Turnover-Based Franchise Royalties in China: Agree Calculation Rules, Reconciliation and Audit Rights Before Signing

When entering China’s franchise market, do not focus solely on the upfront franchise fee. If a franchisor charges ongoing royalties based on turnover, the same percentage can produce very different bills: the amount a customer pays, the platform’s settlement figure and the amount reaching the outlet’s account are often different. This guide focuses on turnover-based royalties, helping prospective franchisees turn charging rules into a contract schedule whose calculations they can independently check.

1. Establish the charging basis: “the system calculates it automatically” is not an answer

Franchise arrangements in mainland China are specifically governed by the Regulations on the Administration of Commercial Franchises, alongside other legislation, including the Civil Code of the People’s Republic of China. Article 11 of the Regulations requires franchise agreements to specify the types, amounts and payment methods of franchise fees. Article 21 requires the franchisor to provide the prescribed information and the contract text in writing at least 30 days before signing. Article 22 lists the matters to be disclosed, including the types, amounts and payment methods of franchise fees.

These requirements mean that ongoing royalties cannot be left at a sales representative’s verbal assurance that the brand will “take a small percentage of sales”. However, the law does not prescribe a universal rule requiring every outlet to calculate sales before or after platform deductions. The precise basis must still be defined in the contract. Do not assume that turnover means the net amount received, and certainly do not confuse it with profit.

Ask the franchisor to provide its fee guidance, the relevant contract terms and an anonymised sample monthly statement together. Check each item: are the fee names consistent? Is there a minimum monthly charge? Are fees calculated per outlet or across all outlets operated by the franchisee? Is there a separate system service fee? If promotional materials refer to “actual income” but the contract refers to “total transaction value”, resolve the discrepancy before signing or paying.

The most important deliverable is a calculation formula agreed by both parties, not a system screenshot. At a minimum, the formula should specify the calculation base, royalty rate, adjustments, billing period and payment date. Where rates are tiered, it should also explain whether reaching a threshold means the new rate applies to all turnover or only to the portion above that threshold.

2. List transactions that could lead to duplicate or excessive charges

Consider attaching a “transaction treatment schedule” to the contract. Each row should identify the transaction type, the amount included, when it is included and the source of supporting evidence. Pay particular attention to the following:

• Refunds and cancelled orders: Are uncompleted orders excluded? If a royalty was charged last month but the refund occurs this month, in which period is the charge reversed? How are partial refunds handled?
• Vouchers and platform subsidies: How are outlet-funded discounts, brand-funded promotions and platform subsidies treated separately? A blanket statement that charges are “based on the original price” is not enough.
• Platform commission and delivery charges: Is the calculation based on the amount paid by the customer or the platform’s net settlement? Does it include charges paid by the customer but received by the delivery provider?
• Stored-value cards and multi-visit passes: Is the royalty charged when credit is purchased or when it is redeemed? If both stages appear in the system, there must be rules to prevent double charging, together with corresponding adjustments when a card or pass is refunded.
• Cross-outlet purchases: If outlet A takes payment but outlet B provides the service, which outlet is allocated the turnover? When a package sold centrally by the brand is redeemed at an outlet, what amount is allocated to that outlet?
• Tax and non-sales receipts: Does the calculation base include tax? Are refundable deposits, payments received in error and similar receipts excluded? Not every amount entering the outlet’s payment account should automatically be treated as sales revenue.

There is no single commercial answer that suits every brand. What matters is that the rules are clear and verifiable. Ask the franchisor to demonstrate the complete calculation for a sample order involving a discount, platform deductions and a subsequent refund. If its finance team and franchise sales team arrive at different answers, the rules are not yet clear enough for you to sign.

3. Reconcile before debiting, and keep a route for correcting errors

A clause stating that “head office system data shall prevail” may seem convenient, but it can prevent franchisees from checking their own costs. The contract should identify the data sources and the sequence of checks to follow when figures differ. For example, it might require order records to be compared first, followed by payment records, refund records and platform settlement statements, rather than assuming that any one system is always correct.

Consider requiring the franchisor to provide downloadable transaction details for each billing period, including at least the order number, transaction date, amount used for calculation, adjustments and royalty charged. Franchisees should have a reasonable period to check the figures and raise objections. There should also be a procedure for corrections or reversals where refunds fall in a later period, orders are duplicated or systems fail.

If payments are collected automatically, agree how statements will be issued before collection, how disputed amounts will be treated and how incorrect deductions will be refunded. You may negotiate a mechanism under which the undisputed portion is paid first while the disputed portion is checked. However, this needs to be agreed by both parties: do not assume that a franchisee automatically has the right to withhold all fees.

Also review clauses stating that a failure to object within a deadline permanently waives your rights. The Civil Code contains rules on the duty to draw attention to and explain standard terms, and on their validity, but future litigation should not be your main safeguard. A safer approach is to preserve reasonable scope in the contract to correct duplicate charges, hidden errors and refunds relating to earlier billing periods.

4. Allow necessary audits, but limit access and additional charges

It is not unusual for franchisors to request access to records to verify turnover. The risks for franchisees are an unlimited expansion of the audit’s scope and demands for additional fees or substantial contractual penalties based solely on the franchisor’s estimates.

Contract negotiations can focus on four boundaries: which records may be examined, who may examine them, how much advance notice is required and how discrepancies will be handled. Checks should be confined to the outlet’s business records needed to calculate royalties. They should not involve blanket demands for personal account passwords or all business records unrelated to that outlet.

Transaction details may contain customers’ personal information. Both parties should assess the legal basis for processing, the necessary scope and the security measures required under legislation including the Personal Information Protection Law of the People’s Republic of China. Where checks can be carried out using records with identifying details removed or masked, complete customer information should not be exported unnecessarily. If a third party is appointed to conduct the audit, its confidentiality obligations and restrictions on using the records should also be defined.

When addressing under-reported turnover, distinguish between omitted orders, delayed refunds, system mapping errors and deliberate concealment. The contract should allow objections to audit findings, require transaction-by-transaction evidence for additional amounts claimed and set clear conditions for allocating audit costs. For clauses allowing charges “based on head office’s estimated turnover where records are missing”, require, at a minimum, a transparent estimation method and the opportunity to challenge the estimate with evidence of actual transactions.

Practical takeaway: Before signing, ask the franchisor to produce a simulated monthly statement using your transaction treatment schedule. Ongoing royalties become a manageable franchise cost only when every charge can be explained, every adjustment can be checked and every audit has clear limits.