The Iowa Supreme Court has affirmed a lower court ruling allowing the state to tax royalties paid by in-state franchisees to out-of-state franchisors. The International Franchise Association (IFA) has asked the Supreme Court to overturn the ruling, citing the heavy tax burden that will be borne by franchisors that could end up being taxed twice on monies earned. The IFA claims the ruling is the result of states’ scrambling for revenue in a cash-strapped economy and does not hold up to scrutiny when considering rulings of past cases. For more on this continue reading the following article from BlueMauMau.
The International Franchise Association has warned the US Supreme Court of the ramifications of the Iowa Supreme Court decision that allows the state to tax franchisors even though they only have franchises in Iowa.
“The lower court’s ruling, if upheld, would have a devastating impact on job creation and economic growth by franchise businesses, and would cause a decline in job growth and economic activity in a sector responsible for one out of every eight jobs," said IFA President & CEO Steve Caldeira.
In the lawsuit, KFC Corporation v Iowa Department of Revenue, the Iowa Supreme Court affirmed on December 30, 2010 a lower district court’s decision that “Iowa may impose an income tax on revenue received by a foreign corporation that has no tangible physical presence within the state but receives revenues from the use of the corporation’s intangible property within the state.” The court stated that after the Iowa Department of Revenue (IDOR) imposed an income tax assessment against the out-of-state corporation, the taxpayer filed a protest with the agency on constitutional and statutory grounds. IDOR then rejected the protest. After a review of the agency’s action, the district court affirmed and KFC appealed.
The Iowa Supreme Court then ruled that it affirmed the judgment of the district court.
But IFA objects. "Granting the petition of KFC is important and necessary to protect the settled interests of thousands of franchisors, hundreds of thousands of franchisees, millions of individuals employed by them and trillions of dollars of economic impact that franchising provides to the U.S. economy," Caldeira exclaims. While other states have attempted to collect corporate income taxes from out-of-state franchisors for the royalties paid by franchisees operating in the state, the challenge in Iowa is the first case to rise to the US Supreme Court. IFA asserts that the flawed decision will lead to increased enforcement efforts in Iowa, and encourage other states looking to raise revenues during a down economy.
In a “friend of the court” briefing that law firm Nixon Peabody prepared for the Supreme Court, the IFA cites the historic Geoffrey [Toys R Us] v South Carolina. The high court ruled in that case that the presence of the trademark and the royalty source in their state was enough to constitute “economic presence” and render liable for income tax. Bruce S. Schaeffer of Franchise Valuations, Ltd. and author of Tax Aspects of Franchising is cited as one of the brief’s authorities. The New York corporate tax attorney has long been on record as saying the states have a right to collect income tax based on “nexus”, or in franchising’s case royalties collected, since at least the Geoffrey case of 1993.
IFA said it has worked for the past several years to build support for federal legislation to clarify state standards. The franchisor/franchisee association strongly supports the Business Activity Tax Simplification Act (BATSA), bipartisan legislation introduced by Reps. Bob Goodlatte (R-VA) and Congressman Bobby Scott (D-VA) to bring greater certainty to franchise small businesses seeking to comply with state tax laws.
IFA member Corey Schroeder, vice president and CFO of Outdoor Living Brands, Inc. testified before a House subcommittee last month in support of BATSA and spoke of the difficulty his company faces navigating the unpredictable nature of state tax nexus decisions across multiple jurisdictions, and the impact those decisions have on the nearly 825,000 franchise small businesses that collectively account for nearly 18 million jobs in the United States.
The Tax Executives Institute, Inc. also filed a petition for writ of certiorari last week in support of KFC. TEI is a voluntary, non-profit association of corporate and other business executives, managers, and administrators who are responsible for the tax affairs of their employers. The 7,000 member organization represents more than 3,000 leading corporation in the United States, Canada, Europe and Asia.
“Because TEI members and the companies by whom they are employed will be materially affected by the Court’s disposition of the constitutional issues raised by this case, the Institute has a special interest in this matter,” the organization states. Its core issue is whether the Commerce Clause of the United States Constitution prohibits a state from imposing its corporate income tax on businesses with no connection to the state other than having customers located there.
This article was republished with permission from BlueMauMau.