State Income Taxation of Out-of-State Franchisors

The U.S. Supreme Court denied review of a decision by the Iowa Supreme Court holding that physical presence within the state was not a constitutional prerequisite to the state’s imposition of income tax on a franchisor. The Iowa court had held that the dormant Commerce Clause of the U.S. Constitution did not require a franchisor to maintain a physical presence within the state in order for the state to impose an income tax on revenue arising from the use of the franchisor’s intangibles by franchisees located within the state.

State courts are currently split on whether the physical presence requirement of the Constitution applies to state income and franchise taxes. While the courts of three states have held that a taxing state could not impose income or franchise taxes on out-of-state businesses that did not maintain a physical presence in the taxing state, 13 other states have reached the opposite conclusion. It is unclear whether Iowa’s decision will lead to policy changes in other states, but until the U.S. Supreme Court rules on the issue, we expect continued uncertainty and discord on this subject.

KFC Corp. v. Iowa Dept. of Revenue, Dkt. No. 10-1340, petition denied October 3, 2011.

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