FRANCHISOR 101: WASHINGTON JOINS EFFORTS TO TAX NON-RESIDENT FRANCHISORS
Washington has joined at least at least three other states looking for ways to subject non-resident franchisors to taxation. Under legislation that became law June 1, 2010, resident and non-resident franchisors alike must pay Washington a business and occupations tax on all franchise fees, royalties, and other income derived from franchisees operating in the state.
Technically, the new law applies to many other businesses other than franchisors, and it specifies that you no longer need to have physical presence in Washington in order to have "nexus" there - legalspeak meaning that no matter where you hang your hat, you're subject to Washington's business and occupations taxation if you have any franchisees in the state, even if you never set foot there, much less set up an office and work there.
What's more, the new tax law applies to franchisors big and little alike; no matter what your size, you're subject to the tax so long as your Washington franchisees:
- Have payrolls exceeding $50,000 annually
- Own commercial property worth at least $50,000, or
- Show annual sales exceeding $250,000.
Worst of all, Washington's business and occupation tax can put a hole in your pocketbook. It is a flat tax ranging from 0.015 % to 0.0330 %, and it apples to revenues, not profits. It's not a graduated tax, in other words, and business owners must pay it even when they make no profits.
Similar efforts are under way or are already on the books in North Carolina, California, and New York. North Carolina wants franchisors to identify franchisees operating in that state and report on their gross sales total income [See our June 2010 Newsletter]. California wants non-resident franchisors to pay income taxes on royalties, rents, and lease income derived from California franchisees [See our October 2009 Newsletter], and New York requires non-resident franchisors to report sales and royalty data on their franchisees in the Empire State [See our August 2009 Newsletter].
However, the New York Tax Department recently reported that they have only received filings from about 400 of the thousands of franchisors that have franchisees in the state. Franchisors should be aware ignoring the requirements of these new laws may result in demands for substantial audit fees and penalties in addition to the back taxes that may be found to be due. |
FRANCHISEE 101 - WHAT SHOULD I DO BEFORE I PURCHASE A FRANCHISE?
You must conduct substantial due diligence (research all available information on the franchise system and industry) before purchasing any franchise. You should start with a comprehensive review of the Franchisor's franchise disclosure document (FDD). The FDD outlines key provisions of the franchise agreement and also provides crucial information about the franchisor. Review it with an eye to these points:
- Compare franchising opportunities within the industry you are interested in to determine which franchise is best suited for you and which franchise may be the most successful. Once you have chosen to purchase a particular franchise, speak with as many franchisees in that system as possible, including franchisees recommended to you by the franchisor as well as those that were not.
- Is the FDD current? A FDD expires after a year. You should insist upon seeing the currently registered version. If it is close to a year old, make certain that a newer version has already been written or submitted to the governing agency for approval.
- Study the audited financial statements attached to the FDD, particularly the most recent one. By studying the financial statements, you should be able to determine how successful the franchisor is and how successful its existing franchisees are. Question any aspect of the statements that aren't clear to you. Ask your accountant to review them and provide feedback to you.
- Visit the franchisor's headquarters. Do they appear to have the resources that are needed? Does personnel appear to be competent?
- Prepare a business plan. Be as realistic as possible with your projections.
- Get actual numbers whenever possible. Ask your accountant to review the plan and provide feedback.
- Ask probing questions.
We are available to assist you in reviewing the FDD and in overseeing your purchase of the franchise. |
| UPDATE ON MASSACHUSETTS COURT FIGHT OVER FRANCHISEE/EMPLOYEE STATUS
Note to franchisors: Schedule some time soon to read over your disclosure documents and franchise agreement. And while you're at it, give your business practices a good look-see, too, paying special attention to those sections that detail the dealings between you and your franchisees.
Why? Because a recent court fight in Massachusetts makes it clear that if you step over an uncertain line in controlling your franchisees, you may well find the courts' declaring that you are not a franchisor with franchisees, but rather an unwitting employer subject to state and federal laws governing work hours, overtime, workers' comp, and mandated employee benefit programs, not to mention withholding and other taxes.
In the Massachusetts case, three franchisees of Coverall of North America, Inc., a franchisor of commercial janitorial cleaning services, claimed status as employees, not franchisees, because of the control that Coverall maintained over the contracts to clean office buildings and the franchisees.
In a first go-round, U.S. District Court Judge William G. Young agreed with the franchisees, handing down a partial summary judgment that the franchisees were really Coverall employees. Coverall appealed, and after a second, go-round back in U.S. District Court, Young dismissed the franchisees' claims on technical grounds - namely that two of the franchisees had signed releases and the third had run afoul of Massachusetts' statute of limitations.
Although Coverall thus won the day, the franchisor may yet lose the war, with unforeseeable consequences for franchisors in other industries. For one thing, during the second go-round, Judge Young made a point of noting that, even though he had dismissed the franchisees' cases, his decision on the partial summary judgment that they were really employees remained in effect. For another, after Young dismissed the franchisees' cases, their lawyers quickly sought certification under Massachusetts state law for class action litigation seeking employee status for all Coverall franchisees, and filed a class-action suit accusing Coverall and four other providers of commercial janitorial services of unfair and deceptive trade practices.
Stay tuned.
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Barry Kurtz Interviewed on Voice of America's Stars of PR
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Listen to the interview on Voice of America |
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This communication published by Barry Kurtz, APC is intended as general information and may not be relied upon as legal advice, which can only be given by a lawyer based upon all the relevant facts and circumstances of a particular situation.
Copyright © Barry Kurtz, A Professional Corporation 2010
All Rights Reserved.
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Barry Kurtz is a prolific writer on the subject of franchise law. From due diligence to franchise
appraisal, his articles are a valuable resource to any franchisee and franchisor. He
was recently named a Certified Specialist in Franchise and Distribution
Law by the State
Bar of California Board of Legal Specialization.
Visit our website for more articles
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