What do overseas franchises need to consider before setting up in Australia?

We recently acted for an overseas franchisor entering the Australian early learning and preschool play groups market. The business offers franchises directly from the UK, rather than via master franchising or an Australian area developer. Its systems and resources are accessible online to franchisees and franchisees pay their royalties directly to the overseas franchisor.

This set up raised a few issues such as:

1. Does the franchisor need to register as a foreign company with ASIC?
2. Will it be considered a resident for the tax purposes in Australia and 
3. Other commercial considerations regarding risk and liability

The two main options for overseas companies are to:

1. Register as a foreign company to carry on business in Australia or
2. Establish a wholly owned Australian subsidiary to operate in Australia.

There are a number of other practical considerations apart from ASIC compliance and tax issues. These include:

• Ways to protect the overseas company from the local risks of litigation
• How to monitor local franchisees’ performance and deliver franchise support
• Arranging training for franchisees
• Monitoring marketing and brand promotion
• Whether there is a need for local presence and if so the need to lease premises or engage staff in Australia

Registration as an overseas franchise company with ASIC

Does the company need to register as a foreign company with ASIC? The answer is, not necessarily. The issue requires some expert advice and consideration of a number of factors.

A foreign company is defined as a body corporate that is set up outside Australia. The company can hold property in the name of its secretary or other officer, and it can sue or be sued.

So, does the business need to register with ASIC?

The answer lies in Section 21 (2) of the Corporations Act 2001. This provides that a foreign company must not carry on business in Australia unless it is registered with ASIC.

Interestingly there is no definition for carrying on business.

The Act however, sets out things considered not to be carrying on business in Australia. When the company merely:

• is or becomes a party to a proceeding or effects a settlement of a claim
• holds meetings of directors and shareholders or carries on activities concerning its internal affairs 
• maintains a bank account
• effects a sale via an independent contractor
• solicits or procures an order which becomes a binding contract if the order is accepted outside Australia
• creates evidence of a debt or creates a charge on property
• conducts on isolated transaction completed within 31 days and it is not one of a series of transactions repeated

Therefore, a firm may not need to register as a foreign company if it is simply investing funds, collecting debts or holding property. In other words, it must be engaging in a commercial enterprise for profit to require registration, which is the common law view of carrying on a business.

It’s likely an overseas company offering a franchise, license or distribution rights will need to register as a foreign firm because it repeatedly enters into contracts and will be considered engaging in business activities in Australia. This is true even if the bulk of its business is conducted overseas.

The test for carrying on business however, is a somewhat different test for taxation purposes.

The test of carrying on a business for tax purposes

Is the entity an Australian resident for tax purpose? It all depends on whether the central management and control of the company is in Australia or overseas. 

An ATO ruling sets out four matters the tax office will take into account to determine if it is a resident for tax purposes:

1. Does the company carry on a business in Australia?
2. What does central management and control mean in the circumstances?
3. Who exercises that central management and control? Is there one person making the decisions? Are they the resident director or is it an overseas board? 
4. When and where is central management and control exercised?

The ATO ruling has determined a company’s central management and control is where the chief decision maker is, This was referred to in the High Court decision in Bywater Investments Ltd and Ors v Comm of Taxation: Hug Weng Bank Berhad V Comm of Taxation (2016) HCA 45 (Bywater Investments).

ASIC registration requirements

A franchisor seeking to register as a foreign company in Australia must provide ASIC a series of documents which includes a certified copy of the current certificate of incorporation or registration and certified copy constitution. There will be additional information to collate and provide and it is best to use your professional advisor to assist with the process.

Australian registered office, local agent, and public officer

An overseas franchise will need to appoint an Australian local agent or representative as well as have a registered office. The agent is personally liable for anything the foreign company is legally required to do.

ASIC will issue a foreign company with an Australian Registered Body Number (ARBN) and the company must ensure its ARBN and name (as registered with ASIC) and place of origin are shown on public documents.

The company will also need to meet ASIC’s annual reporting requirements.

Business name and trade mark issues

A foreign company or Australian subsidiary must register its trading business name with ASIC if that is different to its own name (as registered with ASIC). 

It is essential to do a trade mark search to minimise the risk of infringement and avoid any claim for misleading or deceptive conduct under the Competition and Consumer Act 2010 before you proceed to register

This is necessary whether or not the foreign company is trading under its own name or a new name. 

Trade mark registration

Trade mark registration confers monopoly use of the mark for the particular goods or services registered. This is so important but often overlooked by overseas companies and we recommend it be the first step before entering any overseas market.

GST issues specific to franchising

There are rules around franchisees paying GST to non-resident franchisors:

1. Currently franchisees must pay GST on franchise fees, unless the franchise services are exempt as a financial supply.
2. A franchisee must withhold a flat rate of 30 per cent from the gross amount of a royalty payment and 10 per cent from the gross amount of an interest payment when paying royalties to a non-resident franchisor.
3. Double tax agreements (see below) can help reduce this rate.
4. The franchisee must remit the withholding sum in its BAS activity statement for the reporting period (usually quarterly) with an annual report.
5. A franchisee can deduct the royalty payment as a business expense. But this is only if the franchisee has withheld the tax from the royalty or interest and it has been paid to the ATO.

When a franchisee makes a payment to a franchisor registered for GST the payment will generally include the tax. The ATO will then provide a tax credit to the registered franchisee for the GST paid. This covers a franchisee’s tax included in the initial franchise fees, franchise renewal fees, royalties, advertising and marketing fees, transfer and training fees.

Tax deductibility of franchise fees

The initial upfront franchise fee or transfer fee is not deductible as a business expense, as it is considered a capital cost, that is part of the cost base of the franchisor’s business.

However, if this is not the case, franchisees may be able to deduct renewal fees, subject to prepayment rules.

 Royalties, interest payments and ongoing training fees are on the other hand a deductible business expense only in the year incurred.

Other issues to consider

• Transfer pricing – this relates to setting prices of goods and services exchanged between subsidiary, affiliate or commonly controlled companies.
• Thin capitalisation – these are debt and equity tests to identify which finance arrangements constitute debt and aims to prevent multinational entities shifting profits out of Australia by funding their Australian entity with high debt level to reduce the tax payable. The Australian Government is tightening these rules to ensure entities align the value of their assets with the value in their financial statements.
• Double tax agreements – tax treaties (DTA) agreements apply between countries to avoid double taxation of business and personal income. Australia has signed treaties with more than 40 countries.

Overseas companies need to consider many issues before entering the Australian market. They can make the process easier and avoid unintended  risks and compliance issues by engaging experienced and specialist advice to ensure the best start in the market.

Marsh & Maher Richmond Bennison is a member of the Franchise Council of Australia (FCA), International Franchise Lawyers Association (IFLA) and the US Commercial Service.