IFA Supports Business Activity Bill to Preserve Nexus Standard

September 27, 2005

Dear Chairman Cannon and Rep. Watt:

The International Franchise Association (IFA) would like to express strong support for the Business Activity Tax Simplification Act ("BATSA") (H.R. 1956). BATSA would answer the need for a fair, clear and uniform nexus standard for the imposition of business activity taxes by states and localities.

Who we are:

The IFA is a trade association of more than 1,000 franchising companies and 8,000 franchise members, representing over 75 industries. The association's mission is to enhance and to safeguard the business environment for franchising worldwide; and it is the only association serving as the voice for franchising in the United States. The over 767,000 franchised businesses in the U.S. account for more than one and a half trillion dollars of economic output (about 9.5% of the private-sector economic output). Franchisors and their franchisees directly employ almost 10 million people, and indirectly are responsible for the creation of over 18 million Jobs. The great majority of the approximately 2,500 franchisors operating in the U.S. are small businesses, with fewer than 50 franchised outlets.

What BATSA Does:

BATSA would codify current law (which itself is derived from the Constitution's Commerce Clause) to ensure that states and localities may impose their business activity taxes only in situations where an entity has physical presence (i.e., property or employees) and thereby receives related benefits and protections from the jurisdiction. We agree that a physical presence nexus standard should be preserved in order to ensure, an equitable and measurable application of the state tax laws for all industries.

Why the Franchise Industry Supports BATSA:

Enactment of BATSA is important to the franchise industry because of the business relationship between a franchisor and its franchisees. Central to that relationship is a shared trade identity. That shared trade identity is established and maintained by the franchisor's license of its trademark, trade dress and other intellectual property (i.e., intangible property) to each of its franchisees. Thus, each of the hundreds of thousands of franchise relationships that exist in the U.S. involves a license of intangible property, The great majority of those licenses cross state lines.

Most franchisors own no property in the state in which their franchisees operate, do not maintain offices there and employ no residents of those states. A franchisor's employees may make occasional visits to its franchisee's place of business to assist the franchisee in opening his business and to inspect the franchisee's performance and furnish advice and guidance, but the duration of such visits normally is limited to a few hours or days. The services that a franchisor furnishes to its franchisees, and communication among a franchisor and its franchisees, are implemented almost entirely at the franchisor's principal offices and through interstate communications media. Most franchisors do not rely on the states of their franchisees' domicile for any services and impose no costs on those states.

The franchise relationship evolved over the last half century with the understanding that the franchisor is not subject to state income taxes (other than those imposed by the franchisor's domicile state) on the royalty income paid to the franchisor by franchisees located in a different state. Prior to the late 1980s, with rare exception, the states did not seek to tax such income, unless the franchisor clearly established a traditional nexus by owning or leasing real estate, operating its own outlets, or maintaining an office or employees in the taxing state.

Recently, however, some state revenue departments have argued that the mere presence of intangible property in their jurisdiction satisfies the "substantial nexus" requirement under the Commerce Clause for the imposition of state income and related business activity taxes. Such arguments radically expand the classes of persons, relationships and transactions potentially subject to state income taxation.

The issue has enormous implications for the many thousands of businesses engaged in interstate franchising and licensing of intangible property, a rapidly expanding part of the American economy. If permitted, such assessments would subject licensors of intangible property in interstate commerce to income taxation by every state in which goods or services exploiting the licensed intangible property are sold. If a tax return is not filed, no statute of limitations will limit the period for which taxes, interest and penalties may be due.

Such a result would represent a radical departure from the historical understanding of the reach of taxing authority and a significant increase in the tax liability and burden of compliance of thousands of American businesses. 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.

Conclusion:

States that attempt to assess taxes on businesses with no physical connection to the jurisdiction would substantially extend the reach of state taxing powers to companies having no contact with the taxing state by interpreting significant constitutional limits on these powers so narrowly as to effectively eliminate them. 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. Thus, enactment of BATSA is critical for thousands of businesses, franchising companies, their franchisees and other licensors and licensees of intangible property across state lines.

Thank you for considering this written testimony.