The Australian Government should have a full understanding of the workings of the Australian Franchising industry which has an annual turnover of $172 billion dollars, generated through 94,524 outlets, employing 565,251 people. Australia’s franchising industry is second only in size to the United States’, in terms of the number of small businesses which operate under a franchised model and referable to gross turnover. 75% of franchises are concerned with the delivery or distribution of food – usually fast food.
In modelling the pandemic Jobkeeper Relief Package, former Treasurer, Josh Frydenberg, ought to have been focused not only on saving jobs but also, on the potential to recoup the Government’s largesse, through maintaining business revenue, so that the money doled out might flow back to the Federal Government’s coffers down the line.
Many Franchisors and Master Franchisees (de facto Franchisors who acquire the exclusive right to operate as the Franchisor in Australia from an overseas operator) – “Franchisors” – have skimmed the profits from increased revenue generated from take-out food sales during the pandemic lockdowns, leaving just crumbs, if even crumbs, for their Franchisees and Sub-Franchisees (“Franchisees”).
Typically, fast food Franchisors offered generous incentives to Franchisees’ customers, in the form of vouchers, discounts and rebates, while also cutting prices, so that their particular franchised business could gain a competitive edge against rivals. Almost all food was ordered online and then delivered but with the opportunity for drive-by pickup.
If ordered online, Franchisees were commonly charged an ordering fee by the Franchisor; all of the price reductions and delivery charges as well as discounts and vouchers, were charged as overheads which had to be borne by Franchisees. Franchisees were forced to increase staffing levels, pay workers’ penalty rates, as applicable and meet all of the other on-costs of increased turnover. While sales increased, the bottom line did not and for many franchisees – indeed, for the great majority – net profit actually declined for Franchisees, even as their turnover increased.
Fair Work reforms following the 7-Eleven exposé of underpayment of wages in franchising which my firm joined in bringing to air, only went so far as to make Franchisors co-liable when they do not take steps to ensure that Franchisees’ employees are paid all of their entitlements under applicable Industry Awards. Franchisors make sure, after they have taken their own enormous cut, which includes big mark-ups on the price of wholesale supplies, which their Franchisees have no alternative but to buy from them, as well as rent, royalties, marketing fees and other charges – from what little is then leftover to the Franchisee, that the Franchisees’ employees rank after the Franchisor but before the Franchisees for payment.
Franchisees, who have usually invested heavily to buy their franchised business – somewhere between $300,000.00 and $1,200,000.00 – using their own, family and borrowed money, mostly supplied by the ANZ or sometimes another Bank – and guaranteed by the Franchisor – are too often, financially squeezed to the point of having nothing or almost nothing left with which to make their loan repayments, feed their families or draw a living wage, for working 50 to 60 hours per week. They are forced to work themselves, not just in a management role but on the “pizza production” line or breaking their backs for burgers. The Franchisor has to guarantee the Bank’s loan because the Franchisees are mostly newbies to Australia, with no local collateral or trading history, and would not be granted finance to buy any other business, where there was not a local “backer”, like a Franchisor.
Franchisors control the revenue
Wives and children are brought into the process, too, to knead the dough and try to make sure that it stretches far enough. They provide their own cheap labour to the franchised business. The larger food Franchisors, in particular, gain control of most of the Franchisees’ revenue which they only partly pass on to the Franchisee, after they have taken the lion’s share for themselves, and deducted the cost of ingredients, rent, labour expenses and on-costs.
Apart from the Franchisee, the big loser is invariably the ATO, because there is not enough money left over for a Franchisee to afford to pay the recurrent liability, which the Franchisee is required to report to the ATO, by way of lodging a Business Activity Statement (BAS) and to pay PAYG tax and GST each quarter.
I have met with food Franchisees across Australia, engaged in selling lines as diverse as pizza, poultry and burgers – and as a result of unconscionable franchising systems, they have not been able to lodge and pay BAS statements for GST and PAYG tax, for at least two (2) quarters and in the worst cases, for as many as sixteen (16) quarters.
