International Franchise
Structures
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A Primer for Franchise Companies on International Structuring:
Currently utilized international structures
Alternatives and variations
Practical implications
Summary review of tax issues
Where is international franchising going?
Future trends and implications
Structuring to Enhance Franchise Value
Page 2
The Future of International Structures
U.S. Legislative Agenda
“BEPS” and the OECD Guidelines
Structuring to Enhance Franchise Value
Introduction
International Structuring Basics
Intangible Property Rights
Global Franchise Operations
Structures for US Public Corporations
“Deferral” Structure
Foreign Business Activity Discussion
Structures for Non-Public Companies
Blocker Structure
Full Flow-Thru
International Deferral
Alternative Parent Structure
Contents
Page 3
Page 4
The Future of International
Structures
U.S. Legislative Agenda
“BEPS” and the OECD Guidelines
The Future of International Structures
U.S. Legislative Agenda
Now that Congress has returned from its August recess the top priority for House Ways and Means Committee
Chairman Paul Ryan (R-Wisconsin) will be the consideration of a major tax bill to reform the international tax system,
based on a measure, expected to be released in September, that will dominate the agenda well into October.
Objectives include:
(1) to unlock $2 trillion of American companies parked overseas IF brought back into the US under favorable tax rules;
(2) to stay ahead of the tax reform project underway at the OECD for “base erosion and profit shifting”;
(3) enacting a US “innovation box” for development of innovative products in the US through lower tax rates; and
(4) stem the tide of corporate inversions and cross-border mergers;.
Comprehensive tax reform has stalled, over the issue of individual tax rates, so the focus is now on the need to “triage”
the tax system and address reform of international rules. While it is possible that the Committee could include some other
domestic business tax provisions in the package it is very unlikely that it will include a reduction in the corporate tax rate.
Both Congress and the Administration are concerned that failure to address these issues will result in a massive wave of
inversions and self-help efforts by major US companies.
The details of Ryan’s international reform plan have not been released, but the likely contents will include:
(a) a transition from the current US system of worldwide taxation to a territorial system in which foreign profits are
generally not subject to taxation when earned and subject to a low level of taxation when brought into the US (through a
dividend-exemption mechanism),
(b) base erosion provisions to remove incentives for US companies to operate in extreme low-tax jurisdictions (or to
encourage those jurisdictions to raise their rates),
(c) a one-time tax on accumulated foreign profits not previously taxed by the US that would be dedicated to US
infrastructure, and
(d) innovation box to encourage US companies to undertake development, and commercialization in the US.
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The Future of International Structures
BEPS and the OECD Guidelines
The Organization for Economic Cooperation and Development (OECD), is releasing guidelines for
member countries (U.S., EU, China, etc.) for addressing “base erosion and profit shifting” (or BEPS)
The main objective is to provide tools and anti-abuse rules in order to limit inappropriate shifting of
taxable profits. The focus is to restrict the use of tax-haven countries (BVI, Cayman, etc.) and
Require increased scrutiny of substance, in particular in relation to entities receiving interest,
dividends and royalties.
Adverse consequences may include:
Disallowance of interest deductions
Unavailability of treaty benefits to reduce local interest / dividend withholding taxes
New / Anticipated Anti-Abuse Rules Increase Need for “Substance”
Effective January 1, 2016, the EU adopted a general anti-abuse rule ("GAAR") for the disallowance of
tax benefits (e.g., reduced treaty rates for withholding taxes) for transactions with a main purpose of
avoiding tax (ie, transactions that lack a valid commercial reason).
The EU has announced that a similar rule that will be implemented for interest and royalties.
Local tax authorities have become increasingly aggressive in evaluating substance in related party
transactions.
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Structuring to Enhance
Franchise Value
Introduction
International Structuring Basics
Intangible Property Rights
Global Franchise Operations
Introduction
International Structure Objectives
Best practices legal operating structure
Aligned with the global franchise strategy to compete in an effective and efficient
manner
Fund the growth of globalizing the brand / business (and the cost of needed
presence outside the U.S.)
