Franchise FAQ

The background and legalities of getting into franchising

Franchise FAQ

What are the tax implications of running a franchise?

A franchise can take the different forms available to all businesses: they usually operate as sole traders, partnerships or limited companies, and their tax position will vary accordingly. Also, like any other business, a franchise will be taxed on its profits and account is made of business expenses when calculating tax liability.

What is a franchise?

In business, "franchising" is called business format franchising and is what happens when an original company, the franchisor, grants rights to a third party, the franchisee, to run its business using the same brand, products, services, promotions and management systems. Business format franchising can cover a range of businesses from fast food restaurants to courier services.

The franchisor is the owner of the business system and any brands and trademarks. Franchisors allow their franchisees to use these under licence in a designated area. They provide support for them in starting their business, and in running, promoting and developing it. The franchising business must be properly set up according to the Companies Act 1985 and operate under the relevant government legislation.

Franchisees own and run each outlet within a franchise network. They buy the rights to run the business using its established brands and trading systems. Franchisees remain self-employed and own the individual outlet but must operate the business according to procedures set up in the franchise agreement. They pay for the owner's help in the form of national promotion, training, administration services and continuous product and system development. Payment can be a set fee, or linked to turnover, or a combination of both.

Further Information

Further information is available from the British Franchise Association, the Business Link network and banks.

What legal forms can a franchise take?

A franchise can take any of the legal forms available for a business operating in the UK, although the most natural forms are sole trader, partnership, and limited company.

What rules regulate trading schemes such as pyramid selling?

Trading schemes may be called direct selling schemes, network marketing, multi-level marketing or multi-level franchising, and they are all covered by the Fair Trading Act 1973, as amended by the Trading Schemes Act 1996, and the Trading Schemes Regulations 1997. Participants in such schemes are self-employed.

It is a criminal offence to persuade someone to pay into a scheme by promising them benefits if they recruit further people, although recruitment rewards can be given. A scheme must also legitimately be selling a product or service.

Advertisements about a scheme must conform to the general advertising code of practice and must also show the name and address of the promoter, the product or services covered by the scheme, and a warning saying: " It is illegal for a promoter or participant in a trading scheme to persuade anyone to make a payment by promising benefits from getting other people to join a trading scheme. Do not be misled by claims that high earnings can be easily achieved ".

A promoter must give participants a written contract setting out their rights and obligations. This contract is only binding when signed by the participant and the promoter must not accept money before it is signed. The contract must include:

Participants have certain rights after they have signed the contract. In the first 7 days the scheme can legally bill them for no more than �200 in total. They have the right to cancel their contracts within 14 days of signing and come out of the scheme. The termination notice must be given in writing, goods can be returned at the participant's expense and the money for the goods reclaimed by the participant. However, if the goods have been allowed to deteriorate, the promoter does not have to give a refund and can levy a reasonable handling charge for repacking opened goods. These rules are in addition to participants' rights under the Sale of Goods Act.

Commission already paid to a participant on goods which have later been returned can be recovered if promoters have made such circumstances clear in the contract. However, once a contract has been ended, promoters can only reclaim commission if it was paid within the previous 120 days.

Promoters can include non-competition clauses in contracts which means that participants terminating their contracts cannot set up a competing business.

Further Information

For further information see the Department of Trade and Industry web site.

What is the general legal background to franchising?

There is no legislation specifically about franchising but franchisors and franchisees work within normal business regulations. Both parties in the franchise business must have been set up under the Companies Act 1985. Membership of the British Franchise Association (BFA) means that the franchisor has been vetted and should be abiding by a code of practice and set of ethical standards.

Companies involved in franchising are regulated under the Fair Trading Act 1973 and the Trading Schemes Act 1996, which ensure that there is a predetermined agreement period, usually five years. Ethical regulations ensure that the franchisee pays a reasonable "front end" fee to allow for start-up and training that does not give excessive profit to the franchisor. Parts of the the Competition Act apply to franchising, and was updated in 1998 so that UK law complied with European law on competitiveness.

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