Taxes are key part of landscape when expanding around world
An expo in Siberia proves the popularity of global expansion. But seeking expert advice first is crucial, especially on legal and tax matters.
If you’re looking for proof of global growth in franchising look no further than Siberia. In October, the iconic Russian region will host an international franchising exhibition at the Novosibirsk Expo Center.
The international trend, especially over the past two decades, mirrors the direction U.S. franchising has taken over the past 40 to 45 years.
Global franchising may be popular, but it’s not without risk. Here are just a few considerations:
Economic conditions. What is the disposable income of the target demographic, and what is your ability to hire labor at costs equal to or lower than those prevailing in the home market?
Regulatory policies. How favorable or adverse are the intended country’s regulatory policies toward foreign franchisors entering the market?
Exchange controls. If you earn a respectable profit in the host country, how difficult is it to repatriate your profits and loans back to your home country?
Local laws. A franchisor new to a foreign market must be mindful of local laws as they relate to franchisors. Some countries provide little or no protection for intangibles to the foreign franchisor, while other nations are more protective. The point is that host country laws are all over the map in terms of enforcement and protection.
U.S. and foreign tax considerations. The goal of the franchisor establishing a franchise arrangement abroad is to maximize after-tax cash flow in both the host and home country. This could be challenging at times because of the different types of taxes that may be applicable while engaging in international franchising, as described below.
Analysis is complex
The franchisor must choose a suitable method of entering the foreign market. This decision will be influenced, in part, by the host country’s method of taxing franchisors. Once a U.S. franchisor decides to go international, the transaction and tax analysis become more complex from both a foreign and U.S. standpoint.
As a first step, whether it is a U.S. franchisor entering a foreign market or a foreign franchisor entering the U.S. market, it is imperative to determine the exposure to foreign taxes. For example, if a U.S. franchisor is engaged in considerable continuous and regular activity in the host country, it may cause the U.S. franchisor to fall into the host tax system and require the filing of a foreign tax return.
The statutory law in each host country is modified by any tax treaties that the country has entered into with the franchisor’s country. These tax treaties tend to provide more liberal rules.
For instance, the various tax treaties always require the taxpayer have a permanent establishment (PE) in the host country before the foreign taxpayer becomes subject to the host country’s tax system. The PE requirement is a higher threshold to meet, giving the foreign taxpayer a little more leeway. Generally, the PE requirement provides that the foreign taxpayer must have a fixed place of business, like a branch or an office, in the host country before it is subject to the host country’s tax system.
Another major issue is any withholding tax levied by the host country on certain payments to the home country. The general rule is that a U.S. franchisor that receives royalties from a foreign franchisee may incur a rather steep withholding tax. This tax can range up to 30 percent of the gross amount of the royalty. Thus, a $1 million royalty may attract a $300,000 foreign withholding tax and then the $1 million will be subjected to U.S. tax as well.
The question becomes: Can the U.S. franchisor “soak up” 100 percent of the foreign withholding tax against the U.S. tax liability? If not, double taxation can occur.
Treaty network is safeguard
One of the safeguards is the vast tax treaty network of which many U.S. and foreign corporations can take advantage. These tax treaties, in most instances, provide more liberal treatment of international transactions. To reduce the potential for withholding tax, some franchisors use holding company structures to avail themselves of the best treaty network.
Under some international agreements, franchisors are asking the foreign franchisees to “gross-up” the royalty payment to account for the fact that the franchisor may not be able to credit the entire withholding tax due to facts and circumstances. In some cases, franchisees that gross-up royalties request a recalculation in the event the franchisor can credit all or a portion of the withheld tax.
The introduction of international franchising to the mix requires both franchisor and franchisee to review the impact of import duties and value added tax (VAT). Both of these could mean additional costs that become part of the puzzle to do international franchising.
Many more factors must be analyzed before one dives into international franchising. The importance of getting correct and personalized legal and tax advice cannot be overemphasized. Go slowly and plan carefully.
Cary Rodin is shareholder emeritus in the tax department at Bennett Thrasher, an Atlanta-based certified public accounting and consulting firm. Rodin was an adjunct professor at Georgia State University, where he developed the international taxation course. Reach him at email@example.com