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INTERNATIONAL FRANCHISING: A PASSAGE TO INDIA

by Srijoy Das
 

India is a large market with a thriving class of urban consumers, comprising more than 500 million. Coupled with sustained economic growth, India is a an exciting destination for foreign franchisors. As a result, franchising is increasingly being used as a model by foreign companies entering India for the first time.

Home to over a billion people, India offers vast openings for a franchisor to set up business, create product/service awareness and exploit the enormous market offered. A combination of various factors has led to this situation, including the Government of India's policy, restricting foreign investment in certain sectors while freely permitting franchising arrangements with Indian parties.

While India has no specific legislation regulating franchise arrangements, there are a number of laws that affect the franchisor-franchisee relationship. Intellectual property, taxation, labor, competition, property and exchange control regulations all influence franchising.

Unlike countries with a developed system relating to franchising, the absence of specific regulations or guidelines, coupled with the applicability of several laws, do pose a number of challenges for foreign franchisors. However, the present ambiguity also offers scope for flexibility and variation in a franchisor's approach.

Since 1991, India's Government has continuously liberalized rules relating to foreign direct investment. However, the Government has also specifically maintained that foreign retailers will not be permitted to invest in India. Rather than shying away from the enormous market that India offers, international companies like Marks & Spencer, the global department store chain, have adopted innovative strategies. They have adopted a number of different organizational forms range from simply trademark licencsing to a more complete franchising format.

The Indian Government permits foreign franchisors to charge royalties up to 1% for domestic sales and 2% on exports for use of the foreign franchisor's brand name or trade mark, without transfer of technology. In effect, this means that by lending just their brand name or trademark to an Indian company, a foreign company can receive royalties. A notable example is the franchising of its famous character names and logos by Walt Disney Inc. which are common on various merchandise, clothes etc. in India.

A foreign company must approach the Reserve Bank of India, India's banking regulatory authority (which is also responsible for exchange control regulations) if royalties exceeding prescribed limits are sought.

If the proposed franchise arrangement involves technology collaboration, the Government permits a lump sum not exceeding US$2 million to be paid to the foreign franchisor. Usually, the Indian franchisee will pay the lump sum in three equal installments. In addition, royalties up to 5% on domestic sales and 8% on exports can be paid to the franchisor without approval. However, no separate payments are permitted on account of brand name or trademark, and the technology or know-how and the fee on the former is presumed to be subsumed by the amount payable for the latter.

The Government has specified a formula for calculation of royalties which must be adhered to before the foreign company can remit funds out of India. If the franchise agreement proposes royalties or lump sum fees beyond the specified limits, the approval of the Foreign Investment Promotion Board is required. The Foreign Investment Promotion Board is the government agency responsible for reviewing and approving foreign investment and technology collaboration proposals. This review occurs on a case-by-case basis.

Taxation is another issue which deserves due consideration. It is important to know the local sales tax, property tax, and withholding tax applicable in a certain area. Further, how the franchise arrangement is structured and the existence of treaties between the countries involved may have considerable influence on the structure adopted.

Where the franchisor receives royalties, service or franchise fees, tax has to be paid under the income tax act (as income arising and accruing in India), whether the franchisor is an Indian or foreign party. In a case where the foreign franchisor sends training personnel and supervisors to India, the salaries payable to these persons may 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).

In calculating the amount of tax payable by the franchisor or the franchisee company, the deductions available in tax laws of India can be important for tax planning purposes. Some of these relate to rent, repairs and insurance in respect to premises used for business; depreciation and expenditure on research; and, expenditure of capital nature on acquisition of patent rights or copyrights. However, the availability of tax advantages depend on the type of franchise, the product of the franchise and unit locations.

It must be noted the above is subject to double taxation avoidance agreements involving India and any foreign country. The tax liability would be reduced accordingly. The income tax law in India gives recognition to this and double taxation agreements takes precedence over the terms of the income tax act.

India is a signatory to the international conventions on intellectual property rights, thereby offering protection to trademarks or brand names, as well as copyright and designs of the foreign franchisor. A significant recent step includes recognition and protection extending to service marks in India. This enables the foreign franchisor to tender its mark to a franchisee in order to extend the services synonymous with him to the consumers in India.

Foreign franchisors should take time to understand the huge potential India offers their business. A combination of a resolved legislative will and business people upskilled by foreign franchisors, will advance a new era of successful franchising in India - raising the standard of the products and services for Indian consumers.

 
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Srijoy Das is a Partner with the law firm of Archer & Angel, based in New Delhi, India with offices in Chennai and Mumbai.

Archer & Angel advises on franchising, intellectual property, foreign investment, technology and corporate law.

Email: sdas@archerangel.com

 
 
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