Enhance franchise value
Public Companies: Improving earnings per share (“EPS”)
Private Companies: Increasing available cash for investment in business growth
Increase future cash flow
Foreign funds may be re-invested in international expansion, including acquisitions
and joint ventures
Structure should facilitate cash repatriation (to US) and potential exit strategies
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Company value can be enhanced
through evaluating available
options for an efficient
international structure, which
Increase cost efficiencies
Limit exposures
Address key business objectives
An international “structure”
involves “choice” of location and
form for these key elements:
Holding company
Intangible Property
Principal company
Given fixed Sales and
Service locations
Parent Company
Management Services,
Financing and Domestic
Distribution and Services
Parent Profit
International Franchisor/Principal
(non-US for low tax rate)
Centralize International IP, Risks and cash-flow
Coordinate/Fund Distribution and Services
“Residual” Profit
Limited Risk Service
Provider
(often high-taxed)
Franchise Development
and Support Activities
Controlled Profit
Limited Risk
Distributor
(often high-taxed)
Local Distribution of
Product or Supplies
Controlled Profit
See “Global Tax Rate Makers,” JP Morgan (May 2012)
Introduction
International Structuring Model
Page 9
Page 10
Introduction
Impact of “Structure” on Income Tax
Income Tax Rate Factors
US based companies are taxed at 35%/40% rate, plus 20-24% on US
shareholder distributions or capital gains for a total tax burden of 54%
US shareholders of international flow-thru structures are taxed on worldwide
income as earned at a total net rate of 40-42% (depending on state)
Effective tax rates for US multinational companies with significant
international operations and deferred foreign income can be 20-30%, (total
tax burden on US shareholders still 54%, without repatriation planning)
Tax rates for companies domiciled outside the US (or able to “invert” or on
the foreign earnings) can be as low 15-20% (total burden of 36% with full
repatriation)
An efficient international structure
Take advantage of treaties to reduce
withholding taxes
Limit direct connection of U.S.
company to foreign jurisdictions
“Choice” of location and form is
important:
Netherlands, Luxembourg, Ireland
and Switzerland for treaty protection
Plus Dubai, Singapore, Hong Kong
Asia and ME presence
Disregard (CTB) for flow-thru to U.S.
of foreign costs and taxes
Regard (as corporation) to control
timing and amount for inclusion to
U.S. parent corporation
U.S. Parent Company
Management Services,
Financing and Domestic
Distribution and Services
Parent Profit
International Franchisor/Principal
(non-US for low tax rate)
Coordinate Foreign Franchise Payments
International Structure Basics
Blocker Structure
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Foreign
Franchisee
Franchise
Fees
Foreign
Franchisee Foreign
Franchisee Foreign
Franchisee
Income
inclusion
and credits
International Structure Basics
Objectives
Corporations are blockers between jurisdictions and layers of ownership
Limited liability for shareholders, as well as corporate liability between countries
Facilitate local payrolls and employment contracts for personnel providing
franchisee support or managing franchisee relationships
Facilitate accumulation and allow efficient repatriation of surplus cash to the
parent company and/or shareholders
Provides for proper allocation of revenues, expenses and income among
jurisdictions and taxable parties
Platform for Joint Ventures and M&A transactions
Acquisitions including placement of debt, ease of post-close reorganization,
integration of business units or assets
Disposition of subsidiaries or assets (segregation of business units or assets,
reinvestment of proceeds, reduce tax on gains)
Permits use of internal debt for efficient transfers of cash, reduction of net asset
values, interest deductions
Allows utilization of participation exemption and foreign tax credits to reduce
taxable income on distributions
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Intangible Property Rights (“IPR”)
Legal Concepts
Page 13
Global IPR Management Concepts:
1. Protection of intangible property and related rights (IPRs), e.g., intellectual
property, technology, trademarks, through patents, copyrights, registrations, etc.
For franchising, legal protection of trade marks, copyrights and confidential
information is a main component of franchise agreements
May require more extensive identification and documentation of IPRs,
including legal registration, as well as clarity of economic or beneficial owner
2. Exploitation of IPRs through licensing, production and distribution of
products, provision of services, or other contractual arrangements
Revenues from franchisees often include 2 types of income streams:
franchise rights (royalties), and services (training, oversight); and sometimes
also re-sale of retail product, equipment and supplies
Franchise royalties may be subject to withholding tax in some countries
(consider gross-up provisions or use of treaty based intermediary company)
License of
international IPRs
Non-US
Revenue
Parent Company
(US)
International
(non-U.S.)
