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International Franchise

Structures

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Tuesday, September 15, 2015 | 1:00 p.m. EDT

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A Primer for Franchise Companies on International Structuring:

Currently utilized international structures

Alternatives and variations

Practical implications

Summary review of tax issues

Where is international franchising going?

Future trends and implications

Structuring to Enhance Franchise Value

The Future of International Structures

U.S. Legislative Agenda

“BEPS” and the OECD Guidelines

Structuring to Enhance Franchise Value

Introduction

International Structuring Basics

Intangible Property Rights

Global Franchise Operations

Structures for US Public Corporations

“Deferral” Structure

Foreign Business Activity Discussion

Structures for Non-Public Companies

Blocker Structure

Full Flow-Thru

International Deferral

Alternative Parent Structure

Contents

The Future of International

Structures


“BEPS” and the OECD Guidelines



Now that Congress has returned from its August recess the top priority for House Ways and Means Committee

Chairman Paul Ryan (R-Wisconsin) will be the consideration of a major tax bill to reform the international tax system,

based on a measure, expected to be released in September, that will dominate the agenda well into October.

Objectives include:

(1) to unlock $2 trillion of American companies parked overseas IF brought back into the US under favorable tax rules;

(2) to stay ahead of the tax reform project underway at the OECD for “base erosion and profit shifting”;

(3) enacting a US “innovation box” for development of innovative products in the US through lower tax rates; and

(4) stem the tide of corporate inversions and cross-border mergers;.

Comprehensive tax reform has stalled, over the issue of individual tax rates, so the focus is now on the need to “triage”

the tax system and address reform of international rules. While it is possible that the Committee could include some other

domestic business tax provisions in the package it is very unlikely that it will include a reduction in the corporate tax rate.

Both Congress and the Administration are concerned that failure to address these issues will result in a massive wave of

inversions and self-help efforts by major US companies.

The details of Ryan’s international reform plan have not been released, but the likely contents will include:

(a) a transition from the current US system of worldwide taxation to a territorial system in which foreign profits are

generally not subject to taxation when earned and subject to a low level of taxation when brought into the US (through a

dividend-exemption mechanism),

(b) base erosion provisions to remove incentives for US companies to operate in extreme low-tax jurisdictions (or to

encourage those jurisdictions to raise their rates),

(c) a one-time tax on accumulated foreign profits not previously taxed by the US that would be dedicated to US

infrastructure, and

(d) innovation box to encourage US companies to undertake development, and commercialization in the US.


BEPS and the OECD Guidelines

The Organization for Economic Cooperation and Development (OECD), is releasing guidelines for

member countries (U.S., EU, China, etc.) for addressing “base erosion and profit shifting” (or BEPS)

The main objective is to provide tools and anti-abuse rules in order to limit inappropriate shifting of

taxable profits. The focus is to restrict the use of tax-haven countries (BVI, Cayman, etc.) and

Require increased scrutiny of substance, in particular in relation to entities receiving interest,

dividends and royalties.

Adverse consequences may include:

Disallowance of interest deductions

Unavailability of treaty benefits to reduce local interest / dividend withholding taxes

New / Anticipated Anti-Abuse Rules Increase Need for “Substance”

Effective January 1, 2016, the EU adopted a general anti-abuse rule ("GAAR") for the disallowance of

tax benefits (e.g., reduced treaty rates for withholding taxes) for transactions with a main purpose of

avoiding tax (ie, transactions that lack a valid commercial reason).

The EU has announced that a similar rule that will be implemented for interest and royalties.

Local tax authorities have become increasingly aggressive in evaluating substance in related party

transactions.

Structuring to Enhance

Franchise Value

Introduction

International Structuring Basics

Intangible Property Rights


Introduction

International Structure Objectives

Best practices legal operating structure

Aligned with the global franchise strategy to compete in an effective and efficient

manner

Fund the growth of globalizing the brand / business (and the cost of needed

presence outside the U.S.)

