China franchises, IP licences, and their alternatives: which is better for your business?

Background

A UK company can authorise its own trademarks, patents or other intellectual property (IP) rights to any companies in China and guide Chinese companies to apply their own methodology to manage and operate similar Chinese enterprises.

The reason for the emergence of this business model is that UK enterprises have their own years of management experience and a good brand influence which is famous nationwide and even globally. These advantages have attracted companies with similar businesses in China to learn from, but it is difficult to distinguish among these agreements by only looking at the agreement name in practice. That is because that they have lots of similar elements based on the IP which has been authorised. However, from the perspective of fees, they can be ‘intellectual property license fee’, ‘service fee’ or ‘royalties’; from the perspective of contract relationship, legal supervision and tax fees, there are also many differences among them.

If the difference among them cannot be properly handled and appropriate legal agreement can’t be applied in the early stage of business, further issues will arise.

In practice, it is very important to determine what business model this is and the type of contract signed, because it is directly related to which laws and regulations in China should be followed and how to pay taxes.  Here are three different business models:

Intellectual property licence contract

Intellectual property licencing is the legal act of authorising others to use IP within a certain period and scope without changing ownership and with the consent of the IP owner. Specifically, according to the scope of the licence, it can be divided into exclusive, solo and general licenses.

According to whether the licence is voluntary, it can be divided into voluntary licence and involuntary licence. The involuntary license includes the statutory licence in the copyright law and the compulsory license in the patent law.

According to the different types of rights, the licence can be divided into:

• Copyright licence
• Patent licence
• Trademark licence
• Trade secret licence
• Integrated circuit layout-design exclusive right licence
• New plant species right license

The payment under the intellectual property licence contract is usually the trademark, patent, copyright and other royalties. In the tax treaty, these fees have a specific name of ‘royalty’. The term “royalties” in the tax treaty refers to all kinds of payments paid as compensation for using or having the right to use the copyright of any literary, artistic or scientific works. This includes cinematographic films, any patents, trademarks, designs or models, plans, secret formulas or procedures, or various payments paid as compensation for information about industrial, commercial or scientific experience.

Franchise agreement

Franchise contracts refer to the business activities in which an enterprise with registered trademark, enterprise logo, patent, proprietary technology and other business resources licenses its business resources to other operators – franchisees.

They comes in the form of a contract, and the franchisee carries out business under a unified business model in accordance with the contract, and pays franchise fees to the franchisor.

If it is a franchise mode, it shall pay ‘franchise fee’. However, in addition to franchise fees, franchises can also collect deposits. Unlike the intellectual property licence contract, franchising, on the basis of the intellectual property license, will also form a comprehensive system of a series of relationships and many elements. These include the business model and the supervision, management, support and service of the franchising parties, rather than a simple license for the sale of specific products or the use of specific intellectual property. It is a comprehensive service contract.

Consulting contract/cooperation agreement

In practice, many agreements are called consulting agreement or cooperation agreements, and it is difficult to determine their business models from the name. Both the administrative regulatory authority and the court will usually confirm the substantive content of the agreement according to the actual content of the contract in China.

That is to say, in the aspect of agreement contents, the nature of the agreement should be determined by observing the principle of “fact is more important than form”. If the agreement includes IP licencing, business guidance, fees payment and related supervision and management services, the agreement is usually recognized as a ‘franchise agreement’ regardless of the change of the contract name.

In this case, the requirements for franchisors are much stricter than those for ordinary intellectual property rights. This is because the intellectual property rights authorisation complies with the intellectual property law and the autonomy of the parties to the agreement. However, franchising has strict management requirements. If it fails to meet these requirements, the authoriser is liable to be punished.

Charge and tax payment of three businesses

In addition to different business forms, contract contents and types of charges, another important difference is tax. In China, the tax types and rates of different business types are different. If the UK company can clearly distinguish themselves and further determine their business model, they can not only avoid administrative risks, but also obtain further tax benefits.

In practice, the cooperation agreement is easy to be identified as a franchise agreement. If it cannot be separated from the legal and operational perspectives, once a dispute occurs, the licenser is identified as a franchise. The franchise will not be filed and will be subject to business model, project planning, technical guidance, management supervision and other contents, which conform to the legal characteristics of the commercial franchise contract.

“Franchise” refers to the ownership of registered trademarks, corporate logos and patents. An enterprise that operates resources such as proprietary technology, licenses its own operating resources to other operators in the form of a contract, and the franchisee operates under a unified operating mode in accordance with the contract, and pays franchise fees to the franchiser. The main difference between the franchise contract and the trademark license contract is that the franchise contract is a comprehensive system composed of a series of relationships and many elements such as intellectual property rights, business model, supervision, management, support and service of both parties to the franchise, rather than a simple license for the sale of specific products or the use of specific intellectual property rights.

In China, if the intellectual property rights and consulting agreement are violated, it is usually settled by the parties to the contract through negotiation or further litigation. However, if the provisions on franchising are violated, the competent department will order the violator to make corrections within a time limit, confiscate the illegal income, impose a fine and make a public announcement. If the circumstances are serious enough to constitute a crime, criminal responsibility will be investigated.

To sum up, if you are engaged in intellectual property licensing business or package business related to intellectual property in China, you must contact professionals to clarify the business model, so as to draft professional legal agreement to avoid risks.