Tax Type
Corporation Income Tax
Description
Restaurant franchisor
Topic
Allocation and Apportionment
Date Issued
04-05-1988
April 5, 1988
Re: Request for Ruling; Corporation Income Tax
Dear******************
This is in response to your letter of April 3, 1986, requesting a ruling on whether your client is subject to Virginia corporation income tax. I apologize for the delay in responding.
Facts
You state that the Taxpayer, a foreign corporation, owns the rights to grant licenses for the use of a trade name, restaurant designs and color schemes, equipment layouts, formulas and specifications for making food products, inventory control methods, accounting and bookkeeping methods, and practice and policy manuals. A franchisee must operate in compliance with the Taxpayer's- standards and policies, must serve at least the Taxpayer's designated food and beverage products, must conform to prescribed building and equipment layouts, and must advertise to the public that franchisee is a licensee of the Taxpayer.
You further state that the Taxpayer does not own tangible property, employ personnel or solicit (by itself or through independent contractors) in Virginia. The Taxpayer's business is granting licenses and servicing licensees who are in the business of operating retail restaurants. The Taxpayer's revenues comes from a license fee at the time the license is granted, and from an ongoing percentage of gross sales in the form of a "service fee."
You state that the license fee generally is earned at the time a licensee secures a location, and that the Taxpayer's efforts in developing the licensing agreements, obtaining the licensing rights and soliciting licensees are not expended in Virginia. With respect to the service fee, you indicate that the Taxpayer mainly communicates new policies and procedures, and that most costs would be incurred outside Virginia unless a franchisee required an inordinate amount of attention. The Taxpayer does not sell products to franchisees.
You also note that the Taxpayer generally does not send agents into Virginia except possibly to approve the site chosen by the franchisee or for sporadic visits during construction of the premises. Generally, the franchisee's training is provided by the Taxpayer before the franchisee's location opens. To date, all training has been provided at the Taxpayer's commercial domicile. After the franchisee starts operations, the Taxpayer (by employees or by independent contractors) will make routine visits into Virginia to assure compliance with the Taxpayer's policy and procedure.
Determination
An annual income tax is imposed on foreign corporations having income from Virginia sources. (Va. Code §58.1-400.) Income from Virginia sources is defined as including income "attributable to a business, trade, profession or occupation carried on in Virginia or attributable to intangible personal property employed in a business, trade, profession or occupation carried on in Virginia." (Va. Code §58.1-302.)
The taxpayer's business, licensing and servicing franchisees, is carried on in Virginia and the taxpayer receives income attributable to its trade name, formulas, and other intangible personal property employed in its business. Therefore, the taxpayer clearly has income from Virginia sources. However, when Virginia's apportionment formula is applied to the taxpayer to compute Virginia taxable income the result is that there is no Virginia income tax liability.
You state that the Taxpayer does not own tangible property in Virginia. If you mean that it neither owns nor rents real or tangible personal property in Virginia, then the property factor is zero.
With respect to the payroll factor, you indicated that the Taxpayer does not employ personnel in Virginia. The Taxpayer's employees do, however, make routine visits into Virginia to ensure that the franchisees are following policy and procedure. Virginia Regulation VR 630-3-413, a copy of which is enclosed, sets forth the tests for whether compensation is deemed paid in Virginia. None of the information presented definitively addresses these tests and you should examine them to see if they apply. For the purposes of this letter, it is assumed that the payroll factor is zero.
You indicated that the Taxpayer does not sell tangible personal property in Virginia, but receives as its income license and service fees. The sales factor will be positive if "income producing activity is performed both in and outside Virginia and a greater proportion of the income producing activity is performed in Virginia than in any other state, based on costs of performance." (VR 630-3-416.) From the facts presented, it does not appear that a legal agency relationship exists between the Taxpayer and its franchisees. The facts presented, therefore, suggest that the Taxpayer's costs of performance related to the license and service fees are predominantly located outside Virginia, and the sales factor will also be zero.
Based on the foregoing, it appears that none of the Taxpayer's property, payroll or sales factors is positive, and thus the Taxpayer would have no liability for Virginia corporation income tax for its business of granting licenses and servicing licensees who are in the business of operating retail restaurants. This conclusion is based on the facts presented and on the assumptions stated, and will necessarily change if the assumptions are erroneous or if the stated facts change.
Under Virginia Regulation VR 630-3-441 (copy enclosed), a corporation is required to file a Virginia income tax return if it is incorporated under Virginia law or has registered with the State Corporation Commission for the privilege of doing business in Virginia. If either of these conditions is met then an annual Virginia corporation income tax return, Form 500, must be filed even though no tax is due because the apportionment factor is zero for the taxable year.
Sincerely,
W. H. Forst
Tax Commissioner
Rulings of the Tax Commissioner