Franchise – a legal business tool: how a company defended 200 million from the tax authority

The use of franchising can be both an effective tool for business scaling and a reason for close scrutiny by tax authorities. A recent case, where a company faced additional tax assessments of 200 million rubles due to accusations of business splitting through a franchise, vividly illustrates the crucial importance of properly structuring such models. All three court instances ultimately ruled in favor of the business, quashing the claims. Let’s break down what contributed to this success and what key aspects deserve attention.

The auditing tax inspection concluded that an ordinary company, engaged in the sale of meat and sausages, utilized 57 individual entrepreneurs (IEs) under the guise of a franchise for the purpose of business splitting. The grounds for these conclusions included:

1. A unified brand: all retail outlets operated under a single, recognizable style.
2. A sole supplier: goods were sourced exclusively from the parent company.
3. A uniform pricing policy: prices were standardized.
4. Unregistered concession agreements: the lack of formal registration for franchise agreements.

In the tax authorities’ opinion, this indicated that all revenue generated by these individual entrepreneurs effectively constituted income of the main company, leading to additional assessments for VAT, penalties, and fines totaling 200 million rubles.

It was precisely thanks to a compelling body of evidence and a clear legal stance that all court instances sided with the company:

1. De facto execution of contracts: the court established that, despite the absence of formal registration for the concession agreements, the parties actually fulfilled their obligations. This factual adherence to contract terms in their real operations became a compelling argument.
2. Autonomy of individual entrepreneurs (IEs): each of the 57 entrepreneurs conducted their business independently, possessing their own staff, bearing their own costs, and leasing their own retail spaces. There was no evidence of fund transfers to individuals or the use of transit schemes.
3. Lack of centralized management: a crucial factor was proving that each IE made independent management decisions. No single “head office” was found to be “orchestrating” the operations of all outlets.
4. Presence of a business purpose: this was arguably the most significant argument. Tax claims concerning business splitting are frequently based on the absence of a reasonable business purpose for a scheme, beyond mere tax savings. In this instance, the company successfully demonstrated that operating through IEs was more advantageous and efficient from a business management perspective, not solely for tax optimization:
5. Expertise and sales volumes: the IEs possessed specific experience in meat trading, which ensured high sales volumes.
6. Market flexibility: individual entrepreneurs could react more quickly to market changes, unlike the more bureaucratic structure of the parent company.
7. Infrastructure savings: the use of existing equipment and premises by the IEs saved the parent company from significant capital expenditures.

For your franchise to serve as a legitimate development tool rather than a pretext for tax disputes, consider the following aspects:

1. Contractual framework and actual execution: conclude detailed agreements. It is crucial not only to have them, but also to ensure all terms are actually fulfilled.
2. Formalization of business processes: develop and document internal operational standards, business plans, instructions, and financial reporting models. Establish a regime of commercial secrecy or trade secrets. The more complex your model is to replicate, the less likely it is to be deemed fictitious.
3. Separation of management: individual Entrepreneurs (IEs) or franchisees must operate as independent business units. Avoid any signs of total centralized control.
4. Royalties and royalty schemes: clearly defined royalties, instructions, and business plans are hallmarks of a bona fide franchise, rather than mere business splitting.
5. Trademark protection: registering your trademark will strengthen your position and protect your brand.

A franchise is a legitimate and effective business tool. A properly structured and documented model, based on a real business purpose, can not only generate profit but also provide reliable protection against tax claims. If you have doubts about the legal integrity of your scheme or wish to minimize risks, it is better to discuss this in advance, before potential additional assessments. Qualified assistance in the area of Tax disputes can help prevent such situations or resolve them successfully.