Enhance franchise value

Public Companies: Improving earnings per share (“EPS”)

Private Companies: Increasing available cash for investment in business growth

Increase future cash flow

Foreign funds may be re-invested in international expansion, including acquisitions

and joint ventures

Structure should facilitate cash repatriation (to US) and potential exit strategies

Company value can be enhanced

through evaluating available

options for an efficient

international structure, which

Increase cost efficiencies

Limit exposures

Address key business objectives

An international “structure”

involves “choice” of location and

form for these key elements:

Holding company

Intangible Property

Principal company

Given fixed Sales and

Service locations

Parent Company

Management Services,

Financing and Domestic

Distribution and Services

Parent Profit

International Franchisor/Principal

(non-US for low tax rate)

Centralize International IP, Risks and cash-flow

Coordinate/Fund Distribution and Services

“Residual” Profit

Limited Risk Service

Provider

(often high-taxed)

Franchise Development

and Support Activities

Controlled Profit

Limited Risk

Distributor

(often high-taxed)

Local Distribution of

Product or Supplies

Controlled Profit

See “Global Tax Rate Makers,” JP Morgan (May 2012)

Introduction

International Structuring Model

Introduction

Impact of “Structure” on Income Tax

Income Tax Rate Factors

US based companies are taxed at 35%/40% rate, plus 20-24% on US

shareholder distributions or capital gains for a total tax burden of 54%

US shareholders of international flow-thru structures are taxed on worldwide

income as earned at a total net rate of 40-42% (depending on state)

Effective tax rates for US multinational companies with significant

international operations and deferred foreign income can be 20-30%, (total

tax burden on US shareholders still 54%, without repatriation planning)

Tax rates for companies domiciled outside the US (or able to “invert” or on

the foreign earnings) can be as low 15-20% (total burden of 36% with full

repatriation)

An efficient international structure

Take advantage of treaties to reduce

withholding taxes

Limit direct connection of U.S.

company to foreign jurisdictions

“Choice” of location and form is

important:

Netherlands, Luxembourg, Ireland

and Switzerland for treaty protection

Plus Dubai, Singapore, Hong Kong

Asia and ME presence

Disregard (CTB) for flow-thru to U.S.

of foreign costs and taxes

Regard (as corporation) to control

timing and amount for inclusion to

U.S. parent corporation

U.S. Parent Company




Parent Profit



Coordinate Foreign Franchise Payments

International Structure Basics

Blocker Structure

Foreign

Franchisee

Franchise

Fees

Foreign

Franchisee Foreign

Franchisee Foreign

Franchisee

Income

inclusion

and credits

International Structure Basics

Objectives

Corporations are blockers between jurisdictions and layers of ownership

Limited liability for shareholders, as well as corporate liability between countries

Facilitate local payrolls and employment contracts for personnel providing

franchisee support or managing franchisee relationships

Facilitate accumulation and allow efficient repatriation of surplus cash to the

parent company and/or shareholders

Provides for proper allocation of revenues, expenses and income among

jurisdictions and taxable parties

Platform for Joint Ventures and M&A transactions

Acquisitions including placement of debt, ease of post-close reorganization,

integration of business units or assets

Disposition of subsidiaries or assets (segregation of business units or assets,

reinvestment of proceeds, reduce tax on gains)

Permits use of internal debt for efficient transfers of cash, reduction of net asset

values, interest deductions

Allows utilization of participation exemption and foreign tax credits to reduce

taxable income on distributions

Intangible Property Rights (“IPR”)

Legal Concepts

Global IPR Management Concepts:

1. Protection of intangible property and related rights (IPRs), e.g., intellectual

property, technology, trademarks, through patents, copyrights, registrations, etc.

For franchising, legal protection of trade marks, copyrights and confidential

information is a main component of franchise agreements

May require more extensive identification and documentation of IPRs,

including legal registration, as well as clarity of economic or beneficial owner

2. Exploitation of IPRs through licensing, production and distribution of

products, provision of services, or other contractual arrangements

Revenues from franchisees often include 2 types of income streams:

franchise rights (royalties), and services (training, oversight); and sometimes

also re-sale of retail product, equipment and supplies

Franchise royalties may be subject to withholding tax in some countries

(consider gross-up provisions or use of treaty based intermediary company)

License of

international IPRs

Non-US

Revenue

Parent Company

(US)

International

(non-U.S.)

