanding Taxation in International Franchise in 2022
Are you planning to set up an international franchise of your business?
Do you want to leverage the international market for your business?
If your answer to any of the above questions is a definite yes! then welcome to our ultimate guide to understanding taxation in the international franchise in 2022 where we provide in-depth explanation of the various models of the franchisee, documents you need to establish an international franchise, and most importantly how to understand and handle tax in the international franchise. So, let’s get started!
A franchise is a business arrangement between an already existing business and a new entrant of the same business model. The franchise is an authorized user of the brand’s reputation by getting permission through a license. The franchisor is the business owner that grants the license, and the franchisee is the license holder of the same.
The main motive of this arrangement is to share profits and royalties between the franchisor and franchisee.
The franchisor gets license fees, and the franchisee establishes a business under the name that already has a reputation and value in the market.
Every business arrangement is unique in its way. Some terms and conditions are exclusive to the lending and gaining of specific business arrangements. Based on this, let’s understand some of the standard franchising models given below.
- Business format franchise
This franchise model comes with all the recognition and brand value. A franchisee can obtain it in exchange for a license fee or royalty. The fast food industry is a good instance.
- Operator franchise
In this kind of franchise, a business adds to an existing businesses. It involves using the name and the brand value, not the business model. As a professional joins a firm, he uses the firm’s name but works on his own rather than the firm’s business model.
- Manufacturing franchise
Under this franchise, a business allows franchisees to use their name and brand value to produce their goods. A good instance here is bottling companies. They fill the syrups of franchisor businesses and use their name.
Franchising in the International Market
The sole purpose of any business is to generate more revenue and have the best recognition. Companies and businesses have turned to international expansion to achieve this purpose. Businesses expand overseas to increase global representation as well as earn profits.
Businesses enter into agreements with some local person and grant licenses for the operation of the business in their jurisdiction.
Now, what could be better than this is that businesses do not have to do the market research and surveys but instead enter into an agreement with local businesses. They enter into franchise agreements with them and expand internationally. Businesses must have the following agreements before giving a franchise:
- Master franchise agreement
- Franchise agreement
- Non Disclosure Agreement.
- Non-competing agreement.
Some of the benefits of international franchising are:
- It saves time and energy for the company.
- It creates additional earning resources for the company.
- The company goes global.
- Enhanced speed of growth.
- Boosts new talents into an original business.
Taxing in International Franchising
Taxation is an essential process in establishing a valid legal franchise. While establishing a international franchise, it is implied that the agreement should mention which tax regime is applicable and how parties to this agreement will pay taxes.
Taxing in an international franchise usually is a multi-jurisdictional and interconnected web. Various teams, professionals, and experts are involved in deciding upon the tax regime of business governance. It involves treaties, orders, and regulations from time to time. Parties must decide in advance the jurisdiction, time frame, and policy for filing taxes.
The international franchise tax is not the same as income tax. Instead, it is an extra amount imposed on a corporation apart from income and corporate taxes.
Many countries have proper laws that govern international franchise taxation and establishment in their jurisdiction. While in some countries, it depends upon the nature of the agreements and contracts entered upon by the parties.
Franchise taxes levy on corporations, business partners, and overseas LLCs. They have to pay taxes as per the jurisdictions in which they operate.
Non-profits, some unincorporated organizations, and political groups are not subject to franchise taxes. It is therefore critical to understand the nature of a business before making a tax system, for example, a joint venture or partnership.
Things to Consider in International Franchise Tax
There are a few things that you should take into note when agreeing to taxes in international franchise.
- Tax on one-time royalty paid by the franchisee.
- Tax on per month royalty.
- Tax on goods and services delivered.
Is the Franchise Subjected to Double Taxation?
Tax on the franchise is called privilege tax. When a person or corporation is subject to tax on his income in his domestic and foreign jurisdiction, it is double taxation. Taxation works as follows:
Tax treaties govern the cross-border tax regimes. Countries have agreements and treaties that govern the taxing system between them either unilaterally or reciprocally, and in case of a taxing treaty is not made, the local tax structure applies in both jurisdictions.
A permanent establishment is a place where the business or franchise operates. In this case, the business has to pay the tax in the permanent establishment jurisdiction. Further, contracting formalities and permanent management can determine the nature of a permanent establishment.
Transfer pricing occurs when the parent company operates the small subsidiary units under it, goods and services in this taxing arrangement are transferred between various units by the parent company. Taxing is also accounted in the parent company’s name only.
Tax planning and management every corporate has to plan a suitable tax system so to avoid any losses.
Furthermore, while agreeing to a tax regime, the franchisee must consider the transfer of brand value, management trade secrets, and intellectual property rights.
The contract in IP licensing should specify what income a licensed product will generate to avoid being held liable for any consequences or taxed in a different category.
The double tax on international franchises is applicable in only some jurisdictions. International franchises are subject to taxes in the jurisdiction where it is established and operate. In some jurisdictions like the USA, international franchises are subject to double taxes.
Operating in a franchising business is advantageous for both parties in a business arrangement. If all the formalities and documents are in the correct order, it is an excellent way for small investors to work under large umbrellas of brands.
A franchise gives the liberty to the franchisor to start a readymade business. It does not have to care about the reputation and market value as the brand already established all these things.
While the franchise holder gets to explore international markets, earn globally, and have a powerful presence. This system of business allows the investors have a diversified investment portfolio and representation in the international market.