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Franchising in India
Home to over a billion people, including a growing class of urban consumers with disposable income, India is proving to be an attractive, but trying, market for international franchisors. According to the Indian Franchise Association, the Indian franchise industry is growing at a 30% rate annually, and this growth is expected to continue.
Unlike the U.S. and many other countries, India has no specific legislation regulating franchise arrangements or requiring pre-sale disclosure. There are, however, a number of other Indian laws that affect the franchise relationship. Contract, intellectual property, tax, labor, competition, property and consumer protection laws and exchange control regulations all impact franchising arrangements. While not a primary concern for franchisors, a franchisee must also comply with real estate, labor, and other industry-specific laws in operating the business. For example, for the food and beverage industry, certain food safety, liquor, and fire safety licenses and police and other local municipality approvals are required.
The most important aspect to be considered by foreign franchisors entering India, however, is the law and procedure for repatriation of fees. All payments to a foreign franchisor under a franchise agreement (including initial franchise fees, royalties, advertising and marketing fees and area development fees) are subject to foreign exchange regulations, which are part of the Foreign Exchange Management Act (FEMA). FEMA is a complex regulation designed to monitor foreign exchange outflows. While intended to facilitate foreign trade and payments, FEMA has the opposite effect and increases the transaction burden on both the foreign franchisor and the Indian franchisee.
FEMA imposes restrictions and conditions on payments made to foreign parties. An Indian franchisee must make payments to a foreign franchisor through its bank, which is known as an “authorized dealer” bank. Credit card or cash payments are not permitted for such transactions. The Indian franchisee must approach its bank and comply with various formalities and provide evidence of the purpose of the payment. The Indian franchisee must also simultaneously approach its auditors and obtain certification from them regarding the reason for payment, nature of the payment, rate of tax and total tax payable, and confirmation that the tax has been withheld and deposited with the Income Tax Department. The certificate of the auditor is critical, and no bank is permitted to authorize a remittance without it. To issue this certificate, the auditors need to review the invoice from the foreign party, among other documents.
While the onus of deducting and depositing the tax is on the Indian franchisee, the foreign franchisor may be able to reduce those taxes if the following information/documents are provided to the Indian franchisee before remittance is made by the Indian franchisee's bank.
- Permanent Account Number (PAN)
A PAN is a 10-digit alphanumeric number issued by the Indian Income Tax Department to facilitate a person or entity in making tax payment filings and returns and claiming refunds. The number, along with other relevant details, is printed on a card called a PAN card. Foreign franchisors having a PAN card are eligible for a tax deduction under the Income Tax Act, 1961. If a foreign franchisor does not have a PAN card, however, it would be subject to a higher rate of taxation, which may be as much as double the tax rate of a foreign franchisor with a PAN.
- Tax Residency Certificate
Beginning with financial year 2012-13, all foreign recipients of funds are required to obtain a Tax Residency Certificate (TRC), which includes certain prescribed details from their country of residence, in order to claim the benefits of the Double Taxation Avoidance Agreement (DTAA). If the foreign franchisor does not provide the TRC, the franchisor will not be able to obtain the benefits of the DTAA (to the extent that there are any such benefits), resulting in a higher tax burden. Consequently, the Indian franchisee would be taxed at a higher rate under the Income Tax Act.
- Self-Declaration Certificate
Auditors require a self-declaration certificate to issue their certificate to the remitter. The self-declaration certificate, which is printed on the foreign franchisor's letterhead, should contain the foreign franchisor's details, such as principal place of business, country of tax residence and tax identification number, and confirm that the franchisor does not have any permanent establishment anywhere in India.
While there is no prohibition on grossing up the payment from the Indian franchisee to mitigate withholding tax implications, this only increases the costs for the Indian party. In addition, it does not serve to circumvent the various banking procedures and documentary requirements detailed above.
Because of the seemingly endless number of procedures and required documents to remit payment to a foreign franchisor, the parties must prepare well in advance to avoid delays. There have been many cases where Indian parties have used the lack of documentation from the foreign entity to delay payments endlessly, blaming the complex FEMA regulations for not paying the fees. The issue cannot be resolved by requiring payment of interest on the delayed payments since the banks have discretion to prohibit the payment of interest or reduce the amount of interest.
Because of the sensitive and complex nature of foreign exchange laws in India, it is imperative that a foreign franchisor understand the laws and address them in its franchise agreements to ensure that the franchisor has the ability to receive funds in a timely manner. The agreements must also address the potential situation where the monies cannot be remitted out of India for some reason. This may entail appointing nominees, improvising on the structure of the transaction or negotiating with the Indian franchisee to provide bank guarantees, although the latter is also subject to foreign exchange regulations.
Srijoy Das is a partner with the New Delhi office of Archer & Angel. Srijoy acts for many Indian franchise systems, as well as many international franchisors and regularly advises about international expansion to India. Robert A. Smith is a partner and Chair of the Franchise Group at Wiley Rein LLP. Maureen A. O'Brien is Special Counsel at Wiley Rein LLP.