Franchisor Tax rate:

10% - 20%

On-Shore (treaty-based) Structure Off-shore Structure

Advantages

Can help achieve lower income tax rate

Relatively low cost of administration

Disadvantages

May delay timing of IPR transfer while

deciding on substance

Advantages

Lower average income tax rate

Exit options available (if necessary)

Workable during “start-up” period of international

structure (expected losses in E&P due to IP buy-in)

Disadvantages

No treaty network for IP Co

Not available for U.S. flow thru structures

Parent Company

(US)

International

(non-US)

Franchisor

Variable

Rate

Royalty

Tax rate:

12% - 20%

Tax rate:

0%

IP Co

(non-US)

License of

international IPRs

Non-US

Revenue


Structure Concepts

Economic transfer/”migration” of IPRs

1. Consider the alternative transfer mechanisms

Cross border license, sale, cost sharing, acquisition or development funding

All are permitted under appropriate parameters, such as transfer pricing

regulations and OECD guidelines, taking into account implications of the

applicable jurisdiction

May depend upon the type of IPR transferred and the timing/value

For example, license of developed trade marks, sale of acquired rights (if

high basis or NOLs), foreign affiliate funding of the creation/development of

international rights

2. Determination of IPR values

KEY ISSUE: Timing – transfer may be more effective/beneficial/least costly when:

No significant foreign markets or income streams yet exist

Existing U.S. NOLs available to offset initial gains or license income

Various methods are available to value transfers, which are required to support

the intercompany license royalties

3. Prudent use of “off-shore” IP vehicles is advisable due to lack of income tax

treaties, withholding tax and exposure to permanent establishment


Economic Concepts


Function and Intercompany Arrangements

“Principal” company functions

1. Serves as the HubCo” for international activities

Coordinating major activities with franchisees, as well as affiliates, and operating as

the international franchisor

Owns or licenses valuable IPRs

2. Typical Principal company location alternatives

Global Principal in US -- default without international tax planning

US and foreign affiliate (i.e., Ireland, Switzerland, Singapore, Hong Kong)

Regional principals (US, Europe and Asia), if franchisee or operational needs

3. “Limited risk” service (LRS) companies

Shared services, procurement, foreign vendor management, franchisee support, etc.

Do not own or license valuable IPRs, and IPR development on a cost-plus basis

only, under certain conditions

4. “Limited risk” distribution (LRD)

Routine sales support activities

May centralize the purchase of some product, supplies or equipment for franchisees

Parent Company

• Management Services,





Centralize IP, Risks and cash-flow

International Distribution and Services

“Trading” Profit

Limited Risk

Distributor

• franchisee Product

• Location flexibility


Product and Other Sales

License of

international IPRs

Franchise Fees

Foreign

Franchisee Foreign

Franchisee Foreign

Franchisee Foreign

Franchisee

Foreign

Product

Supplier

Sales or Resales

U.S./NA

Product

Supplier Intercompany Sales

“Trading” Profit may be

limited by “Subpart F”

considerations

Limited Risk

Distributor

franchisee Product

Location flexibility

Parent Company




Parent Profit




Coordinate/Fund International Services

“Service” Profit


Provider

• Support Activities

• Location Flexibility


Intermediary Services

License of

international IPRs

Franchise Fees

Foreign

Franchisee Foreign

Franchisee Foreign

Franchisee Foreign

Franchisee

Services or contracted services

“Service” Profit may be

limited by “Subpart F”

considerations)

Intercompany Service Fees


Provider


• Location Flexibility


Provider

Support Activities

Location Flexibility

Structures for US

Public Corporations

“Deferral” Structure

Foreign Business Activity Discussion

Redux: IPR Structures and Supply Chain



withholding taxes

Limit direct connection of U.S. company

to foreign jurisdictions

Regard (as corporation) to control timing

and amount of profit inclusion to U.S.

