Franchisees: Think Twice About Agreeing to Paying Franchisor State Tax

In a recent review of a franchise disclosure document (FDD), I spotted a provision from a franchisor requiring the franchisee to pay any state taxes imposed on the franchisor as a result of the franchise operations within the state. Franchisees (particularly here in Iowa) should think twice before agreeing to this type of provision due to the Iowa Supreme Court's decision against KFC Corporation in December of 2010.

As I have touched on before in posts on this blog, the Iowa Supreme Court ruled that KFC Corporation could be taxed on revenues received from the state of Iowa even though the company had no physical presence within the state but rather received royalty revenues resulting from intangible property (i.e. the use of trademarks and license fees) within the state. It was probably the most significant franchise case to occur nationally over the past couple of years and understandably franchisors are concerned about it.

However, I doubt most franchisees understand the potential liability at stake. It's certainly not something most franchisees would anticipate paying in their business plan.  It could seriously cut into profitability. Given the court ruling on the subject in Iowa, tax payment shifting from a franchisor to the franchisee is not something to take lightly.

My advice for franchisees is that I would not agree to pay the franchisor's tax. Obviously a franchisor isn't agreeing to pay the franchisee's tax obligations. I have a hard time understanding how such a provision would be fair for a franchisee. 

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