Franchisor Tax rate:
10% - 20%
On-Shore (treaty-based) Structure Off-shore Structure
Advantages
Can help achieve lower income tax rate
Relatively low cost of administration
Disadvantages
May delay timing of IPR transfer while
deciding on substance
Advantages
Lower average income tax rate
Exit options available (if necessary)
Workable during “start-up” period of international
structure (expected losses in E&P due to IP buy-in)
Disadvantages
No treaty network for IP Co
Not available for U.S. flow thru structures
Parent Company
(US)
International
(non-US)
Franchisor
Variable
Rate
Royalty
Tax rate:
12% - 20%
Tax rate:
0%
IP Co
(non-US)
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License of
international IPRs
Non-US
Revenue
Intangible Property Rights (“IPR”)
Structure Concepts
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Economic transfer/”migration” of IPRs
1. Consider the alternative transfer mechanisms
Cross border license, sale, cost sharing, acquisition or development funding
All are permitted under appropriate parameters, such as transfer pricing
regulations and OECD guidelines, taking into account implications of the
applicable jurisdiction
May depend upon the type of IPR transferred and the timing/value
For example, license of developed trade marks, sale of acquired rights (if
high basis or NOLs), foreign affiliate funding of the creation/development of
international rights
2. Determination of IPR values
KEY ISSUE: Timing – transfer may be more effective/beneficial/least costly when:
No significant foreign markets or income streams yet exist
Existing U.S. NOLs available to offset initial gains or license income
Various methods are available to value transfers, which are required to support
the intercompany license royalties
3. Prudent use of “off-shore” IP vehicles is advisable due to lack of income tax
treaties, withholding tax and exposure to permanent establishment
Intangible Property Rights (“IPR”)
Economic Concepts
Global Franchise Operations
Function and Intercompany Arrangements
Page 16
“Principal” company functions
1. Serves as the HubCo” for international activities
Coordinating major activities with franchisees, as well as affiliates, and operating as
the international franchisor
Owns or licenses valuable IPRs
2. Typical Principal company location alternatives
Global Principal in US -- default without international tax planning
US and foreign affiliate (i.e., Ireland, Switzerland, Singapore, Hong Kong)
Regional principals (US, Europe and Asia), if franchisee or operational needs
3. “Limited risk” service (LRS) companies
Shared services, procurement, foreign vendor management, franchisee support, etc.
Do not own or license valuable IPRs, and IPR development on a cost-plus basis
only, under certain conditions
4. “Limited risk” distribution (LRD)
Routine sales support activities
May centralize the purchase of some product, supplies or equipment for franchisees
Parent Company
• Management Services,
Financing and Domestic
Distribution and Services
International Franchisor/Principal
(non-US for low tax rate)
Centralize IP, Risks and cash-flow
International Distribution and Services
“Trading” Profit
Limited Risk
Distributor
• franchisee Product
• Location flexibility
Global Franchise Operations
Product and Other Sales
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License of
international IPRs
Franchise Fees
Foreign
Franchisee Foreign
Franchisee Foreign
Franchisee Foreign
Franchisee
Foreign
Product
Supplier
Sales or Resales
U.S./NA
Product
Supplier Intercompany Sales
“Trading” Profit may be
limited by “Subpart F”
considerations
Limited Risk
Distributor
franchisee Product
Location flexibility
Parent Company
Management Services,
Financing and Domestic
Distribution and Services
Parent Profit
International Franchisor/Principal
(non-US for low tax rate)
Centralize IP, Risks and cash-flow
Coordinate/Fund International Services
“Service” Profit
Limited Risk Service
Provider
• Support Activities
• Location Flexibility
Global Franchise Operations
Intermediary Services
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License of
international IPRs
Franchise Fees
Foreign
Franchisee Foreign
Franchisee Foreign
Franchisee Foreign
Franchisee
Services or contracted services
“Service” Profit may be
limited by “Subpart F”
considerations)
Intercompany Service Fees
Limited Risk Service
Provider
• Support Activities
• Location Flexibility
Limited Risk Service
Provider
Support Activities
Location Flexibility
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Structures for US
Public Corporations
“Deferral” Structure
Foreign Business Activity Discussion
Redux: IPR Structures and Supply Chain
An efficient international structure
Take advantage of treaties to reduce
withholding taxes
Limit direct connection of U.S. company
to foreign jurisdictions
Regard (as corporation) to control timing
and amount of profit inclusion to U.S.