“Choice” of location and foreign

activities:

Netherlands, Luxembourg, Ireland and

Switzerland for treaty protection

Plus Dubai, Singapore, Hong Kong Asia

and ME presence

Requires significant foreign business

operations to defer foreign income (see

the case for foreign oversight)

U.S. Parent Company




Parent Profit




Perform business activities (954(c))

Structures for U.S. Corporation

Deferral Structure

Foreign

Franchisee Foreign

Franchisee Foreign

Franchisee Foreign

Franchisee

Repatriation

of foreign

income and

credits

Franchise

Fees

The case for foreign franchise oversight

Consider the advantage of being in the same time zone or geographic proximity with foreign franchisees

Facilitate more regular and continuous contact to improve chances of success of the foreign markets

Training, start up assistance, and oversight can be done on a real time basis

Consider “regionalizing” the franchisee oversight (Europe, Asia, ME, S.Am)

Reduces lost travel time and cost to foreign locations

Additional considerations:

Contracting authority for international business arrangements could be concluded outside the US

Location should have multi-language capability, including English, and choice of laws flexibility

Employee availability should consider productivity (working hours), social costs and difficulty of termination/severance

Income tax deferral (foreign profit not taxed as earned in U.S.)

IF comply with active business requirements of US tax regulations (IRC 954c related to foreign personal holding company income or FPHCI)

Should be alignment with foreign franchise oversight activities, with choice of location


Foreign Business Activities

License of

international IPRs

Non-Us

Revenue

Parent Company

(US)

International

Franchisor

(non-US) Tax rate:

10% - 20%

On-Shore (treaty-based) Structure Off-shore Structure

Advantages

Lower average income tax rate

Exit options available (if necessary)

Workable during “start-up” period of international

structure (expected losses in E&P due to IP buy-in)

Disadvantages

No treaty network for IP Co

Parent Company

(US)

International

Franchisor

(non-US)

Variable

Rate

Royalty

Tax rate:

12% - 20%

Tax rate:

0%

IP Co

(non-US)


IPR Structure Options (redux)

License of

international IPRs

Non-US

Revenue

Advantages

Can help achieve lower income tax rate

Relatively low cost of administration

Disadvantages

May delay timing of IPR transfer while

deciding on substance

Parent Company




Limited Risk

Service Provider


• Flexible Locations

Limited Risk

Distributor




Supply Chain – Product and Service (redux)

License of

international IPRs

Franchise Fees

Foreign

Franchisee Foreign

Franchisee Foreign

Franchisee Foreign

Franchisee

Product

Supplier

Sales or Resales Services or contracted services




International Sales and Services

“Trading and Service” Profit

Intercompany Service Fees

Limited Risk

Distributor

Franchisee Supplies

Flexible Locations

Limited Risk

Service Provider



Limited Risk

Service Provider

Support Activities

Flexible Locations

Non-Public International

Structure Basics

International Blocker

Full Flow-Thru Structure

US Flow-Thru with International Deferral

Redux: The Importance of Supply Chain

Alternate Parent Structure



withholding taxes

Limit direct connection of U.S. company

to foreign jurisdictions

“Choice” of location and form for these

key elements:

Netherlands, Luxembourg, Ireland and

Switzerland for treaty protection

Disregard (CTB) for flow-thru to U.S. of

foreign costs and taxes

Regard (as corporation) to control timing

for inclusion to U.S. parent corporation

utilizing E&P deficit and deemed paid

credits

U.S. Parent Company




Parent Profit




Non-Public International Structure Basics

Blocker Structure (redux)

Foreign

Franchisee

Franchise

Fees

Foreign

Franchisee Foreign

Franchisee Foreign

Franchisee

Income

inclusion

and credits

U.S. Parent Company




Parent Profit





Full Flow-Thru Structure

Foreign

Franchisee

Franchise

Fees

Foreign

Franchisee Foreign

Franchisee Foreign

Franchisee

Full income

inclusion

and credits

to

shareholders

Shareholders

Advantages:

Early losses may be deductible to shareholders;

Seller may obtain capital gains rates if sells entire

business (advantage to buyer of asset purchase for

step up); and

Foreign taxes flow-thru and creditable to

shareholders (instead of being subject to deemed

paid credit limitation)

Applications:

Expected sale of business prior to profitability;

Limited potential foreign markets or non-U.S.

business activity.

