How to Define Franchise Royalty Calculations in India

When franchising your existing business, setting a royalty percentage may seem straightforward. The real challenge is deciding which amount that percentage applies to. If shop invoices, online orders, discounts and customer refunds are counted differently, the same agreement can produce two different calculations. To build trust in your franchise relationships, clarify how royalties will be calculated before you start collecting them.

1. Define the royalty base before setting the rate

A royalty is generally a payment for the ongoing use of a brand and business system, together with agreed support. Distinguish it from the initial franchise fee, training fees, technology fees and contributions to shared marketing. If the cost of a service appears under two separate charges, explain why.

Start by examining how billing actually works in your business. Where are sales recorded, who receives the money and who issues customer refunds? Then have a definition of ‘sales subject to royalties’ drawn up. It should specify, at a minimum:

• Whether the calculation is based on invoices issued or payments received.
• Whether goods and services tax (GST) collected from customers is included in or excluded from the base.
• When cancelled orders and genuine refunds will be deducted.
• How discounts will be treated, depending on which party bears their cost.
• How delivery charges, packaging charges and amounts received from online platforms will be treated.

Simply writing ‘gross sales’ or ‘net sales’ is not enough. These terms must mean the same thing in the accounting system and the contract.

2. Test the calculation against different sales scenarios

Before announcing a percentage, apply the proposed definition to actual past transactions. The aim is not to illustrate future earnings, but to identify ambiguity in the calculation.

Online orders: A delivery platform collects the customer’s payment and transfers the balance after deducting its commission. Will the royalty be calculated on the customer’s purchase amount or the amount received by the franchisee? These are different figures. State clearly whether the platform’s commission is treated as a deduction from sales or as a franchisee expense.

Discounts and promotions: Discounts offered under a mandatory brand promotion do not necessarily have to be treated in the same way as discounts voluntarily offered by a local operator. Decide who will approve discounts, who will bear their cost and how they will affect the royalty base.

Refunds and advance payments: If a sale from last month is refunded this month, specify which month the adjustment belongs to. With gift vouchers, memberships and advance bookings, payment may be received at a different time from the delivery of the goods or services. Make sure the same amount does not attract royalties twice.

Include a sample calculation for each scenario in a schedule to the agreement. A worked example should explain the definition, not replace the actual terms.

3. Set out the reporting, payment and correction process

A sound royalty clause does more than state a payment deadline. It allocates responsibility for everything from preparing sales statements to correcting errors. Monthly statements should show sales, permitted deductions, adjustments, the royalty base and the amount payable separately.

The agreement should set reporting deadlines, the invoicing procedure and payment terms. If bank receipts differ from the sales report, who will reconcile them? If a technical fault delays reporting, how will a provisional calculation be made and subsequently corrected?

The brand owner’s inspection rights should also be clearly defined and limited: which records may be inspected, how much notice must be given and how confidential information will be protected. Specify when either party will bear the cost of additional checks.

If you are introducing a minimum royalty, test its impact in low-sales months. Set out any annual increases, late-payment charges and the process for changing the rate in advance. Verbal assurances or vague provisions for unilateral changes increase the risk of future disputes.

4. Have the terms reviewed for compliance with Indian law and tax requirements

India has no dedicated central franchise law, mandatory national franchise disclosure format or franchise-specific registration regime. This does not mean that royalty terms fall outside general law.

The Indian Contract Act, 1872 provides the basis for contractual validity, consent and the parties’ obligations. Avoid misrepresentation and ensure that promises about fees match the written terms. Mandatory purchasing requirements, price controls and other restrictions may need review under the Competition Act, 2002. The Trade Marks Act, 1999 is also relevant to rights to use the brand.

Ask a tax adviser to check the GST applicable to royalties, invoicing requirements and responsibility for tax deducted at source. State in the contract whether fees include tax or whether tax is payable in addition. If payments are made to a foreign party, also review the Foreign Exchange Management Act, 1999 and the relevant rules. Applicable stamp duty and any requirement to register related property documents are separate matters.

Practical takeaway: Before signing, ask both parties to calculate royalties independently using one month of actual sales. If the results differ, fix the definitions and process first, rather than the percentage.