March 2008 Franchising World
A survey conducted by the Brazilian Franchise Association in 2006 shows that the number of franchise units in that country increased 11 percent in 2006, compared to 2005. The total revenue of business-format franchises amounted to more than U.S.$18.5 billion.
By Cândida Ribeiro Caffé
Today there are about 1,013 franchise networks, with more than 62,500 outlets, which makes Brazil one of the largest countries in the world in terms of number of units. Around 11 percent of this total are foreign-based franchisors. This limited participation of foreign franchisors shows the potential of development of international franchises into Brazil.
Brazilian Franchise Law and Disclosure Requirements
Article 2 of the Brazilian Franchise Law defines a commercial franchise as “a system whereby a franchisor licenses to the franchisee the right to use a trademark or patent, along with the right to distribute products or services on an exclusive or semi-exclusive basis and, possibly, also the right to use technology related to the establishment and management of a business or operating system developed or used by the franchisor, in exchange for direct or indirect compensation, without, however, being characterized as an employment relationship.”
The franchise law requires the delivery of a franchise offering circular to prospective franchisees containing several aspects of the business, at least 10 days prior to the execution of any binding document related to the franchise and receipt of any payment.
Failure by the franchisor to supply such a disclosure document at least 10 days prior to the execution of the agreement or payment by a franchisee of any amount renders the agreement voidable by a franchisee and penalizes the franchisor with the refund of all amounts paid by a franchisee in connection with the franchise, plus recovery of damages. For this reason, franchisors tend to be conservative in relation to this requirement as the local law provides for a severe penalty in the event of default of this legal obligation.
Even when international franchise agreements are governed by foreign law and elect foreign jurisdiction, the delivery of an offering circular to a franchisee, in accordance with the Brazilian Franchise Law, is extremely advisable, to comply with the local law, since the franchise will be operated in Brazil.
In fact, the disclosure requirement of Brazilian law is valid and enforceable for any franchise granted for operation in Brazil, as Article 8 expressly establishes the following:
The franchise law does not distinguish between Brazilian and foreign franchisors and the requirement of delivery of the document, as established in Article 3, is mandatory for all franchisors, provided that the franchise is intended to be installed and operated in Brazil.
Indeed, the National Institute of Industrial Property, the government office responsible for registering property and agreements involving technology, has taken a strong view that the local law applies to franchises granted to be operated in Brazil and requires the submission of the executed document or at least acknowledgement of receipt of it by the franchisee. A Statement of Delivery of an offering circular is one of the indispensable documents to file the agreement for “recordal” or registration with legal approval at the INPI.
Parties in international franchising may decide to adopt the English language for the document, as long as the Brazilian party knows English fluently and expressly acknowledges that fact, to avoid translation of the entire circular for delivery to the prospective franchisee. The agreement can be entered into in the English language, but a translation into Portuguese is indispensable for presentation of the agreement at the institute.
Registration Requirements: INPI and Central Bank
The recordal of international franchise agreements at the INPI is indispensable. The purpose of the recordal is threefold:
• Make the agreement effective against third parties,
• Permit the remittance of payments to the foreign franchisor, and,
• Qualify the franchisee for tax deductions.
In addition, the recordal serves as prima facie evidence that the franchise agreement is in compliance with the Brazilian antitrust regulations. This understanding is based on an agreement executed between the INPI and Administrative Counsel for Economic Defense in 1997, in which the institute was granted rights to detect antitrust aspects related to industrial property agreements. Whenever antitrust aspects are detected in the agreements, the INPI has the duty to forward such agreements to CADE for analysis. Thus, if the recordal was granted by the INPI without antitrust disclaimers and without delivery of the agreement to the institute, it is possible to sustain, in principle, that the franchise agreement does not violate antitrust rules.
In connection with payments, the parties may freely set out the percentage of royalties and other payments. Nevertheless, remittance of payments involving related companies, when a franchisee is controlled by a franchisor, are limited by the corresponding ceiling of fiscal deductibility specified by Regulation 436/58. Such percentages vary between 1 percent to 5 percent of the net sales price depending on the franchising field.
The INPI usually adopts a very liberal position in the recordal of franchise agreements and focuses on the assessment of the validity of the trademarks in Brazil, the specification of their serial numbers at the INPI and, in case of agreements involving controlled and controlling companies, on the approval of the applicable rate for tax deductibility and remittances. Although trademark applications can only generate royalties under trademark license agreements after they mature into registration, for franchise deals this is not required and the inclusion of trademark applications in a royalty-bearing franchise agreement is admissible.
The institute has a legal term of 30 days to issue a decision regarding agreements presented for recordal. In practice, they usually take 40 days. After this term, the INPI can issue the Certificate of Recordal or an office action requesting further details of the agreement.
After the certificate is issued, the agreement needs registration at the Brazilian Central Bank for remittance of payments. This registration is a very simple procedure and can usually be completed in about two days.
The following documents are required to request the recordal of franchise agreements at the institute:
• One original version of the agreement or two certified copies, together with a translation into the Portuguese language,
• Power of attorney on behalf of any of the parties to a local lawyer,
• Some official forms that have to be filled by the franchisee, and,
• A statement of delivery of the circular, in which the franchisee acknowledges receipt of the offering circular in accordance with Brazilian law.
There are also some formalities for execution of international franchise agreements. They must be executed by the parties and two witnesses and the initials of the parties and witnesses’ names have to be placed on each page of the agreement. Further, the signature of the foreign party needs notarization and legalization at the Brazilian Consulate. In addition, the agreement has to specify the complete name and title of the representatives of the parties, as well as place and date of execution. If the representative is an attorney, a copy of the power of attorney duly notarized and legalized at the Brazilian Consulate is also required.
Taxation on Remittance of Royalties Abroad
The following taxes apply to remittance of franchising royalties abroad:
• Withholding tax: the general applicable rate is 15 percent of the net revenues derived from royalties and franchise fees. In principle, this tax is payable by the franchisor, although the tax burden may be shifted contractually over to the franchisee. Despite the lack of a treaty against double taxation between Brazil and the United States, U.S. tax authorities generally admit tax deduction in the United States.
• Contribution of Intervention on the Economic Order: 10 percent over the remittance of franchise fee and royalties. This tax is payable by franchisee and, despite certain controversy on its applicability on franchising, the tax authorities consider that franchises are also subject to such taxation, although not expressly indicated in law.
• IOF (Financial Transaction Tax): this tax was reduced to zero percent in accordance with Decree 2.219, of May 2, 1997.
In addition, the following taxes represent a risk due to uncertainty whether the tax authorities will apply them to international franchise agreements:
• ISS (Service Tax): varies between 2 percent to 5 percent of revenues, depending on the city where the franchising activities are developed.
• PIS/COFINS-Import: 1.65 percent for PIS-Import and 7.6 percent for COFINS-Import, according to Article 8, in accordance with law 10,965/2004.
Although the legality of such taxes on international franchising is extremely questionable, it is not possible to ignore the tax risk.
The franchise industry is continuously growing in Brazil and there is a great potential for the development of international franchises, which still have a small participation in the Brazilian franchise market.
The government is acting in accordance with this scenario, as the flexibility adopted by the INPI in the analysis of franchise agreements decreases the bureaucracy for international franchises to come to Brazil.
Cândida Ribeiro Caffé is an attorney with the law firm Dannemann, Siemsen, Bigler & Ipanema Moreira in Rio de Janeiro, Brazil. She can be reached at firstname.lastname@example.org.