Q: What do I need to know about buying a U.S. based franchise?

THERE IS NO SHORTAGE of new and promising fran­chise concepts in the United States. Many of these fran­chisors haven’t yet opened franchises in Canada, but are keen to expand north of the border. As a franchisee, you may be tempted to buy an American franchise concept to be the first to implement it in Canada, or perhaps the price of such opportunity appears more attractive than what more established franchisors in Canada are offer­ing. In any case, you should be paying close attention to issues specific to international franchising:

Withholding Taxes

If you are paying royalties to a non-resident of Canada, you must remit a certain percentage of the payment (10 per cent, if the franchisor is a U.S. resident) to the Canada Revenue Agency on account of withholding taxes. With­holding tax is basically a tax on a foreign franchisor’s income generated in Canada, but the burden is on you as a “source” of income to withhold it and remit to the govern­ment. Aside from withholding tax on royalties, payments you make to the American franchisor for the services they provide to you may be subject to 15 per cent tax.

Not only are you liable to the CRA if you fail to pay the tax, some franchisors will try to shift this tax burden on you by including a “gross up clause” in the franchise agreement. A gross-up clause will require you make up the payment so that the franchisor receives the same net amount as if no withholding tax has been withheld. This will significantly increase your royalty payments.

Advertising

Canada may be considered a 51st state, but it doesn’t mean that American advertising can be used “as is” in Canada. If the American franchisor requires you to con­tribute to the national advertising fund, ask them what kind of advertising the fund is paying for. Some materials (website content, social media campaigns, brochures) are easily adapted for use in Canada. For other materi­als, including catalogues, menus and labels, additional costs may be required to bring them in line with local laws (French language requirements in particular) and tastes. The cost of tweaking American promotional materials will generally be on you. U.S. ad funds will not usually cover the cost of buying spot packages to air a TV ad on a Canadian network.

Supplies, Labour and Investment Costs

Financial viability of a business depends, to a large extent, on containing the costs of supplies and labour. Again, the Canadian and American markets are similar, but not identical, and you may run into additional expenses or higher costs when running a similar business in Canada. Minimum wages are higher in many Canadian provinces than south of the border; if you are required to purchase supplies from the franchisor or their approved supplier in the U.S., you may face currency fluctuations, customs duties, shipping charges and even import restrictions (think of the Canadian supply management system for dairy and poultry products).

Consider the effect of trade tensions with the U.S., including whether any of the products you need for the franchise business are now subject to tariffs.

If you are dealing with a franchisor not experienced in international franchising, the estimates of investment costs they provide are likely derived solely from the U.S. operations and may not account for Canadian realities. You need to do your own research to fully understand the costs involved in establishing and running the busi­ness in Canada.

Dispute Resolution

If you operate a franchise in Alberta, British Columbia, Manitoba, New Brunswick, Ontario or PEI, disputes related to disclosure, rescission, duty of fair dealing, and the right to associate must be litigated or arbitrated in your province. However, your franchise agreement is a com­plex commercial contract covering, usually, many other aspects of your relationship, including confidentiality and non-compete obligations, system standards, termination and renewal, advertising, financial audits etc. If the fran­chisor insists on litigating or arbitrating these issues in the franchisor’s home state, it may be cost prohibitive for you to pursue a claim against the franchisor in the U.S.

There are, of course, other considerations when buy­ing a foreign-based franchise, including the franchisor’s ability to provide on-the-ground support, adaptability of the franchise concept to the Canadian market, and avail­ability of trademark protection for the brand in Canada. Study the opportunity as carefully (if not more carefully) as you would assess a domestic offering, and don’t hesi­tate to obtain professional advice before committing the time and expense of developing the business.

Katya Logunov
International Franchise Lawyer
Jones & Co. 
katya.logunov@jonesco-law.ca
647.748.1749