When it comes to the legalities in franchising a food cart business, some requirements need to get addressed as soon as you have decided to embark on this venture. Remember that starting the business right gives you peace of mind and the focus needed to run the business smoothly.
It is common to have much paperwork in your first few months as a franchisee. Although you can get full support from the franchisor in running the business, learning the processes on your own as soon as possible can be helpful.
Moreover, to set your expectations right, part of this learning process is complying with necessary government-mandated licenses, including paying the correct taxes.
What is a franchise tax?
In general, the franchise tax is charged by a state to businesses. This is in exchange for the privilege of incorporating or doing business in a particular country. This tax usually varies from one country to another.
Moreover, franchise taxes, like income taxes, are usually collected annually. Also, the failure to pay this tax can result in the disqualification of the business from operating in the country.
In terms of legalities, any business is required to register in the Philippines, including corporations and partnerships. The said businesses are charged a franchise tax. However, for sole proprietorships, they are not usually subject to franchise taxes since these businesses are not formally registered in the country where they operate.
Franchise Tax vs Other Taxes
Franchise Tax vs Business Income Tax
Between these two, it is important to understand that all businesses pay income taxes. However, only corporations pay income taxes directly based on their profits. Some countries require businesses to pay both income tax and franchise tax.
Franchise Tax vs. Annual Reports
There are businesses that are required to file annual reports. Of course, the report comes with a fee.
Franchise Tax vs. Gross Receipts Tax
A gross receipts tax is basically a tax on sales and not charged to the customer, but rather the seller. It's similar to a franchise tax, but it taxes a different way.
Franchise Taxes in the Philippines
In general, franchises follow the usual income and business taxes scheme, plus a 20% final withholding tax on royalty fees charged by the franchisor. Also, any annual gross revenue that exceeds P3 million will be automatically subjected to a 12% Value Added Tax (VAT).
Otherwise, the franchisor will have to pay a 3% percentage tax instead of VAT. This rule is based on the new value-added tax or VAT threshold under the Tax Reform Acceleration and Inclusion (TRAIN) law.
Type of Business Ownership
Talking about taxes can be a bit of a headache, but it is quite understandable if you know your type of business ownership.
For example, if you register the business as a corporation, the income is subjected to a 30% corporate income tax. However, if you are a sole proprietor, you need to pay a personal income tax of up to 35%.
Moreover, if the franchise is a service business or is registered as a professional, you can always opt to avail of the optional 8% based on your gross sales not exceeding P3 million. This will be in place of both personal income and percentage taxes that are payable every quarter.
Prevailing Legal Laws on Franchise Taxes
It may sound cliche, but ignorance of the law indeed excuses no one. It is essential to learn the basic laws regarding franchise taxes. Here are some of the unknown legal rules that business owners must know.
The franchisee may choose to register as a VAT taxpayer or as a percentage taxpayer.
The first thing to do is to register yourself as a taxpayer. During this process, you need to choose between a VAT taxpayer or a percentage taxpayer. If you choose the latter, you are expected to pay a tax equivalent to three percent of the gross quarterly sales or receipts not exceeding P1.5 million.
This is under Section 116 of the National Internal Revenue Code (NIRC) and is remitted every month, not quarterly. Also, if the business exceeds the amount of P1.5 million during the taxable year, the taxpayer should shift from percentage to VAT taxpayer.
Not all sales transactions requires issuance of official receipt
In every purchase, everyone is entitled to always ask for the receipt. Contrary to this, the law states that official receipts must be issued for the following transactions: (1) sales merchandise or services of the transaction amount exceeds P25, (2) transactions by VAT registered businesses, and (3) payment for rentals, commissions, compensation or fees. Hence, you must not wonder why some business doesn’t give a receipt to their consumers.
There is a 20% final tax on all payments made to the franchisor (including initial franchise fee) and should be withheld by the franchisee.
The above condition is based on Section 24 (B) of Republic Act No. 8424 or the NIRC. Also, under NIRC’s Section 57 (A), the franchisee is the “payor” and is considered as the withholding agent. With this, the franchisee must withhold the equivalent of 20% from amounts paid as franchise fees or royalties.
To receive royalties, the business must generally obtain copyright or patent and is bounded by a contract. Hence, if the franchisee failed to withhold and remit this tax, the franchisee may be subject to criminal or civil penalties under the NIRC.
Businesses must withhold the income tax on the salaries of their employees and remit these to the BIR.
As stated in Section 79 of the NIRC, the tax on salaries compensation income of an individual does not exceed the statutory minimum wage or P5,000/month (changes applied due to TRAIN). Hence, the Annual Income Tax Return (ITR). Any employer who has withheld taxes from employees that exceeded the required amount must refund it to the employee.
As an entrepreneur, knowing the basic law is important. You cannot turn a blind eye or say that you do not know anything when talking about legalities. Having a business is not only about money-making, or managing your business, it is a responsibility that you need to do.
Remember that being aware of the basic legal rules and regulations in business will help you avoid any penalties or conflict upon running a business.
Common Tax Questions and Examples
To further understand how the franchise tax works here in the Philippines, here is an example.
A member of the Association of Filipino Franchisers Incorporated and a franchisor himself, receive royalties that are subjected to a 20% final tax. Now, is it possible for him to avoid this specific tax?
The answer is yes. It can be recalled that the 20% final tax on royalties is mentioned under Section 24 (B) of the National Internal Revenue Code – it's Rate of Tax on Certain Passive Income.
Based on the case GR No. 160756, the Supreme Court upheld Bureau of Internal Revenue (BIR) Ruling DA-501-04 which states that "if the income is generated in the active pursuit and performance of the corporation's primary purpose, the same is not passive income."
Therefore, if the royalties earned are not considered passive income, they will only be subject to the regular corporate income tax, and not the 20% final tax.
Another, what if you franchise business from an overseas franchisor? Is there a withholding obligation on payments made to him/her?
Well, under the Philippine tax law, any income sourced from the Philippines by a foreign corporation is taxed at source. The regular corporate income tax is set at 30%, while royalties are charged at 20%. Given this, the franchisee must withhold the appropriate tax amount and pay it to BIR.
Moreover, foreign franchisors can choose and have more benefit from preferential tax treatment or lower tax rates if he/she is a resident of a country. This is only possible his current country has a bilateral or multilateral tax agreement with the Philippines or allows a reciprocal credit for taxes paid in the Philippines.
In a nutshell, the franchise tax in the Philippines works in a way that is similar to other countries or states. However, with certain provisions and the constitutional laws of the land, any entrepreneur must exert more effort and understanding this part of the business. It is a win-win situation after all.
So, what do you think about this franchise tax scheme? A key takeaway is a fact that it is worth learning as a law-abiding entrepreneur in the country. It can save you from trouble and would make you feel at ease, knowing that you are doing the business right. Moreover, it can help the economy of the country and provide more opportunities for fellowmen.
Hoping this one helps you in your franchising journey. Check the latest franchise listings too!
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