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Fix is Needed to Ensure That Franchised Businesses Are Treated Fairly by States

WASHINGTON, D.C., June 24, 2008—The International Franchise Association (IFA) today urged Congress to fix vague tax laws by enacting the Business Activity Tax Simplification Act (BATSA).

In a letter to the Commercial and Administrative Law Subcommittee of the U.S. House Judiciary Committee, IFA expressed strong support for providing “a fair, clear and uniform nexus standard for the imposition of business activity taxes by states and localities.” 

Traditionally, state income taxes on royalties have been applicable to franchisors who have clearly established a traditional nexus by retaining offices or employees within the state. Recently, however, state revenue departments have begun including the presence of intangible property as fulfilling the “substantial nexus” requirement for business activity and income taxes.
“Such arguments radically expand the classes of persons, relationships and transactions potentially subject to state income taxation,” said Matthew Shay, IFA president and CEO. “Unless addressed, the continuing uncertainty with respect to such issues will impose high costs on companies forced to operate in an environment in which their state tax liabilities are unclear.”

This issue is critical to the success of the unique relationship between the franchisor and its franchisees.  Through that relationship, hundreds of thousands of franchises that exist in the U.S. involve a license of intangible property—a great majority of which cross state lines. Most franchisors own no property in the state in which their franchisees operate, do not maintain offices there and employ no resident of those states. It has been the general understanding that franchisors are not subject to state income taxes (other than those imposed by the franchisor’s domicile state) on the royalty income paid by the franchisees located in a different state.

Unless addressed, Shay said the costs of accountants, consultants and other expenses in analyzing states’ claims of nexus will continue to hurt small businesses.  For franchisors fearful of triggering aggressive nexus standards, the current environment has caused many to scale back training and support visits to franchisees outside of their home state—truly a blow to the framework of franchising.

“Compliance and preparation of returns is a major financial burden on smaller franchisors and in many cases eclipse the taxes being paid,” said Shay. “If every state where a franchisor has granted franchises may tax its income attributable to that state, franchisors will be subject to costly compliance burdens and overlapping taxes. Enactment of BATSA is critical.”