“Choice” of location and foreign
activities:
Netherlands, Luxembourg, Ireland and
Switzerland for treaty protection
Plus Dubai, Singapore, Hong Kong Asia
and ME presence
Requires significant foreign business
operations to defer foreign income (see
the case for foreign oversight)
U.S. Parent Company
Management Services,
Financing and Domestic
Distribution and Services
Parent Profit
International Franchisor/Principal
(non-US for low tax rate)
Coordinate Foreign Franchise Payments
Perform business activities (954(c))
Structures for U.S. Corporation
Deferral Structure
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Foreign
Franchisee Foreign
Franchisee Foreign
Franchisee Foreign
Franchisee
Repatriation
of foreign
income and
credits
Franchise
Fees
The case for foreign franchise oversight
Consider the advantage of being in the same time zone or geographic proximity with foreign franchisees
Facilitate more regular and continuous contact to improve chances of success of the foreign markets
Training, start up assistance, and oversight can be done on a real time basis
Consider “regionalizing” the franchisee oversight (Europe, Asia, ME, S.Am)
Reduces lost travel time and cost to foreign locations
Additional considerations:
Contracting authority for international business arrangements could be concluded outside the US
Location should have multi-language capability, including English, and choice of laws flexibility
Employee availability should consider productivity (working hours), social costs and difficulty of termination/severance
Income tax deferral (foreign profit not taxed as earned in U.S.)
IF comply with active business requirements of US tax regulations (IRC 954c related to foreign personal holding company income or FPHCI)
Should be alignment with foreign franchise oversight activities, with choice of location
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Structures for U.S. Corporation
Foreign Business Activities
License of
international IPRs
Non-Us
Revenue
Parent Company
(US)
International
Franchisor
(non-US) Tax rate:
10% - 20%
On-Shore (treaty-based) Structure Off-shore Structure
Advantages
Lower average income tax rate
Exit options available (if necessary)
Workable during “start-up” period of international
structure (expected losses in E&P due to IP buy-in)
Disadvantages
No treaty network for IP Co
Parent Company
(US)
International
Franchisor
(non-US)
Variable
Rate
Royalty
Tax rate:
12% - 20%
Tax rate:
0%
IP Co
(non-US)
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Structures for U.S. Corporation
IPR Structure Options (redux)
License of
international IPRs
Non-US
Revenue
Advantages
Can help achieve lower income tax rate
Relatively low cost of administration
Disadvantages
May delay timing of IPR transfer while
deciding on substance
Parent Company
Management Services,
Financing and Domestic
Distribution and Services
Limited Risk
Service Provider
• Support Activities
• Flexible Locations
Limited Risk
Distributor
• franchisee Product
• Flexible Locations
Structures for U.S. Corporation
Supply Chain – Product and Service (redux)
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License of
international IPRs
Franchise Fees
Foreign
Franchisee Foreign
Franchisee Foreign
Franchisee Foreign
Franchisee
Product
Supplier
Sales or Resales Services or contracted services
International Franchisor/Principal
(non-US for low tax rate)
Centralize IP, Risks and cash-flow
International Sales and Services
“Trading and Service” Profit
Intercompany Service Fees
Limited Risk
Distributor
Franchisee Supplies
Flexible Locations
Limited Risk
Service Provider
• Support Activities
• Flexible Locations
Limited Risk
Service Provider
Support Activities
Flexible Locations
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Non-Public International
Structure Basics
International Blocker
Full Flow-Thru Structure
US Flow-Thru with International Deferral
Redux: The Importance of Supply Chain
Alternate Parent Structure
An efficient international structure
Take advantage of treaties to reduce
withholding taxes
Limit direct connection of U.S. company
to foreign jurisdictions
“Choice” of location and form for these
key elements:
Netherlands, Luxembourg, Ireland and
Switzerland for treaty protection
Disregard (CTB) for flow-thru to U.S. of
foreign costs and taxes
Regard (as corporation) to control timing
for inclusion to U.S. parent corporation
utilizing E&P deficit and deemed paid
credits
U.S. Parent Company
Management Services,
Financing and Domestic
Distribution and Services
Parent Profit
International Franchisor/Principal
(non-US for low tax rate)
Coordinate Foreign Franchise Payments
Non-Public International Structure Basics
Blocker Structure (redux)
Foreign
Franchisee
Franchise
Fees
Foreign
Franchisee Foreign
Franchisee Foreign
Franchisee
Income
inclusion
and credits
Page 25
U.S. Parent Company
Management Services,
Financing and Domestic
Distribution and Services
Parent Profit
International Franchisor/Principal
(non-US for low tax rate)
Coordinate Foreign Franchise Payments
Non-Public International Structure Basics
Full Flow-Thru Structure
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Foreign
Franchisee
Franchise
Fees
Foreign
Franchisee Foreign
Franchisee Foreign
Franchisee
Full income
inclusion
and credits
to
shareholders
Shareholders
Advantages:
Early losses may be deductible to shareholders;
Seller may obtain capital gains rates if sells entire
business (advantage to buyer of asset purchase for
step up); and
Foreign taxes flow-thru and creditable to
shareholders (instead of being subject to deemed
paid credit limitation)
Applications:
Expected sale of business prior to profitability;
Limited potential foreign markets or non-U.S.
business activity.
