Royalty, lump-sum fee and taxation under the franchise agreement
When drawing up a franchise agreement, it is necessary to provide for a remuneration clause. In accordance with the Civil Code of the Russian Federation, this condition is essential, and Rospatent, in its absence, will refuse to register a commercial concession agreement. The law provides for several methods of remuneration for a commercial concession. They differ in the frequency of payments and the procedure for determining the size, you can provide one of them or a combination of them. At the same time, for both the franchisee and the franchisor, the issue of taxation of royalties and lump-sum fees will be important, since this directly affects income. You can read about what kind of remuneration to choose for the franchisor in our article.
- Methods of remuneration under a commercial concession agreement
- Taxation of royalties and lump-sum payments
Methods of remuneration under a commercial concession agreement
The commercial concession or franchise agreement must establish the amount of remuneration that the franchisor will receive. Art. 1030 of the Civil Code of the Russian Federation establishes the following methods:
- Fixed one-time payments;
- Fixed recurring payments;
- Deductions from proceeds;
- Wholesale price markup.
In practice, they have the following names.
Lump-sum fee as remuneration under the franchise agreement
Fixed one-time payment. Usually paid at the very beginning when concluding a contract or starting an activity. In foreign practice, it is sometimes considered as a membership fee.
Royalties as remuneration under a franchise agreement
Royalties represent the reward as a percentage of a certain metric. The main question is what to make royalties dependent on:
- From the volume of turnover;
- From the amount of net profit;
- From gross proceeds;
- Another indicator.
In order to correctly calculate royalties, a reporting form should be prescribed in the contract. For example, you can install a system from which indicators will be taken (1C, R-Keeper) (А40-106396 / 2020). Or the form can be set in the Appendix to the Agreement (А56-84902 / 2019). At the same time, the franchisor (rightholder) must have ways to track royalty rates, since the franchisee can abuse his rights. For example, in one of the cases, a user under a commercial concession agreement, who opened a coffee shop, changed signs, stopped transferring data to the copyright holder. However, he continued the same activity. The franchisor went to court with a demand to pay remuneration. In this case, the plaintiff calculated the royalties based on the average revenue for the previous months, and the court analyzed the revenue for the months until the franchisee paid the fee (А40-32984 / 2020).
Taxation of royalties and lump-sum payments
The VAT rate is 20%. VAT is calculated on the sum of the lump-sum contribution and royalties, and franchising is considered as a service.
Now let's look at specific models of franchising in the presence of a foreign element. Imagine that the franchisor has to pay 1 million rubles as a lump-sum fee and 10% of the profit as royalties.
Resident franchise taxation
The franchisee can deduct VAT on the basis of an invoice after registering the complex of exclusive rights received for use. A deduction is possible provided that the exclusive rights are intended for use in an activity that is subject to VAT. Then the tax from the lump-sum contribution can be taken immediately in full.
The Code also provides for exemption from VAT when transferring exclusive rights to
- inventions, utility models, industrial designs, i.e., objects of patent law,
- know-how,
- rights to these objects under license agreements (clause 26.1. Article 149 of the Tax Code of the Russian Federation).
Periodic payments under a license agreement are referred to as royalties. In practice, however, this exception will not apply to a franchise agreement. The courts proceed from the fact that the payments under the franchise agreement differ from the licensed ones, therefore, they are not subject to the benefit of Art. 149 of the Tax Code of the Russian Federation (A41-7603 / 13).
Thus, the tax is the following:
RUB 200,000 (with lump-sum payment) + royalties x 20%
Taxation of a franchise between a resident franchisor and a non-resident franchisee
A situation may arise in which the franchisee will be located outside of Russia if you enter a foreign market. You can read more about this process in our article " Packing a local franchise for entering foreign markets". If the franchisee is not a resident, then the franchisor does not have to pay VAT, since the place of sale of services is not the Russian Federation. The franchisee will have to pay VAT in accordance with the law of their country (subparagraph 4 of paragraph 1 of article 148 of the Tax Code of the Russian Federation; Letter of the Ministry of Finance of Russia dated December 10, 2019 No. 03-07-14 / 95812).
The Ministry of Finance considered a similar question: is it necessary to pay VAT on services for the transfer of exclusive rights to trademarks. He was guided by this rule: the territory of Russia is not recognized as the place of implementation of services for the provision of patents, licenses, copyrights, if the buyer of services does not operate on Russian territory. For a more detailed study, you can familiarize yourself with the letters: Letter of the Ministry of Finance dated 20.07.2018 No. 03-07-08 / 50871; dated October 27, 2017 No. 03-07-11 / 70530.
Consequently, the Russian franchisor does not pay VAT in Russia.
Taxation of a franchise between a resident franchisee and a non-resident franchisor
If a Russian organization buys a franchise from a foreign one, then it will be obliged to pay VAT as a tax agent. The place of sale of franchising services is the buyer's place of business, i.e. Russian company. A foreign organization does not have a permanent establishment in Russia. Therefore, the Russian franchisee withholds the amount of VAT:
RUB 200,000 (with lump-sum payment) + royalties x 20%
Royalty tax on franchise agreements in accordance with Double Taxation Treaties
Also, the parties will need to pay income tax. If the franchisor or franchisee is a foreign partner, then it will be necessary to refer to the Agreements for the avoidance of double taxation (hereinafter - DTT). Russia has concluded them with more than 80 states. They usually provide special rules for the payment of tax on royalties or income from copyright and licenses. This category includes income from the use of almost all the results of intellectual activity: objects of copyright, i.e., works of science, literature, art, patents, trademarks, secret formulas, etc. The norm usually provides for one of three models for calculating the tax:
- A specific tax rate has been set, for example 10%;
- It is indicated that the rate is determined by the law of the country where the copyright holder is located - the one who will receive the royalties;
- Sometimes it is added to the second model that in the user's country a tax must be paid up to a certain percentage: for example, a Russian user pays 10% of royalties, more than this percentage is the rightholder in accordance with the legislation of his country.
Thus, the contract can establish the obligation of the franchisee to pay remuneration in the form of a lump-sum fee or royalties. Although royalty is a more flexible way of determining the amount, it causes the most controversy in practice: the franchisee is obliged to provide reports, the way of reporting must be prescribed in the agreement, the franchisor must follow the accounting and always have data on the user's work. Then it is worth determining which of the parties will pay the tax and in what amount. This is especially true if the franchise agreement is concluded between partners from different countries. If you have any questions or need help with the execution of a franchise agreement, please contact the lawyers of A4 Law Firm.
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