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Know the law related to franchising

Becoming acquainted with the basic legal aspects of franchising can help you avoid financial ruin
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Numerous articles have been written about franchising, but most of them deal with how to choose the right franchise, how to deal with the franchisor, or how to cope with the day-to-day running of a franchised business. Aside from these, however, the franchisee must also be familiar with the basic legal aspects of running the business. Knowing the law and how it applies to franchised businesses can avoid legal problems and needless  expenses on the part of the franchisee.

The following are some of the not so commonly known legal rules and regulations that franchisees—and business owners in general—need to know:
1.  The franchisee should withhold a 20 percent final tax on all payments made to the franchisor, including the initial franchise fee. The franchise fee and the monthly royalty payments paid by the franchisee to the franchisor are subject to a 20 percent final tax, based on section 24(B) of Republic Act No. 8424, otherwise known as the 1997 National Internal Revenue Code (NIRC).

The imposition of this 20 percent final tax is not limited to the monthly royalties on gross sales but is also imposed on the initial franchise fee. The Bureau of Internal Revenue (BIR), through BIR Ruling No. 002 dated January 4, 1990, has defined “royalties” to mean the following: (a) “payment of any kind received as a consideration for the use of or the right to use any copyright of literary, artistic or scientific work, including cinematographic films or tapes used for radio or television broadcasting, any patent, trademark, design or model, plan, secret formula, or process or other like right or property”; and (b) “gains derived from the sale, exchange, or other disposition of any such right or property which are contingent on the productivity, use, or disposition.”
Under Section 57 (A) of the NIRC, the franchisee is the “payor” and is thus constituted as the withholding agent. As the withholding agent, the franchisee is responsible for withholding the equivalent of 20 percent from amounts paid as franchise fees or royalties. Failure on the part of the franchisee to withhold and remit this tax may subject the franchisee to criminal and civil penalties under the NIRC in addition to the payment of the tax.

2.  The franchisee may choose between registering as a VAT taxpayer or as a percentage taxpayer. The general rule is that any person who, in the course of trade or business, sells, barters, exchanges, leases goods or properties, renders services, or imports goods shall be subject to value added tax (Section 105 of the NIRC, as amended by Republic Act No. 9337). However, businesses that expect their gross annual sales and receipts, or both, not to exceed P1,500,000 may opt to register as a percentage-tax taxpayer instead of as a VAT taxpayer.

Businesses that avail of the percentage tax system shall pay a tax equivalent to 3 percent of the gross quarterly sales or receipts of the business (Section 116, NIRC). The BIR has mandated that the percentage tax be remitted every month instead of quarterly.  If during the taxable year, the gross sales of the business exceeds the threshold amount of P1,500,000, the taxpayer must amend his registration from that of a percentage-tax taxpayer to that of a VAT taxpayer.

Since it is significantly less than the VAT, the percentage tax scheme is the government’s way of helping small businesses. The percentage tax amounts to only 3 percent of the gross sales per month of the business, as compared to the 12 percent rate of the VAT.


NOTE: It must be clarified here that the VAT is not fully passed on to the consumers. Section 8 of RA 9337 (B) provides that in computing the net VAT payable, the input VAT that may be credited for every quarter shall not exceed 70 percent of the output VAT. For this reason, not all of the VAT paid by the business on its purchases is passed on to the consumers through its sales. It is therefore much simpler for small- and medium-sized businesses to use the percentage tax system, particularly if it is impractical for them to have full-time accounting personnel.

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