Taxation Rules in India for International Franchise Expansion

Considering the growing demand in the country we have seen a lot of companies entering India under the franchisee model. When international brands expand into through the franchising arrangements it is very imperative to determine the relationship anticipated between franchisor and franchisee before the formal agreements can be executed. Though unlike US, India does not have any formal franchising law and the relationship is ideally driven by the Franchisee agreement and the contract law. Under the franchising agreement, the franchisor (usually an established brand) gives to franchisee, for a certain fee-franchise fee or royality, the rights to sell or manufacture goods or provide certain services under its brand name. The Companies may enter India under the model of direct franchising, master franchising, regional franchising or local incorporation. Normally the relationship between the franchisor and franchise is of an Independent contractor. However, when culling out the terms of franchisee relationship, the taxation effect cannot be undermined.

Ideally the direct taxation of the franchisee arrangement is governed by Income Tax Act, 1961. The franchisee(s) often makes the payment in the form of royalty or the franchisee fees to the franchisor and is required to deduct a withholding tax of 10% on the payments so made. However, in case the franchisor (nonresident) is entitled to obtain the benefits of the double tax agreement signed by India, then he can claim the benefit of the more beneficial tax provisions.

Further in a case where the franchisor (being a foreign party) sends certain technicians and supervisors to India, the salaries payable to these persons would be subject to personal income tax, whether an arrangement is made to deduct the tax at source or they are taxed as self-employed persons if they come as consultants. 

The drafting of Franchisee agreement should be done very carefully as the same, if results in the creation of permanent establishment in India, then the Companies may be subject to additional taxation burden and the amounts will be charged as business income.

The permanent establishment of the franchisor can take the form of Agency PE (when the Franchisee acts as an agent of the Franchisor and can conclude contracts on its behalf);Fixed place of business PE(when the business of franchisor is carried through a fix establishment in India).

From the indirect tax side, the Indian franchise need to pay GST under reverse charge as import of service on amount paid to non-resident franchisor. However, if the franchisor is resident or where the non-resident franchisor maintains fixed establishment in India, the franchisor need to charge GST on amount charged from franchisee.

In a nut shell it can be reasonably assumed that the franchising model play a very important role in the country however, the arrangement has to be very carefully prepared considering the taxation and applicable DTAA.

This Article is Authored By Mr. Sameer Mittal, Managing Partner, Sameer Mittal & Associates LLP and Chairman, International Trade Council in India