In an industry of this size, this has gobsmacking consequences for the public purse. It is not the fault of the Franchisees. So many Franchisees have been made inappropriate and unconscionable loans. Banks typically finance Franchisees, who are often neophytes to Australian business and finance, buying into a franchised business relying on the strength of a Franchisor’s guarantee to the Bank and representations about how prospective Franchisees will profit from buying the franchised business.
Franchisees are mostly immigrants from Asia and South-Asia, and have academic or IT backgrounds, with little or no Australian business experience or local knowledge. They are usually relatively young (under forty (40) years of age) and contribute some family overseas money to the purchase – after all no one came here as a foreign student without family money to back them up – but have no Australian assets or at least, if they have a domestic residence, it is already mortgaged by the time that they buy their franchised business. Banks clearly do not follow the “Know your Customer – Know your Client” (KYC) guidelines. The Franchisees know next to nothing about our labour and taxation laws.
Usually the only security taken by the Bank from the Franchisee is a personal Guarantee by a director – which can ultimately extend to forcing the sale of the director’s principal residence – and the principal security taken is a Personal Property Interest charge over the franchised business. This means that after years of grinding work to repay the finance borrowed from the Bank, the Franchisee may end up with nothing or next to nothing left over, after the Franchisor has cleaned up. When the Franchisee is faced with nugatory, if any, net profit, and the ATO finally gets round to serving a Directors Penalty Notice for unpaid B.A.S (GST and PAYG tax), a Franchisees’ company may be forced into administration, so that the Franchisee’s directors may avoid personal liability to the ATO. Frequently the Franchisee’s directors have nothing left to lose anyway.
Appointing an administrator to the franchisee company automatically results in forfeiture of the franchised business to the Franchisor, leaving the Franchisee exposed to the Bank. The Bank recovers first against the value of the franchised business, with the Franchisor standing next in line to pick up what is left, controlling the distribution of the residue. Faced with an administration or winding-up order against the Franchisee company, the Franchisor steps in to make sure that it gets paid ahead of the rest, effectively frustrating the priorities prescribed under section 556 of the Corporations Act, 2001, applicable on the winding-up of a company, as applied to the remaining assets from the insolvent franchised business.
Throughout the franchised fast food industry, because of the Franchisors’ systems, the Franchisee will be trading insolvent or on the verge of insolvency, for months if not years, before the ATO makes a move. Many of the Franchisors operating in Australia in the fast food franchise industry are multi-national corporations who engage in profit-shifting and transfer pricing.
They have structures in place which make it easier for them to ensure that they are not fully taxed in Australia. Since 2017, Dominos Pizza Enterprises Limited, the Australian Master Franchisee which operates Dominos Pizza out of New Zealand, Belgium, France, the Netherlands, Japan, Germany, Luxembourg, Denmark and Taiwan and has over 28,000 stores, have also been delivering pizza to the accountants and tax attorneys who support Luxembourg’s role as a tax haven for large corporations around the world.
7-Eleven, McDonalds and Craveable Brands (Oporto, Red Rooster) are all ultimately controlled from outside Australia.
Luxembourg attracts as much foreign direct investment as the United States. A favourable tax regime encourages corporations to establish special purpose entities in Luxembourg to take the benefit of the lack of withholding taxes on interest and royalty payments which may allow these payments to escape taxation in the jurisdiction where these receipts were generated. They eat pizza in tax havens, too, and there may be nothing sinister in the fact that 80% of profits shifted from EU countries wind up in tax havens located in the EU, namely Luxembourg, Ireland and the Netherlands, (the Dominos Australian Master Franchisee sells take-out pizza in the Netherlands, too).
Whilst Luxembourg may be the big winner in terms of revenue, Australia is a big loser when it comes to tax collection and this appears to be pursuant to a system or strategy operated by franchisors around the country, which starve their franchisees of the ability to be able to feed their families, meet their essential, subsistence commitments and to discharge their BAS liabilities, once the Franchisor has peeled off its major share of the spoils.
