The Iowa Supreme Court and Iowa Department of Revenue issued interesting opinions that continue to expand corporate income tax nexus arguably beyond the limitations of the Commerce Clause of the U.S. Constitution.

The Iowa Supreme Court held that physical presence is not a required ingredient of the secret recipe for substantial nexus in the corporate income tax context. KFC Corp. v. Iowa Dep’t of Revenue, No. 09-1032 (Iowa Dec. 30, 2010). The Department issued a corporate income tax assessment to KFC Corp., which had no employees or property in Iowa. KFC’s only connection with Iowa was that it licensed the KFC intangible property to independent franchisees operating or conducting business in Iowa. The Iowa Supreme Court held that, despite this tenuous connection and no physical presence, KFC had substantial nexus in Iowa.

First, the court concluded that KFC’s licensing of intangibles to unrelated Iowa franchisees was “the functional equivalent of ‘physical presence’ under Quill.” Second, the court concluded in the alternative that physical presence is not required to find substantial nexus in the corporate income tax context. The court relied on the “economic presence nexus” principles from Geoffrey and its progeny; however it failed to recognize that this was the first of such intangible holding company cases that involved licensing to unrelated third parties.  Up to this point, the only “economic presence nexus” cases that involved transactions with unrelated third parties were in the financial institutions context (e.g., MBNA and Capital One Bank). Thus, KFC may run “afowl” of the Commerce Clause.

Earlier in December, the Department issued an informal opinion resulting in similar consequences. The Department determined that a company had substantial nexus in Iowa despite having no physical or economic presence in Iowa. The company was an out-of-state registered agent, with no property or employees in Iowa, that subcontracted to an Iowa law firm to receive documents for customers located primarily outside Iowa.  The Department determined that the company was “exploiting the Iowa market” and, therefore, had corporate income tax nexus in Iowa.   

Thus, it appears that Iowa is the latest state to make clear that physical presence nexus does not apply for income tax purposes.