Ekaterina Lutenko
Internal Auditor
The franchise market in Russia is increasing year on year. There are more and more business persons who are ready to try to set up in business using a reliable business model. Ekaterina Lutenko, Acsour’s Assistant of Internal Auditor told how to make such a deal and how to keep accounts.
Every year, opening a franchise company becomes more and more popular. This model involves buying the right from a well-known brand to conduct business according to its rules and technologies, which allows entrepreneurs to minimize their risks. In turn, for large companies that sell franchises, this is an opportunity to expand their business and enter new markets.
However, this type of business activities raises many questions in terms of legal registration, accounting and taxation.
From the perspective of international practice, a franchise is covered by a franchise agreement. However, in Russian legislation, the terms “franchise “and” franchising” are almost not used. This business model is usually drawn up by entering into a franchising agreement, which is governed by chapter 54 of the Civil Code.
According to this contract one party (the rights holder, alias franchisor) provides another party (the user or franchisee) with the right to use scope of exclusive rights owned by the rights holder in business activities, such as the right to a trademark, commercial designation, production secret and other objects of the rights.
Such an agreement is commutative and can be concluded either for a certain period or indefinitely. The contract may specify the minimum or maximum amount of use of a scope of exclusive rights. When signing a franchising agreement, it is important to observe two mandatory conditions: the contract should be concluded in writing, and then the contract should be registered with Russian Federal Service for Intellectual Property (Russian acronym “Rospatent”). If at least one of these requirements is not met, the transaction will be considered null and void (article 1028 of the Civil Code of the Russian Federation).
By default, the rights holder is responsible for ensuring state registration of the agreement, but the contract may provide otherwise (clause 2 of article 1031 of the Civil Code of the Russian Federation). Also, the franchisor is generally responsible for providing technical and advisory assistance to the franchisee and quality control of goods, works or services produced by the user under the agreement. It is important to remember that the rights holder shall bear subsidiary liability for requirements made to the user about the nonconformity of quality of goods, works, services (article 1034 of the Civil Code of the Russian Federation).
Please note: up to $500,000,000 is the franchising market in Russia (according to Forbes with reference to the Russian franchise association, as of July 2018)
Usually the franchise has the following obligations under the agreement: use of rights indicated in the agreement as prescribed; ensuring the conformity of quality of their goods, works and services to a certain level; compliance with instructions and directions of the rights holder; non-disclosure of confidential commercial information of the rights holder; provide all additional services on which they could count, acquiring goods, work or service directly from the rights holder to the buyers, as well as informing buyers about the fact that they use means of individualization (trademarks, etc.) under a franchising agreement.
Special attention should be paid to the matter of fixing the agreement price (the amount of remuneration for the franchisor). It can be fixed in the form of (article 1030 of the Civil Code of the Russian Federation): established one-time and (or) periodic payments, deductions from revenue, markup on the wholesale price of the goods transferred by the rights holder for resale and in any other form specified in the contract.
In the franchisor’s accounting, exclusive rights are recognized as intangible assets if all the conditions established in clause 3 of PBU 14/2007 are met. Such intangible assets are not subject to write-off and continue to be depreciated. They should be reflected individually in the accounting (clause 38 of PBU 14/2007), opening a separate sub-account to account 04.
All franchisor’s remuneration received under the agreement is recognized as other income (clause 7 of PBU 9/99). A one-time (lumpsum) payment is reflected as part of accounts payable on account 76 (Instruction for Using the Chart of accounts) and is written off as part of other income during the entire term of the franchising agreement (clause 15 of PBU 9/99).
As a rule, intangible assets, the right to use which is provided under the agreement, are used by the franchisor in its ordinary operations – consequently, depreciation is an expense for ordinary activities and other expenses (clauses 5, 11 of PBU 10/99). The procedure for dividing depreciation between these two types of expenditures should be stipulated in the accounting policy.
As for the franchisee’s accounting, since only the rights to use a scope of exclusive rights are transferred to the franchisee under the franchising agreement, there are no intangible assets in its accounting. However, they should be reflected off the balance in the amount corresponding to the amount of the franchisor’s remuneration under the agreement (a one-time payment plus periodic payments for the entire term of the agreement) by opening a special account for this purpose. If the amount of periodic payments cannot be determined immediately, then only the lumpsum payment should be reflected on the off balance sheet account. Periodic payments are included in expenses for ordinary activities (clause 5 of PBU 10/99). A one-time (lumpsum) payment is reflected as expenses of future periods and is written off evenly over the term of the agreement (clause 39 of PBU 14/2007).
As an example, I will give several entries in the accounting of the franchisor and franchisee when reflecting transactions under a franchising agreement. The examples assume that franchising is not the principal activity of the rights holder.
Accounting for the franchisor (rights holder).
