Franchise Royalties in China: Agree Turnover Definitions and Calculations Before Signing

A franchise quotation that charges royalties ‘as a percentage of turnover’ may seem more straightforward than a fixed fee. Yet the real cost depends on how turnover is defined. For investors considering a franchise in China, the priority before signing should be to set out a reproducible royalty calculation in a contract schedule, rather than simply comparing the percentages quoted by franchisors. This guide focuses on ongoing royalties for use of the brand, not on who collects sales proceeds.

1. Establish the charging basis: turnover is not profit

Article 11 of China’s Regulations on the Administration of Commercial Franchising requires franchise agreements to be in writing and to include the types, amounts and payment methods of franchise fees among their principal terms. Article 22 also requires franchisors to disclose information on fee types, amounts and payment methods. Ongoing royalties should not rest solely on verbal explanations from franchise sales representatives.

The Regulations do not set a uniform royalty rate for all brands or prescribe a universal turnover calculation. Franchisees need to check that the disclosure documents, main agreement and fee schedules are consistent. If the agreement says fees are ‘subject to head office policy’, request the current policy and clarify whether future changes require both parties’ written consent.

First, establish which charging model applies: a fixed monthly fee, a percentage of turnover, a share of profits, or a fixed fee plus a percentage charge. Pay particular attention to whether any ‘minimum fee’ counts towards that month’s royalty or is payable on top of it. A turnover-based royalty does not generally mean that head office shares the outlet’s losses. Fees may still be payable even if there is no profit after rent and staffing costs.

2. Break turnover down into verifiable items

Do not accept a definition consisting only of ‘all operating revenue’. Ask the franchisor to explain the following points using a sample monthly statement, and record the answers in a contract schedule.

• Tax treatment: Is the fee based on tax-inclusive or tax-exclusive sales? Where different tax treatments apply, what supporting records will be used for the calculation?
• Discounts and refunds: Is the calculation based on list prices or actual selling prices? How are refunded purchases, cancelled orders and partial refunds deducted? In which period are refunds relating to an earlier month adjusted?
• Platform orders: Delivery and e-commerce platforms may deduct commissions and technical service fees before transferring the proceeds. Is the royalty calculated before or after those deductions? Are delivery charges included?
• Promotions and subsidies: Are customer payments, platform subsidies and head office subsidies each included? Money received should not automatically be treated as the outlet’s sales revenue.
• Prepaid balances and redemption: Is the fee charged when a customer tops up a prepaid balance or when they spend it? How are purchases at another outlet allocated? The calculation must prevent royalties being charged twice, once on the top-up and again on the purchase.

There is no single default answer to these questions that applies to every contract. The aim of negotiations is not to exclude every item, but to align the charging basis with how the outlet actually operates. The contractual fee basis should also be distinguished from accounting and tax treatment: ‘revenue’ in the accounting system should not automatically be equated with ‘turnover’ under the agreement.

3. Test the formula against quiet periods and temporary closures

Once you have the formula, model at least three scenarios: normal trading, low sales and a temporary closure. Each calculation should show the fee base, applicable rate, minimum fee, credits or deductions, and final amount payable. Do not rely solely on the ideal sales figures presented during the franchise sales process.

If tiered rates apply, the agreement must specify whether reaching a threshold means the new rate applies to all turnover or only to the portion above that threshold. The two methods can produce substantially different results. Any annual cumulative adjustment should also specify the calculation year, how an outlet trading for less than a full year is treated, and how fees already paid are credited.

For closures due to refurbishment, equipment failure or head office’s failure to provide agreed support, separately clarify whether fixed or minimum fees will be suspended, what supporting documents are required and the deadline for confirming an application. Do not assume that ‘no trading means no fees’. Nor should a breach by head office automatically be taken to mean that the franchisee may stop all payments. Whether fees can be reduced or waived, or the corresponding payments withheld, depends on the agreement and the specific circumstances of performance.

4. Agree billing, audit and discrepancy procedures

A sound charging mechanism must be verifiable as well as calculable. The agreement should specify when each statement will be provided, the source of the underlying data, the franchisee’s review period, and the correction procedure for duplicate orders or omitted refunds.

Ask for statements to show sales data for the period, each category of deduction, the applicable rate, any top-up needed to meet the minimum fee, prior-period adjustments and the amount currently payable. Where platform data differs from the outlet’s system, agree a cross-checking method rather than simply giving head office’s records unconditional priority.

If head office retains audit rights, clarify the scope and frequency of checks, notice arrangements, confidentiality requirements and the conditions under which audit costs are payable by each party. For under-reported amounts, specify the basis for additional payments and the steps for raising objections. For overcharges, set a deadline for refunds or credits. Consider negotiating a provision allowing the undisputed amount to be paid while both parties check the figures, with the disputed portion handled under an agreed procedure. This can help prevent a single data error from immediately becoming a dispute over breach of the entire agreement.

Practical takeaway: Before signing, ask the franchisor to produce a complete fee statement from a single sample set of trading transactions. If refunds, platform deductions, prepaid balance redemptions and minimum fees remain unclear, settle the formula and contract schedules before deciding whether to accept a long-term payment obligation.