Franchisor Subject to Iowa Income Tax Absent Physical Presence

By Paul Masters

In an opinion filed December 30, 2010, the Supreme Court of Iowa has upheld a lower court decision imposing income tax on a franchisor (KFC), a Delaware corporation with its principal place of business in Louisville, Kentucky.  KFC had no physical presence within the state of Iowa, but licensed its system to related entities and independent franchisees.  KFC owned no restaurant properties in Iowa and had no employees in Iowa.

The Iowa Department of Revenue imposed an income tax assessment against KFC.  Penalties were assessed.  The ALG did not make a ruling in connection with the issue of penalties.  The lower court, in reviewing the agency’s decision, affirmed Iowa’s position on the commerce clause finding that “physical presence” was not required under the Commerce Clause for purposes of the state income tax.  And on penalties, the lower court ruled that KFC failed to preserve the issue in not seeking a ruling from the agency and also in not seeking a ruling on the issue in its motion for summary judgment.

The Supreme Court upheld the lower court’s decision following an in-depth analysis on the nexus issue as it relates to state cases, interpretation of quill, and an in-depth review of dormant Commerce Clause cases in recent years.

For any franchisor who is operating under the position that it has no physical presence and therefore is not subject to state income tax, it should reevaluate its position in light of the Iowa case.  Additionally, taxpayers should be wary of similar action in other states. In Texas, the Comptroller of Public Accounts has already ruled that a similar arrangement employed by Taco Bell is subject to Texas franchise tax.

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