On December 30, 2010, the Iowa Supreme Court upheld the state’s ability to tax out-of-state franchisors based solely on the use of their intangibles by franchisees located in the state. This decision, although not unexpected, will lead to increased enforcement efforts in Iowa, and perhaps other states.
In KFC Corporation vs. Iowa Department of Revenue, KFC argued that a taxpayer must have a physical presence in a state before the state could require the taxpayer to pay corporate income tax. Iowa argued that the state could impose its corporate income tax on KFC regardless of KFC’s lack of physical presence in the state.
The court held that the intangibles that KFC licensed to its Iowa franchisees “would be regarded as having a sufficient connection to Iowa to amount to the functional equivalent of ‘physical presence.'”
Additionally, the court held that “by licensing franchises within Iowa, KFC has received the benefit of an orderly society within the state and, as a result, is subject to the payment of income taxes.
Franchisors should expect Iowa’s actions to be repeated in other states as they struggle with their budget deficits. Further, franchisors should look to limit their future exposure by making strategic changes in their franchise agreements.