In a franchise, a business operates under the trademark of another business in exchange for a fee. The franchisee sells or distributes products or services under licence as though they were a branch of the franchisor, but they’re actually separate businesses.
It’s a common misconception for franchises, but because they’re separate, franchisees record and pay tax just like any other business. We’ll look at how franchisees report and pay tax.
Do I need to submit tax returns if I’m a franchisee
Although you might be paying the franchisor fees to operate under their brand, HMRC treats the franchise like any other business, and expect it to pay taxes accordingly. You’re not part of their company, just paying to use their trademark and business model as if you were.
The fees you pay to the franchisor do not cover the tax you must pay on your profits as a franchisee.
Be careful around any franchise agreements which suggest they’ll take care of your tax reporting for you in case this is a potential red flag.
You’ll be operating a separate business, so you’re the one responsible! The way you pay tax on your franchising profits depends on how you register the business.
What kind of tax do franchisees pay?
Franchising describes a way of working rather than a tax structure, so you might operate your franchise as a sole trader, a limited company, or something else. This means that the taxes that you must pay as a franchisee depends on how you set up your business.
Most franchisees tend to register as a limited company, though you might also be a sole trader or in a partnership.
- A sole trader is a self-employed person who is the sole owner of the business – a professional one-person band if you like. Sole traders pay Income Tax and National Insurance on the profits they make in a tax year.
- A limited company is a separate legal entity, independent from its owner(s) or director(s), with its own unique liabilities and separate assets. They submit Company Tax Returns and pay Corporation Tax on their profits, and then individuals who pay themselves from the business will pay Income Tax on their own personal income.
Common types of tax for franchises
Once you know what type of business structure you will use to operate as a franchisee, you’ll have a better idea of the tax that you’ll need to pay, and how to pay it.
Income tax
UK taxpayers usually start to pay income tax on any money they earn above the £12,570 tax-free Personal Allowance threshold.
So, if you earn £25,000, deduct the personal allowance from it, leaving £12,430 of taxable income. The way that you pay income tax depends on how you earn the money:
- Employees pay income tax through their employers, who deduct it from their wages and pay it to HMRC on their behalf
- Sole traders pay income tax on the profits they make with their business. Because sole traders aren’t legally separate from the business, this means they pay income tax on all of the business’ taxable profits.
- The owner of a limited company is considered separate to their business, so they only pay income tax on money that the business pays to them as a salary. You might also pay yourself dividends, which are subject to dividend tax.
Corporation Tax
Limited companies pay Corporation Tax on the profits they make. So, if your franchise is set up as a limited company, the business will submit Company Tax Returns to report its income and expenses. Unlike Income Tax, there is no personal allowance relief on Corporation Tax, but there are other ways you can reduce your tax bill such as claiming expenses.
Value Added Tax (VAT)
Not all businesses need to register for VAT, though you’ll still pay VAT to your suppliers if they’re registered.
A business must register for VAT as soon as its taxable turnover reaches £90,000 in a 12 month period. This threshold takes gross sales into account – not profits.
Sometimes it’s useful for a business to register for VAT voluntarily before its taxable turnover reaches the current £90,000 threshold. For instance:
- The franchisor might require you to be VAT registered
- To get a VAT number in order to make the business look more professional
- To reclaim VAT that your business has paid on some items over the last 4 years
- If your business usually pays more VAT to suppliers than it would charge to customers (for instance if the things you sell are zero rated), then you’ll be able to reclaim the difference
Would a franchisee benefit from having an accountant?
Running a franchise can be complicated, and tax affairs can be confusing too. Anybody navigating the complexities of tax, legal regulations, and HMRC deadlines will benefit from having a tax accountant. Having a professional in your corner is a total no-brainer, franchisee or not.
They’re also an independent party! If you’re considering entering into a franchise, independent advice will help protect you, without the hard-sell of a franchisor.
Compare accountancy packages in our information centre.
