Franchise And Distribution News: January 2015

DW PRACTICE NEWS

by Ned Levitt, Toronto Office

Exciting things are happening at Dickinson Wright LLP. We welcome the arrival of Paul Fransway, who will be working on U.S. franchise and distribution matters out of our Ann Arbor office. As a senior, highly experienced and highly respected, practitioner, Paul will bring a powerful new dynamic to our team and allow us to offer seamless franchise and distribution law services between the U.S. and Canada. Paul will co-chair our franchise and distribution law group with me. For those of you attending the International Franchise Association's annual convention in Las Vegas next month, please contact either Paul or me to arrange a meeting. We will be sponsoring the International Lounge again this year and look forward to hosting you there during the convention.

TAKE ACTION NOW TO AVOID UNEXPECTED STATE TAX LIABILITIES

by Paul R. Fransway, Ann Arbor Office

Traditionally, nexus for state income tax liability has required some type of physical presence or continuous contacts by the franchisor/distributor with a particular state. With the advent of taxing authorities asserting that all that is needed is "economic nexus," franchisors are now increasingly exposed to income tax liability based upon royalty revenue they receive regardless of its bricks and mortar in the state.1 Furthermore, budget deficits in many states cause many states to become increasingly aggressive in the assessment and collection of taxes from nonresident franchisors. After all, it is more politically expedient to raise revenue from nonresident businesses than to impose new taxes on resident businesses. Considering this, franchisors should assume that they owe taxes not only in their home state but also in any state where they have franchisees, regardless of whether they have a physical presence in the state. Only through a proactive approach can tax liabilities be quantified and minimized. These include:

1. Conduct an overall review of current operations and relationships. A careful analysis should be conducted to determine the exposures that exist, returns that have been filed, states in which you have not only paid taxes, but also those with franchisees where you have not. This review should consider not only locations, but also the applicable law and franchisor activities that are conducted in a state.

2. Take action to limit risk. Examine where you have franchisees and have not filed a return even if you've received advice in the past that it was not necessary. As more states continue to adopt an economic nexus approach, it may only be a matter of time before these states begin to assert liabilities that were thought unlikely before the advent of the assertion of economic nexus theories. This review should also be conducted by foreign franchisors and distributors that do business in the U.S. For example, a Canadian franchisor may not be required to file a U.S. federal income tax return if they do not have enough physical presence in the U.S., but such franchisors may still be required to file returns and pay taxes to the states where they have franchisees if their franchisees are located in states where economic nexus is the law.

   Consider also whether the states where franchisees are located have unfavorable law or are aggressive in asserting liability on out of state franchisors. The danger is obviously greater with a state where the applicable law is favorable to the state and where the state has indicated a willingness to use it. If so, the problem is not going to go away by ignoring it. It will only get worse. It is important to remember that if there is no return filed, the statute of limitations will typically never run. If the state involved does assert liability for income taxes at a later date, the assessment will also usually require the payment of interest and penalties for not filing the required returns. These assessments can quickly become significant enough that the cost of even a valid challenge to the existence of sufficient nexus and the application of the tax will force a franchisor to consider an unfavorable settlement.

3. Determine if there are any voluntary compliance programs and examine total tax exposure in all states. A number of states have programs to encourage voluntary compliance with tax laws. While these programs vary...