Iowa Tax Case Could Cost Nation’s Franchises

September 2010 Franchising World
Franchisors should also expect the impact of the decision in KFC Corp. to extend beyond Iowa.
The Iowa Supreme Court in late May heard oral arguments in KFC Corp. vs. Iowa Department of Revenue, a case that could have a substantial financial impact on franchisors across the nation.
Iowa asserted that KFC is subject to the state’s corporate income tax based solely on the fact that it received royalties from franchisees in Iowa. The state cited Geoffrey v. South Carolina Tax Commission and related cases in support of its position. However, a victory by the state would represent an extension of those cases because KFC involves licensing agreements between unrelated parties.
The KFC case could result in a landmark decision for states attempting to impose income tax on out-of-state franchisors and other similarly situated taxpayers.
Background on State Tax Nexus
Historically, many franchisors have reported and paid income taxes only in states in which they have a physical presence. This practice is based on a 1992 U.S. Supreme Court case, Quill Corp. v. North Dakota, which held that the Commerce Clause of the United States Constitution barred states from imposing a use-tax collection obligation on out-of-state corporations that had no physical presence in the taxing state. The court held that such corporations did not have the “substantial nexus” with the state that was required under the Commerce Clause.
Since Quill, many state taxing authorities have argued that the physical-presence requirement enunciated in that case applied only to state sales and use taxes. Taxpayers, on the other hand, have read Quill to apply to state income taxes as well.
The first major case to address these conflicting interpretations was Geoffrey, which was decided by the S. C. Supreme Court in 1993,