International Franchise Lawyers Association e.V.
 
 
Franchising in India
 
For further details please contact:

DAS, Srijoy

ARCHER & ANGEL Attorneys

K-4 South Etension - 2

New Delhi -  110 049

India

Phone + 91-11-26261302

Fax + 91-11-26261303

sdas@archerangel.com

www.archerangel.com

 
Introduction
 

The franchising industry rightly deserves to be called the wave of future business
in India. The phenomenon of franchising developed at the end of Second World
War and the system has taken its roots in the United States of America, where
almost 50% of all retail sales are through franchise outlets. Decades later, India
has begun to see the growth of both domestic and international franchises
balancing the philosophy of the free market with the philosophy of swadeshi
(indigenous) products.
Franchising encourages spirit of entrepreneurship with its essence lying in an
agreement between two independent undertakings, the franchisor and the
franchisee. The consideration is the payment of some fee or royalty to the
franchisor against the rights granted to the franchisee to market the goods and
services of the former with their brand names using the franchisor’s trade marks
and business methodology for which the franchisor would also provide the knowhow
and technology.


Emergence of the Indian market


One of the primary factors which control the success of a franchising business in
an emerging economy like India is the ability of a foreign franchisor to identify
and seize the appropriate moment when the business environment is favorable
and reap its rewards. Home to over a billion people, including a flourishing class
of urban consumers possessing considerable amounts of disposable income
together with the continued growth of the economy have strengthened India’s
claim to be a viable and beneficial destination for a foreign franchisor.
India ranks as the fourth largest economy globally in terms of purchasing power
parity (PPP) with GNP of US $ 2.91 Trillion (2001-02). According to a recent
report by UNIDROIT, the foundation of a successful franchising industry in any
country lies in the existence of a “healthy commercial law environment” which
has been defined as one with a ‘general legislation on commercial contracts, with
an adequate company law, where there are sufficient notions of joint ventures,
where intellectual property rights are in place and enforced and where
companies can rely on ownership of trademarks and know-how as well as on
confidentiality agreements’. The Indian business and legal set up is characterized
by all these attributes, a fact which has been acknowledged as well as exploited
by numerous foreign companies.
 

India offers vast openings for a franchisor to set up its business; create
awareness for his products or services and exploit the enormous market offered.
As a result, it comes as no surprise that India has recently been declared as the
second most attractive destination for retailers among 30 emerging markets.
Though current investment regulations of the Indian Government bar foreign
investment in the retail sector, it hasn’t deterred foreign participation. Rather than
shying away from the enormous market that India offers, international companies
like Marks & Spencer, the global retail chain of stores have taken to entering into
different forms of franchising arrangements, ranging from just use of its trade
mark for a fee to the standard model of allowing its system to be used for a
franchise fee.
Seasoned franchisors such as McDonalds were one of the first to realize the
widespread prospects offered by India and extended its services into this market.
The international recognition of its brand together with the adaptation of its
products to suit the preference of Indian consumers, which include offering more
spicy items in its menu, has resulted in McDonalds becoming a household name
in India.
An important aspect which determines the feasibility of any franchising business
in a country relates to the class of consumers it caters to. India is a country with
the largest young population in the world; a staggering 870 million people are
below the age of 45 years, a market that will suit the products and services of
multinational franchising companies primarily dealing in Food &Beverages (F&B)
and lifestyle products. Indian consumers have experienced the standard of
services offered overseas and have sufficient exposure through media, which
has further fuelled their expectations. They now want to avail of the benefits that
a foreign franchisor can generate for them.
However, to state that a franchisor can rely on the international recognition of his
brand and proven business system to ensure a successful venture in India would
be nothing short of an oversight. Almost every product or service has a market in
India but sometimes, innovative strategies like ‘indianisation’ of its products and
marketing techniques must be employed by a foreign franchisor to further access
the sizable market of India. A notable example in this regard is the deliberate
exclusion of beef by McDonalds giving due consideration to the religious
sentiments of the Indian public. Majority of India’s population is follower of the
Hindu religion which preaches that the cow is considered sacred and is therefore
anti cow slaughter.


The Legal Framework in India


There is no specific legislation regulating franchise arrangements in India, but
there are various laws which affect the relationship between the
franchisors and franchisees, including intellectual property laws, taxation, labor
regulations, competition laws, property and exchange control. A deep
understanding of the laws related to the business of franchising is imperative for
a foreign franchisor which is planning a foray into the India market.
The 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 trade mark to an Indian company, a foreign company
can receive royalties. The laws in India also permit lump sum and royalty
payments to be made by Indian franchisees to their foreign counterparts for use
of foreign techno logy, which includes manuals, systems etc. Lump sum
payments up to US$ 2 million are permitted and royalties of 5% on domestic
sales and 8% on exports can be paid to the foreign franchisor. In addition, foreign
companies can enter into consulting agreements and receive up to US$ 1 million
per project. Amounts in excess of these can also be received but with the
permission of the Indian Government. These rules allow a foreign franchisor to
structure its business in India in such a way so as to ensure that it can repatriate
the maximum amount from India.