In the first example, the accountant has to reflect the receipt of remuneration for a monthly payment: Debit 76 Credit 91.1 – income in the form of remuneration is recognized;
Debit 91.2 Credit 68 – VAT on remuneration is accrued;
Debit 20 Credit 05, Debit 91.2 Credit 05 – depreciation is accrued;
Debit 51 Credit 76 – remuneration is received.
Entries for accounting of a one-time payment:
Debit 51 Credit 76 – remuneration in a single payment is received.
Debit 76 Credit 91.1 – part of a one-time payment is recognized as part of the current month’s income;
Debit 91.2 Credit 68 –VAT is calculated from the amount of income received in the period to which they relate.
Accounting for the franchisee (user).
If the accounting specialist needs to reflect the receipt of a scope of rights, the entries will be as follows:
Debit 0XX (depending on which off balance sheet account is stipulated in the accounting policy – the intangible assets received for use are accepted for off balance sheet accounting.
Reflection of payment of remuneration with monthly payments:
Debit 20 Credit 76 an expense in the form of remuneration is recognized;
Debit 19 Credit 76 –VAT presented by the franchisor is reflected;
Debit 68 Credit 19 – “input” VAT is accepted for deduction;
Debit 76 Credit 51 – remuneration is transferred.
To reflect one-time entries, the franchisee accountant should make the following entries:
Debit 97 Credit 76 – a one-time payment is recognized as part of expenses in future periods;
Debit 76 Credit 51 – remuneration is transferred in the form of a one-time payment;
Debit 19 Credit 76 –VAT presented by the franchisor is reflected;
Debit 68 VAT Credit 19 – “input” VAT is accepted for deduction;
Debit 20 Credit 97 – part of a one-time payment is recognized as part of the current month’s expenses;
For the franchisor. If franchising is not the principal activity of the rights holder, then the income from granting exclusive rights for use is included in non-operational ones (clause 5 of article 250 of the Tax Code of the Russian Federation). If the granting of rights under a franchising agreement is the principal activity of the rights holder, the revenue is taken into account as part of sales income (clause 1 of article 249 of the Tax Code of the Russian Federation).
Income in the form of periodic payments is recognized on the date of payments settlement under the agreement or presentation of documents that are the basis for settlements, or on the last day of the reporting (tax) period (sub-clause 3 clause 4 of article 271 of the Tax Code of the Russian Federation).
Income in the form of a lumpsum (one-time) payment is recognized evenly over the term of the contract (clause 2 of article 271 of the Tax Code of the Russian Federation).
Since the scope of exclusive rights, provided under the franchising agreement, is usually used by the rights holder in the ordinary course of business, the depreciation charges in the tax accounting should be distributed among expenses associated with the production and sale, as well as non-operational expenses proportionally to the share of relevant income in the total amount of all income of the organization (clause 1 of article 272 of the Tax Code of the Russian Federation).
As for VAT, the franchisor should calculate the tax on the amount of remuneration (clause 1 of article 146, sub-clause 4 clause 1 of article 148 of the Tax Code of the Russian Federation). According to the relevant judicial practice, VAT exemption cannot be applied to a franchising agreement on the basis of sub-clause 26 of clause 2 of article 149 of the Tax Code of the Russian Federation (Resolution No. F05-15568/2013 of the Federal Antimonopoly Service of the Moscow District dated December 12, 2013 in case No. A41-7603/13).
The moment when the VAT tax base is determined is the date when services are provided (sub-clause 1 clause 1 of article 167 of the Tax Code of the Russian Federation). If the remuneration is paid to the rights holder in a lump sum, VAT is accrued in the same procedure as when receiving a preliminary payment for remuneration under the agreement (sub-clause 2 clause 1 of article 167 of the Tax Code of the Russian Federation).
Now let us talk about tax accounting for franchisee: it takes into account periodic payments to the franchisor as other expenses associated with production and sales (sub-clause 37 clause 1 of article 264 of the Tax Code of the Russian Federation). With the accrual method, such expenses are reflected in the accounting as of the settlement date under the agreement or the date of presentation of the documents to the user, which are the basis for the settlements, or the last day of the reporting (tax) period (sub-clause 3 clause 7 of article 272 of the Tax Code of the Russian Federation).
A lumpsum (one-time) payment is also taken into account as part of other expenses associated with production and sales (sub-clause 49 clause 1 of article 264 of the Tax Code of the Russian Federation). The amount of such payment should be included in expenses evenly over the entire term of the agreement (paragraph 2, clause 1 of article 272 of the Tax Code of the Russian Federation).
A franchisee accepts the amount of VAT declared by franchisor for deduction under the normal procedure: after acceptance for registration of the scope of exclusive rights received for use, and in case of availability of properly drawn up invoice and, provided that exclusive rights are intended to be used in activities subject to VAT (sub-clause 1 clause 2 of article 171, clause 1 of article 172 of the Tax Code of the Russian Federation).
Internal Auditor
