Buying a Franchise in India: How to Check Royalty Calculations

A low royalty rate can look attractive when choosing a franchise. But the actual cost depends on the amount to which that rate applies. Different definitions can produce different payments, even at the same rate. If you are buying a franchise in India, it is essential to understand the full royalty formula before signing and test it against your projected sales figures.

1. Start by distinguishing sales, receipts and profit

A royalty may be a recurring fee for using a brand and its operating system. The agreement determines its structure: a fixed amount, a percentage of sales, or a combination of both. Do not assume that royalties automatically stop when the business makes a loss.

First, find the definitions of ‘gross sales’, ‘net sales’ and ‘revenue’ in the agreement. Do not infer their meaning from the labels alone. ‘Net sales’ does not necessarily mean the amount left after deducting rent, wages and other expenses.

Get written answers from the franchisor to these questions:

• Does the royalty become payable when an invoice is issued or when the customer pays?
• Will sales include Goods and Services Tax (GST)?
• Will actual discounts and customer refunds be deducted?
• Will cancelled orders count as sales at any stage?
• Will packaging, delivery and other ancillary charges be included in the calculation?

These answers should appear in the agreement or a signed addendum, not just in a presentation or message. If definitions conflict across documents, clarify which document takes precedence.

2. Test the formula across every sales channel

The amount that reaches your bank account may differ between sales at the shop counter and those made through an online platform. A platform may deduct its commission, while the agreement may calculate royalties on the customer’s full bill. In that case, you bear the cost of both commission and royalties.

Ask the franchisor for a sample monthly royalty statement. Review it with your accountant against these scenarios:

• Online orders: Is the calculation based on the amount before or after the platform’s commission is deducted?
• Later returns: If a sale from the previous month is refunded, in which month will the adjustment be made?
• Gift vouchers: Is the royalty charged when the voucher is sold or when it is redeemed? The same amount should not be counted twice.
• Advance payments: When does a deposit for an event or large order count as a sale?
• Credit sales: Is any deduction or adjustment available if the customer does not pay?

Next, calculate the royalty yourself using a sales statement, and ask the franchisor to perform the same calculation. If the results differ, resolve the discrepancy before proceeding. This exercise is just as useful as negotiating the rate.

3. Factor in minimum royalties and additional taxes

Some offers combine a percentage-based royalty with a minimum monthly payment. Check whether you must pay the higher of the two amounts, or whether a fixed fee is payable on top of the percentage-based amount. The financial implications are different.

Run a separate calculation for a low-sales month. If a minimum payment applies, its effective rate rises as sales fall. In a seasonal business, annual averages can conceal this pressure. Also get written confirmation of when royalties start and how the charge for a partial first month will be calculated.

Clarify whether the quoted royalty includes applicable taxes or whether these are payable separately. Including tax in the sales figure used to calculate royalties is a different issue from charging tax on the royalty service itself. Where applicable, ask your accountant to explain the process for tax deducted at source (TDS) and the supporting documentation required.

Keep three separate lines in your budget: the calculated royalty, any additional payment needed to meet the minimum, and the cash-flow impact of applicable taxes. Do not budget on the assumption that available tax credits provide an immediate cash saving.

4. Protect your rights in India with a clear agreement

India has no standalone, comprehensive franchise law. Nor is there a general franchise-specific requirement for a pre-sale disclosure document or registration to sell a franchise. This does not mean that ordinary business registrations and permits are unnecessary.

Royalty-related rights and obligations are largely determined by the agreement. The Indian Contract Act, 1872 provides the principal framework for the validity, performance and breach of contracts, and the remedies available. Rules on fraud and misrepresentation also apply. Relevant tax laws may need to be reviewed, along with the Foreign Exchange Management Act, 1999 and applicable rules where payments are made to an overseas franchisor.

Include deadlines for correcting calculation errors, adjustments for returns, and a process for refunding overpayments or crediting them against the next bill. Also clarify how undisputed amounts will be paid if a dispute arises. Have your lawyer review these provisions; do not assume you have the right to make deductions unilaterally.

Practical takeaway: Agree to the full royalty formula, not just the rate. Before signing, reconcile the calculations in writing for a typical month, a low-sales month and a month with returns.