Franchising and Artificial Business Splitting: How to Reduce Tax Risks

When turning an existing business into a franchise in Russia, simply allocating outlets to different individual entrepreneurs and signing agreements is not enough. If partners are independent only on paper, tax risks arise. A robust franchise network needs a clear distinction between brand standards and business management from the outset: the franchisor provides a proven model, while franchisees genuinely run their own businesses, earn income and bear commercial risk.

1. Document the commercial rationale for expansion

Franchising is not, in itself, unlawful business splitting. Problems arise when formally separate persons or entities effectively conceal a single business, and that separation is used to reduce tax liabilities unlawfully. The actual circumstances matter, not just the labels attached to agreements.

In Russia, commercial concession arrangements—the legal framework used for franchising—are specifically governed by Chapter 54 of the Russian Civil Code. Under Article 1027, the rights holder grants the user, in return for payment, the right to use a package of exclusive rights that includes rights to a trade mark or service mark. However, compliance with civil law requirements does not rule out a tax audit. Article 54.1 of the Russian Tax Code is important when assessing the tax implications: it sets limits on how taxpayers may exercise their rights when calculating the tax base and the amount of tax due.

Before offering a franchise, prepare an internal business case for the model. Answer the following questions:

• Why should an independent partner open new outlets rather than your company?
• What investment, expertise and local connections will the franchisee bring?
• Which costs and risks will each party take on?
• What is the partner paying the rights holder for, and what support will they actually receive?

Valid commercial reasons include expanding with partners’ capital, involving local entrepreneurs and sharing operational risks. Saying that the aim is to ‘retain a preferential tax regime for each outlet’ is no substitute for a commercial rationale.

Take particular care when existing company-run outlets are transferred to relatives, employees or entities under your control. Such a connection does not, by itself, prove a breach, but it calls for an assessment of the entire arrangement and how it operates in practice.

2. Separate brand standards from managing the partner’s business

Shared signage, product range requirements and quality checks are normal features of a franchise network. They do not automatically mean that all outlets constitute a single taxpayer. The risk increases when apparent independence masks the day-to-day management of every business from a single centre.

Draw up a matrix of responsibilities and decision-making authority. For each process, specify who sets the standard, who makes the business decision, who signs the documents and who pays the costs. For example, the franchisor sets staff qualification requirements, while the franchisee acts as the employer, enters into employment contracts and pays wages.

Check that the following boundaries hold in practice:

• Staff. Employees know who their employer is; transfers and concurrent employment arrangements are formally documented rather than replaced by informal instructions from a management company.
• Contracts. The partner enters into transactions in their own name or acts through a duly authorised representative.
• Money. One entity does not pay another’s expenses without a clear contractual basis.
• Decisions. The franchisee manages their business within the agreed standards, rather than merely signing paperwork prepared on their behalf.

Shared IT systems, outsourced accounting and centralised purchasing are not prohibited in themselves. However, the services involved, their cost and the allocation of responsibilities must be transparent. There is no need to abandon useful shared services artificially: the aim is to ensure that genuine business independence is not replaced by nominal participation.

3. Make financial flows clear and justifiable

Each party should have an identifiable financial position of its own: sources of income, expenses, liabilities and operating results. A separate business bank account is necessary for handling payments, but does not, by itself, establish independence.

Start by mapping payments for a typical outlet. Show who receives customer payments, pays the landlord and suppliers, pays wages and transfers royalties. If money passes through an intermediary or a shared payment collection system, separately describe the legal basis, the transfer procedure and how the transactions are recorded in the accounts.

Payments to the franchisor must reflect the terms of the agreement and the substance of the relationship. Keep evidence that rights have been granted, advice and training provided, and other contractual obligations fulfilled. For additional services, record the scope of work and payment arrangements so that they can be distinguished from support already included in the agreement.

Do not set fees with the aim of leaving the partner only a predetermined minimum profit. Low profit at an individual outlet does not, on its own, prove a breach. However, systematically extracting all the financial returns while leaving the partner with no genuine decision-making power warrants scrutiny.

Also review financial flows in the other direction: interest-free loans, loss coverage, equipment transfers and payments of another party’s bills. Every transaction must have its own justification and be properly documented. Paperwork cannot remedy a situation if it describes a relationship that does not exist.

4. Carry out a review before selling your first franchise

Ask a tax adviser and a lawyer to assess not only the commercial concession agreement but also how the proposed network will actually operate. Give them the ownership structure, financial model, payment arrangements, allocation of authority and a description of shared services.

It is useful to walk through a working day for a prospective franchisee: who hires an employee, approves a purchase, controls the takings and pays for an urgent repair? If the answer to every question is ‘the brand owner’, the independence set out in the contract may not reflect reality.

After launch, repeat this review whenever significant changes occur, such as transferring company-run outlets to partners, setting up a shared payment centre or bringing in related parties. No single document or characteristic guarantees freedom from tax challenges: the circumstances must be considered as a whole.

Practical takeaway: before selling a franchise, prepare a documented commercial rationale, a matrix of responsibilities and authority, and a map of financial flows. Then check that the prospective partner will genuinely be able to operate as an independent entrepreneur, rather than merely holding your outlet in their name.