How to Set Franchise Royalty Calculations in India

When franchising your existing business, setting royalties involves more than choosing a percentage. The same rate can produce different results depending on whether it is applied to sales inclusive of tax, money received from customers or prices before discounts. To build trust within your franchise network, define the basis for ongoing royalties and the payment rules from the outset. These arrangements are separate from the initial franchise fee.

1. Choose a royalty model based on actual costs

First, set out what you will provide in return for ongoing royalties: the right to use the brand, operational support, updated training or other specified services. List any services that attract separate charges. This helps reassure franchisees that they will not pay twice for the same support.

Consider three possible structures:

• Sales-based royalties: An agreed percentage of defined sales. Payments rise as sales grow.
• Fixed periodic fee: The same amount payable at each agreed interval. This is simple to calculate, but can become a heavier burden when sales are weak.
• Hybrid arrangement: A combination of a fixed fee and a sales-based component, or a percentage subject to a minimum payment.

Test the proposed model against actual figures from your existing outlet. Under normal, weak and strong sales scenarios, check what the operator would have left after paying staff, rent, purchasing costs and other expenses. Covering the brand owner's support costs is not enough; the franchisee's business must also remain viable.

2. Define ‘sales subject to royalties’ clearly

Simply writing ‘total sales’ in the agreement is often insufficient. Prepare a calculation schedule that clearly identifies what is included and excluded. In particular, answer these questions:

• Will goods and services tax (GST) collected from customers be excluded from the calculation?
• From which price will actual customer discounts be deducted?
• When will cancelled orders and refunds be accounted for?
• Will sales be measured before or after deducting delivery platform commission?
• Whose income are delivery charges and other amounts collected from customers?
• For gift vouchers, will royalties become due when the voucher is sold or when it is redeemed?

Avoid counting the same transaction twice. For example, before charging royalties both when a voucher is issued and when it is used to buy goods, make clear why this would happen and on what basis. Choosing a single calculation point is generally easier to understand.

Do not automatically treat the amount transferred to your bank account by a delivery platform as sales. Commission, promotional costs and other adjustments may already have been deducted. The contractual definition of sales and the payment statement are different things.

3. Set out payment timings and exceptions in advance

Make clear whether royalties accrue when an invoice is issued or when payment is received from the customer. For businesses providing services on credit, the difference can be substantial. If you choose an invoice-based calculation, also specify when adjustments for bad debts are permitted and what evidence is required.

Next, set out the calculation period, the deadline for submitting statements, and the invoicing and payment dates. Include a process for correcting late-recorded refunds or errors from an earlier period in the next payment. It is useful to deal separately with identifying disputed amounts and paying undisputed amounts.

If there is a minimum royalty, state whether it is credited against the sales-based royalty or payable in addition to it. Also explain the effect of any concessions during the initial operating period, partial months and approved closures. Do not leave it unclear whether relief is automatic or requires written approval.

4. Understand Indian law and tax requirements

India has no separate, comprehensive franchise law, mandatory national disclosure document or franchise-specific registration system. This does not mean franchising is exempt from the law. The principal legal basis for contractual obligations, including royalties, is the Indian Contract Act, 1872. Obtaining consent through misleading claims can lead to legal challenges.

The Trade Marks Act, 1999 is relevant to rights to use a brand. For tax matters, consult the applicable GST and income tax legislation. The agreement should state whether applicable GST is included in the royalty or charged separately, and how evidence of tax deducted at source will be provided where such deductions are required. Tax deductions should not be treated as discretionary commercial discounts.

If payments are made to an overseas party, also check the Foreign Exchange Management Act, 1999, the relevant rules and cross-border tax obligations. Do not determine the rate or tax treatment solely because a payment is labelled a ‘royalty’; have a tax specialist review the actual rights and services involved.

5. Test the calculation together before signing

Prepare a sample calculation sheet showing ordinary sales, discounts, refunds, platform commission and taxes separately. Both parties should calculate the royalty independently using the same information. If the answers differ, revise the wording rather than relying on verbal explanations.

The agreement should also include a procedure for changing the royalty rate, calculation basis or minimum amount. Do not create a route for changing fees through routine updates to the operations manual; make the grounds for changes and the required written consent clear.

Practical takeaway: Before granting a franchise, prepare a clear royalty schedule and a worked example. The fee arrangement is clear enough only when the franchisee can calculate the amount due without guesswork.