Dealing with franchising in TP documentation

Intra-group franchising arrangements are not uncommon, and we’ve recently been helping two multinational groups with their intercompany franchise agreements.

For one of those clients, we were provided with a benchmarking report produced by one of the ‘Big Four’ firms, which attempted to provide guidance as to an appropriate franchise fee. The report was curious in two respects: first, it identified only 7 ‘comparable’ third party agreements (3 with one franchisor, 2 with another franchisor, and 1 with a third franchisor). Secondly, there was no consideration of the terms of the client’s franchise arrangements, and in what respects they were actually comparable.

This particular benchmarking report therefore appears to have ignored one of the basic requirements for comparability, as set down in the OECD’s 2017 Transfer Pricing Guidelines:

“The economically relevant characteristics or comparability factors that need to be identified in the commercial or financial relations between the associated enterprises in order to accurately delineate the actual transaction can be broadly categorised as follows: … the contractual terms of the transaction … .” (Underlining added)

The issue is particularly acute in the case of franchising. In real-life, third party arrangements, the term ‘franchising’ covers a multitude of different scenarios. Very different levels of support may be provided by a franchisor, and very different levels of risk may be assumed by the franchisee. This is evident from the 20 plus items required to be included in a ‘Franchise Disclosure Document’ under US law. (The UK has no equivalent disclosure regime.) Many of those items are legal in nature, including the treatment of training and advertising costs, the sourcing of products and services for use by the franchisee, and the obligations of the parties generally.

If you need help creating or reviewing intercompany agreements for transfer pricing compliance, call us on +44 20 3286 8868 or email us at info@lcnlegal.com to arrange a free, no-obligation consultation.