The Albanese Government has been cracking down on tax defaulters but in picking off Franchisees with Directors Penalty Notices, it is actually attacking the victims of scams and ensuring that its recoupments from small business franchisees will be minimal, while remaining as blind as the Morrison Government before it, to the real mischief: the strategy devised by Franchisors to ensure that they are paid ahead of the ATO and that ultimately, it is only Franchisees and the Australian public who are left bereft, when there is no dough or any feathers left over, from the pizza-makers and chook-pluckers.
In 2019, the then Minister for Small Business, Michaelia Cash, hosted representatives from Franchising Industry interest groups in Canberra, at a series of consultations (I was one of the delegates for Franchisees), to discuss reform of the Franchising Code and the deficiencies and inequities which the franchising regime in Australia has produced.
This resulted in a new Franchising Code in 2021, which addressed many of the disclosure issues. However, the formula for franchisee oppression is contained in the “Manual” which Franchisors are still not bound to disclose and do not do so, in advance of signing-up Franchisee lemmings. Disclosure Documents and Franchise Agreements only supply basic information, while Franchisors tend to deploy and implement their oppressive rules and demands aimed at all Franchisees, in a document called a “Manual”, which includes stipulations as to what supplies Franchisees must buy, from whom and how often, and at what inflated prices – mostly above wholesale market.
Additionally, while the new Code has expanded the number of Franchisor offences and increased penalties, there is rarely effective enforcement.
A complaint made by my clients about a Melbourne-based Franchisor, in respect of flagrant actions by the Franchisor which achieved prominent national media coverage – is still under investigation two (2) years later and nothing has yet happened to the Franchisor as a consequence. The matters, disclosed to the ACCC involved serious legal contraventions in Sydney, Melbourne and Brisbane but ASIC is conducting its investigation from Perth!
The plight of Franchisees and Sub-Franchisees, as little more than indentured workers who pay a fortune for the honour of repaying the Bank and providing almost all the meat on the bones of the franchised business to the Franchisor, over five (5) to ten (10) years of hard labour, goes largely unaddressed in Australia.
Many of the Franchisees will earn less money than their workers, even if the workers have been underpaid, because Franchisees are running at a loss and building up debt to the ATO, while Franchisors rake off most of their income at source.
Reform is possible. The new Labor Government, through Treasury and the Deputy Commissioner of Taxation, should stop targeting Franchisees. Legislation must be promptly introduced which makes it unlawful under a Franchise Agreement for a Franchisor to pay itself from revenue generated from the Franchised business, ahead of the payment of wages and salaries (including an indexed management salary to the business proprietor, provided that he is hands-on, of $80,000.00 plus superannuation), and the remittance of all GST and PAYG tax due to the Commonwealth. It is to be observed that the Franchisor invariably has set up systems where all revenue generated from franchised business is received by the Franchisor to distribute only after taking its own big cut, while the Franchisee is left to cover all business expenses including tax, with too little to go around.
In other words, the Franchisor who characteristically strips out its share ahead of the Franchisee, the workers and the ATO, should have its portion of the take postponed to fourth place in the pecking order.
The Australian Tax Office crafted a $1 billion dollar tax settlement in July, 2022 with Rio Tinto in relation to transfer pricing, having resolved a similar dispute with BHP in 2018. It is one thing for the Federal Government to come to terms with the mining industry and its modus operandi and quite another, to recognize what is happening under its very nose, with massive small business defaults, as a result of what is, in practice, a pan-Industry scheme, to exploit Franchisees and deprive the ATO of the revenue which it ought to receive ahead of Franchisors. The Australian Treasury should cease being the victim of a multi-national – and domestic – tax avoidance “franchise”.
Stewart A Levitt is Senior Partner with Levitt Robinson Solicitors, specialising in corporate law, banking & finance, and class action law, www.levittrobinson.com.