Franchising my café — how do franchise fees and VAT work?

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Franchising my café — how do franchise fees and VAT work?

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Over the past year several people have asked whether they could open a café under our name in another part of London. Our café has built a loyal local following, and the idea of franchising is tempting, because it could grow the brand without me taking on another lease and another full team myself. Before I talk to anyone seriously, however, I want to understand how franchise fees and VAT would work, and what I would need to put in place from the start.

In the model I have in mind, a franchisee would pay an initial fee for the right to use our name, recipes and systems, plus training and help with opening, and then a monthly royalty based on a percentage of their turnover. Would both the initial fee and the ongoing royalty be subject to VAT in the usual way, and would I need to charge VAT even if the franchisee is not yet VAT-registered? If I also supplied coffee, branded cups or other products to the franchisee, would those supplies be treated separately for VAT, and could different VAT rates apply to different items?

I am also unsure how to treat the initial fee in my accounts. If it covers several years of support, should the income be spread over the life of the franchise agreement, or recognised when it is received? How would that interact with corporation tax, and would the costs of setting up the franchise, such as legal advice, trademark protection, writing an operations manual and training, be allowable expenses? Would I need a separate company for the franchise business, or could it sit within my existing limited company?

Finally, I would welcome advice on the practical pitfalls. What happens if a franchisee stops paying royalties, or if the agreement ends early and I need to charge a termination fee? How do other small business owners decide whether the fee structure is fair, and what should I ask a solicitor and an accountant to check before I offer a franchise to anyone?

Tagsvat limited company franchising franchise fees

Answer 1

AAmelia Jack

Franchising can be a sensible way to grow without taking on another lease, but the VAT and accounting treatment needs to be settled in the agreement itself. Both the initial fee and the ongoing royalty are normally supplies of services for VAT purposes, and if you are VAT-registered you will usually charge standard-rate VAT on them.

The franchisee's own VAT position does not change that. You charge VAT because you are making a taxable supply, even if the franchisee is below the registration threshold or has not yet registered. What matters is whether you are registered and whether the supply is taxable, not whether the customer can reclaim the VAT. You should state clearly in the contract whether fees are quoted exclusive or inclusive of VAT, because that one sentence prevents most disputes.

Supplies of goods are treated separately, and you cannot simply apply the franchise fee treatment to everything. Coffee, food, branded cups and equipment each have their own VAT liability, so a single invoice that lumps them together can cause errors. Keep goods and services on separate lines, check the liability for each item, and remember that the VAT treatment of food and drink can depend on whether it is supplied hot, cold, or for consumption on or off the premises.

For the accounts, do not automatically recognise the whole initial fee on receipt. If the fee buys several years of rights, training and ongoing support, the income should generally be spread over the period in which you provide those benefits, with the unreleased balance shown as deferred income. That spreading also feeds into corporation tax, because taxable profit broadly follows the accounting treatment for a company. Legal and manual costs are often revenue costs, but expenditure creating a lasting asset, such as trademark protection, may need capital treatment.

On practicalities, build in clear remedies for late or missed royalties, audit rights over franchisee sales, brand standards, and what happens on termination, including whether any part of the initial fee is refundable. You do not need a separate company, and keeping it in your existing limited company is often simpler, but take advice on protecting the brand separately. Ask your solicitor and accountant to review the fee structure, VAT clauses and termination terms together before you offer a franchise to anyone.

Franchising my café — how do franchise fees and VAT work?

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