The U.S. Supreme Court has denied the request for certiorari in KFC Corp. v. Iowa. The issue in the case is the asserting of jurisdiction to asses income taxes based on the concept of economic nexus. In KFC, the franchisor licensed its marks and other intangibles to independent franchisees for use in their business, in return for royalty payments. KFC did not maintain restaurants (physical presence) within Iowa, only operated with independent franchisees. With the denial of cert, the lower court decision stands, and the application of economic nexus to satisfy the physical presence requirement stands.
Any franchisor that lacks a physical presence in a state may be confronted with uncertain tax positions based on their non-filing of income tax returns for any years subsequent to the start of franchising operations. What is significant is that where returns have not been filed, no tolling of the statute occurs, leaving many companies with significant potential tax, interest and penalty liabilities.
While this is of concern in general, within KFC, the relationship between franchisor and third party franchisee is a business relationship with a common theme, i.e. selling a particular product and the parties united in the common business purpose. What then of other relationships where this commonality may be tangential or lacking?
As an example, what is the situation where a designer licenses out their brand for use on a product minimally related to their main endeavors, (e.g. clothing designer name on eye glasses) or unrelated (e.g. luggage)? Does the sale of these products by an unrelated retailer, further removed from the licensor, constitute economic presence? Or is there some point where economic presence ends due to a non exclusive nature of the relationship?
As a corollary, foreign governments facing fiscal needs may also contemplate similar approaches to the payment of royalties by unrelated parties to non-resident companies based on the same economic nexus logic.
To read the full details of the case, visit CHECKPOINT.