A foreign franchisor also needs to decide whether to appoint a master franchisee
for the entire country or appoint franchisees around the country independently or
through its subsidiary which acts as a master franchise. The franchisee will not
only be responsible for developing and adapting the foreign prototype to a new
and different market in which it has limited name recognition, but will also be
responsible for implementing the expansion plan of the franchisor for an entire
country. It is important to recognize that a potential master franchisee in Northern
India may have an extremely strong network in that part of the country but may
not be able to provide similar resources in other parts of the country. India is a
huge market and demands, networks and languages vary from region to region
and state to state. It may be a better idea to appoint different franchisees for
different regions rather than trusting one master franchisee to control the
appointment of suitable sub-franchisees around the country. Further, it is vital to
conduct a thorough financial and legal due diligence or feasibility report on one’s
potential partner, which includes a check on the owners, directors, financial
status and its ability to invest and expand the business.


Taxation is another issue which deserves due consideration. It is important to
know the local sales tax, property tax and withholding tax. Eventually, the local
tax laws 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 selfemployed
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 would depend on the
type of franchise, the product of the franchise and where the unit is to be
located.
It must be noted that the above is subject to double taxation avoidance
agreements (DTA) involving India and any foreign country. The tax liability
would accordingly be reduced. The income tax law in India gives recognition
to this and double taxation agreements take precedence over the terms of the
Income tax act.
A signatory to the international conventions on intellectual property rights,
India offers adequate protection to trademarks or brand names as well as
copyright and designs of the foreign franchisor. A significant step taken
recently is the recognition and protection extended to service marks in India
enabling the foreign franchisor to license its mark to a franchisee in order to
extend the services synonymous with him to the consumers in India.
Enforcement mechanisms are becoming more reliable, which has previously
been a bone of contention for foreign corporations.
The key issue to a beneficial relationship between any franchisor and its
franchisee is related to the smooth transfer of technology and training of
personnel followed by regular assistance provided by the franchisor in the
running of the business. Like other developing countries, India had, till
recently, a restrictive technology policy which attempted but didn’t succeed in
attracting substantial foreign technology. Owing to this, franchisors initially
preferred to spread their business in countries which were investment friendly
or culturally similar to the country of their origin.


India: New Opportunities
 

Post 1991, India has liberalized the economy and has also emerged as an
information technology and outsourcing hub. These, coupled with the
omnipresent knowledge of English language amongst Indians have
substantially bridged the cultural divide between India and the western
countries. Indian franchisees have successfully comprehended and
implemented technology which initially may have been alien to them and have
provided the required impetus to the franchising industry. In addition to
bringing down the costs for the franchisors, the increase in the level of
education amongst Indians has created a pool of talent and skill which can be
relied on by the foreign franchisors for beneficial partnerships and its fruitful
outcome.

India offers a large and expanding consumer market with an increasing
purchasing power which amounts to almost 350 million, more than the entire
population of some European countries put together. World Economic
Reform’s Global Competitiveness Report, 2002-03 has declared India as
having the best technology licensing regime causing an upturn in the interest
of foreign companies to invest in India.
One of the most vital tools for the expansion of any business relates to its
advertising, marketing and brand management. The competence of the
advertising and media sector in India is globally recognized. An extensive media
network is always at the disposal of the foreign franchisor to reach the population
of India of over a billion and create awareness of its services and products.
Sponsorship of events and festivals by franchisor companies is a common
occurrence in India.


Conclusion


Foreign franchisors should take time to understand the huge potential India
offers to their business. Like any business expansion strategy, a foray into the
Indian market would require a detailed feasibility study and calculation of risks
attached to it. On the other hand, the Indian Government must be open to
confidence building measures in favor of the international franchisors including
policy amendments and adoption of a single focus approach to the promotion
and regulation of the franchising industry in India.


Note about authors and firm:
Srijoy Das (sdas@archerangel.com, +91-11 26261302) is a Partner with the law
firm of Archer & Angel, based in New Delhi, India with offices in Chennai and
Mumbai. The firm advises on franchising, intellectual property, foreign
investment, technology and corporate law.
Kartik Srivastava (ksrivastava@archerangel.com +91 -11 51641302) is an
associate in the Corporate and IP department.