Downside:

Reduced operating cash flows due to need to pay

current U.S. income taxes on foreign income.

Combined federal (40%) plus state income taxes,

results in total taxation of 40-45% (even after foreign

tax credits)

Foreign earnings taxed automatically (whether cash

distributed or not), less credit for foreign taxes.

U.S. Parent Company




Parent Profit



Foreign Franchise Payments


U.S. Flow-Thru with International Deferral Structure

Foreign

Franchisee

Franchise

Fees

Foreign

Franchisee Foreign

Franchisee Foreign

Franchisee

U.S. income

inclusion to

shareholders

Shareholders

Advantages:

Foreign repatriates earnings may qualify for lower 20%

rate upon repatriation (“qualified dividend income” or

“QDI” from a treaty country);

Foreign income is not subject to U.S. income tax until

distribution of foreign E&P (can be deferred further by

foreign losses, debt and basis recovery strategies);

Examples:

If foreign income taxed (under Principal structure at

15%), saves 25% on current basis

Upon repatriation the repatriated earnings are taxed

at 25% (with state), for total tax cost of 36%

U.S. income is still subject to 40%+ income tax rates,

BUT some former “U.S. income” may be deferred.

Neutral Applications:

Seller may obtain capital gains rates on U.S. assets

and foreign business (already in deferral structure).;

Foreign taxes do not flow-thru and are not creditable to

shareholders (deemed paid credit limitation), BUT

foreign earnings could be taxed at net lower rates;

Early losses are not deductible to shareholders, BUT

reduce E&P pool and lower future repatriation tax

Repatriation

of foreign

income at

QDI rates

and

deductible

foreign taxes

Parent Company




Limited Risk

Service Provider



Limited Risk

Distributor




Supply Chain – Product and Service (redux)

License of

international IPRs

Franchise Fees

Foreign

Franchisee Foreign

Franchisee Foreign

Franchisee Foreign

Franchisee

Product

Supplier

Sales or Resales Services or contracted services




International Sales and Services

“Trading and Service” Profit

Limited Risk

Distributor

Franchisee Supplies

Flexible Locations

Limited Risk

Service Provider



Limited Risk

Service Provider

Support Activities

Flexible Locations

Important Point: “Principal” strategy is

necessary both for foreign

income deferral AND to keep

foreign income tax rates low.

Examples:

1. If net foreign tax rate is

30%, total tax cost will be in

excess of 48% upon

repatriation;

2. If income is subject to

Subpart F, the income

inclusion to shareholders

losses both QDI and FTC.

Transparent Parent Company (for tax purposes).

U.S. shareholders pay tax on distributed foreign

earnings.

The structure allows for consolidated

accounting, and single U.S. based equity plans

and financing.

Applications:

Substitute for traditional U.S. Corporate

structure:

Significant non-U.S. revenues; and/or non-

U.S. business growth;

Reduces U.S. corporate level complexity,

while allowing for intercompany

arrangements.

Inversion is not possible (or expensive); and/or

U.S. IP value is significant.

Preserves ability to convert to U.S. corporate

structure or flow-through, while avoiding high

exit cost for foreign IP rights.

Shareholders

Parent

Company

U.S. Company

Domestic

Distribution

and Services

International

Franchisor/

Principal

(non-US)

Franchise

Fees

Foreign

Franchisee


Alternative Structure

Questions

Any Questions?

DLA Piper LLP (US)

33 Arch Street, 26th Floor

Boston, MA 02110-1447

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any matter addressed herein.

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