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. Because they’re separate, franchisees record and pay tax just like any other business.
What kind of tax do franchisees pay?
A franchise is a method of running a business, rather than a kind of 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.
The fees you pay to the franchisor do not cover the tax that a franchisee must pay.
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.
What type of business is your franchise?
So, the important thing to establish is the legal structure of 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.
- A limited company is a separate legal entity, independent from its owner(s) or director(s), with its own unique liabilities and separate assets.
The category your business falls under dictates the tax obligations attached to it.
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.
UK taxpayers usually start to pay income tax on any money they earn above the Personal Allowance threshold. The personal allowance for 2021/22 is £12,570
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 that 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.
Limited companies pay Corporation Tax on the profits they make. So, if your franchise is set up as a limited company, the business will pay Corporation Tax on its profits. You’ll pay income tax and/or dividend tax on the money that the business pays you. Unlike income tax, there is no personal allowance relief on Corporation Tax.
Value Added Tax (VAT)
Not all businesses need to register for VAT, though you might still pay VAT to your suppliers if they’re registered.
A business must register for VAT as soon as its taxable turnover reaches £85,000 in a 12 month period. This threshold takes gross sales into account – not profits.
It’s also worth mentioning that:
- If you have multiple sole trader businesses, you must work out your taxable turnover as a total of all your sole trader income.
- You might have more than one limited company, but legally they’re separate entities from you and from each other, so work out their turnover separately.
Registering for VAT voluntarily as a franchise
Sometimes it’s useful for a business to register for VAT voluntarily, before its taxable turnover reaches the current £85,000 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 aren’t VAT taxable), 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.