Downside:
Reduced operating cash flows due to need to pay
current U.S. income taxes on foreign income.
Combined federal (40%) plus state income taxes,
results in total taxation of 40-45% (even after foreign
tax credits)
Foreign earnings taxed automatically (whether cash
distributed or not), less credit for foreign taxes.
U.S. Parent Company
Management Services,
Financing and Domestic
Distribution and Services
Parent Profit
International Franchisor/Principal
(non-US for low tax rate)
Foreign Franchise Payments
Non-Public International Structure Basics
U.S. Flow-Thru with International Deferral Structure
Page 27
Foreign
Franchisee
Franchise
Fees
Foreign
Franchisee Foreign
Franchisee Foreign
Franchisee
U.S. income
inclusion to
shareholders
Shareholders
Advantages:
Foreign repatriates earnings may qualify for lower 20%
rate upon repatriation (“qualified dividend income” or
“QDI” from a treaty country);
Foreign income is not subject to U.S. income tax until
distribution of foreign E&P (can be deferred further by
foreign losses, debt and basis recovery strategies);
Examples:
If foreign income taxed (under Principal structure at
15%), saves 25% on current basis
Upon repatriation the repatriated earnings are taxed
at 25% (with state), for total tax cost of 36%
U.S. income is still subject to 40%+ income tax rates,
BUT some former “U.S. income” may be deferred.
Neutral Applications:
Seller may obtain capital gains rates on U.S. assets
and foreign business (already in deferral structure).;
Foreign taxes do not flow-thru and are not creditable to
shareholders (deemed paid credit limitation), BUT
foreign earnings could be taxed at net lower rates;
Early losses are not deductible to shareholders, BUT
reduce E&P pool and lower future repatriation tax
Repatriation
of foreign
income at
QDI rates
and
deductible
foreign taxes
Parent Company
Management Services,
Financing and Domestic
Distribution and Services
Limited Risk
Service Provider
• Support Activities
• Flexible Locations
Limited Risk
Distributor
• franchisee Product
• Flexible Locations
Non-Public International Structure Basics
Supply Chain – Product and Service (redux)
Page 28
License of
international IPRs
Franchise Fees
Foreign
Franchisee Foreign
Franchisee Foreign
Franchisee Foreign
Franchisee
Product
Supplier
Sales or Resales Services or contracted services
International Franchisor/Principal
(non-US for low tax rate)
Centralize IP, Risks and cash-flow
International Sales and Services
“Trading and Service” Profit
Limited Risk
Distributor
Franchisee Supplies
Flexible Locations
Limited Risk
Service Provider
• Support Activities
• Flexible Locations
Limited Risk
Service Provider
Support Activities
Flexible Locations
Important Point: “Principal” strategy is
necessary both for foreign
income deferral AND to keep
foreign income tax rates low.
Examples:
1. If net foreign tax rate is
30%, total tax cost will be in
excess of 48% upon
repatriation;
2. If income is subject to
Subpart F, the income
inclusion to shareholders
losses both QDI and FTC.
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Transparent Parent Company (for tax purposes).
U.S. shareholders pay tax on distributed foreign
earnings.
The structure allows for consolidated
accounting, and single U.S. based equity plans
and financing.
Applications:
Substitute for traditional U.S. Corporate
structure:
Significant non-U.S. revenues; and/or non-
U.S. business growth;
Reduces U.S. corporate level complexity,
while allowing for intercompany
arrangements.
Inversion is not possible (or expensive); and/or
U.S. IP value is significant.
Preserves ability to convert to U.S. corporate
structure or flow-through, while avoiding high
exit cost for foreign IP rights.
Shareholders
Parent
Company
U.S. Company
Domestic
Distribution
and Services
International
Franchisor/
Principal
(non-US)
Franchise
Fees
Foreign
Franchisee
Non-Public International Structure Basics
Alternative Structure
Questions
Any Questions?
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