New Market Entry: the Brazilian Franchise Guide for International Marks
Franchising has certainly consecrated a very important private sector in Brazil. It still interests to small and medium investors that see in franchise a good opportunity to start-up a business with lower risks of failure.
In the meanwhile, great business’ men, willing to invest significant amount of money in the field, have created strong groups of franchisees that operate not one or two stores of the same brand or group, but dozens of franchised stores – what sometimes make them more relevant to the network than the franchisor itself. So, the franchising sector in Brazil is democratic and the general expectation is that it will continue to develop and grow.
In 2016, the total annual revenues of franchise amounted to US$ 50 billion American Dollars, representing an increase of 8,3% comparing with the numbers of 2015, according to a survey carried out by the Brazilian Franchise Association (ABF). The franchise activity generates 1,192 million jobs directly in the whole country.
This is a great increase, bearing in mind the overall economic scenario. Presently, the Brazilian market accommodates 142.000 franchise units within 3.039 franchise chains. Among these, only 160 (approximately) are operated by foreign-based franchisors, which are mostly dedicated to the food sector (29% of the foreign chains dedicate to the food field).
The rather limited participation of foreign franchisors, roughly 5% of the franchisors in the market, shows the potential of development of international franchises into Brazil. A good plan to a (hopefully safe) new market entry should cover two fronts: business and legal.
Having means to test the concept in the local market, either by a pilot or through a soft launch would be the best-case scenario. Many successful chains, however, have prospered with quite lower investments in market studies: they simply came into Brazil to spend some time here having a normal life, in order to see what general consumers would be missing at the market place.
A very successful brand of Italian gelatos, for instance, simply came into Brazil after noticing that within a huge and tropical country, as Brazil, only 1 brand of gelatos “made in Italy” had the total control over the market for the simple lack of competitors.
From a legal perspective, a foreign franchisor must know that the franchising is currently governed by two regulations in Brazil: Law 8.955, dealing with disclosure requirements, and Normative Act 16/2013, relating to the approval of international franchises. There is no relationship law in Brazil.
The legislation directly related to franchise is Law no. 8.955, of December 16, 1994, requiring that any prospective franchisees be presented a Franchise Disclosure Document, containing several aspects of the business, at least 10 days before any agreement or payment.
The Franchise Disclosure Document needs to be in clear and accessible terms, which does not mean that it must be translated into Portuguese (official language in Brazil), as long as the prospective franchisee expressly acknowledges to be fluent in French or English.
In the event of non-compliance with the provisions of the Law, franchisee may argue the nullity of the agreement and require return of all amounts already paid to franchisor or to third parties indicated by same, as initial fee and royalties, plus damages.
The franchisors tend to be conservative in relation to this requirement as the local law provides for a severe penalty in the event of default to attend to this legal obligation. The Normative Act 16/2013 was designed to permit direct remittance of royalties from local franchisees to the foreign franchisors, without need of establishing local subsidiaries or separate agreements.
Thus, International franchise agreements need to be recorded before the Brazilian PTO (“INPI”), so that the franchisee may be able to pay the remuneration and royalties to the franchisor abroad. Indeed, in order to be officially recognized in Brazil, the franchise agreements where one of the parties is a non-resident of this country shall only be enforceable after recordal.
According to this recordal practice, the agreement is admissible as long as the marks are (at least) filed in Brazil. There is no longer any requirement that the mark must be registered in Brazil. As long as the marks are already on file in Brazil, the parties are entitled to enter into the franchise agreement and record it with the proper Brazilian authorities.
The payment of royalties by the local franchisee is deductible provided that the agreement is recorded at the INPI and that the ceiling for deductibility is observed. In fact, law 4.131 of 1961 established that the payment for licenses and know-how are deductible by the local party to the extent that it does exceed altogether the limit of 5% of net sales of the licensed products.
Furthermore, the law sets forth that the fiscal authorities will set additional reduced ceilings based on the industrial segments involved. Ordinance 436 of 1958, still in force these days, lists the different segments and attributes a maximum ceiling for deduction for each industry, up to 5%.
The Fiscal Authorities in Brazil tend to limit the deduction by local franchisees remitting the royalties to foreign franchisor up to 5% of the net revenues. Any payments exceeding this limit should be treated as profits by franchisee. As for taxation on the amounts to be paid, credited or remitted to a foreign entity, there is a 15% withholding tax (IRRF) levied upon the payments, which should in principle be paid by the foreign franchisor, licensor or supplier. The fiscal burden may be contractually shifted to the local franchisee/licensee.
The IRRF is levied on a general tax rate of 15%, but it may be higher if royalties are paid to a franchisor resident or domiciled in lower tax jurisdictions (25%) or lower if the jurisdiction in which the franchisor is resident or domiciled has entered into a double taxation agreement with Brazil (10%-12,5%).
Other taxes also apply to royalties paid under franchise agreements whereby franchisor is not resident or domiciled in Brazil, but these are all under the exclusive responsibility of the local franchisee.