Many Franchisors Fail to Report Franchisees' Sales to New York State Tax Authority

This posting was written by John W. Arden.

Only 400 of the thousands of franchisors having franchisees within the State of New York have filed annual information returns with the New York Department of Tax and Finance as required by a 2009 statute, according to state officials speaking at a July 14 meeting of the New York State Bar Association Franchise Law Committee.

Last year, New York enacted legislation requiring all franchisors having franchisees within the state to file annual information returns, reporting the gross sales of each franchisee within the state, sales by the franchisor to the franchisee, and any franchisee income reported to the franchisor. The law also requires the franchisor to report such information to the relevant New York franchisees.

The first report was to be filed by September 20, 2009, with a 90-day automatic extension process making the filing deadline December 20, 2009.

The officials made it clear that the Department of Tax and Finance was using the information returns primarily as a means of auditing the sales tax returns of the franchisees, said Bruce S. Schaeffer of Franchise Valuations, Ltd.

“Franchisors should be aware that they are risking substantial audit fees, penalties, and the potential for offending the authorities with respect to back taxes that may be found to be due,” said Schaeffer.

Attendees suggested an amnesty program from franchisors determined to be “out of compliance” with the law. The suggestion was taken under advisement, according to Schaeffer.

Text of the New York statute (New York Tax Law, Article 28, Sections 1136(i) and 1145(i)) appears at CCH Business Franchise Guide ¶4321.

Further information regarding the CCH Business Franchise Guide appears here on the CCH Online Store.

California’s Tax Authority Joins New York’s in Going After Franchisors

This posting was written by Bruce S. Schaeffer of Franchise Valuations, Ltd., co-author of CCH Franchise Regulation and Damages.

As most franchise practitioners know by now, New York recently enacted a statute amending Sec. 1136 of the Tax Law to mandate that all franchisors file information returns giving the names and addresses of all their franchisees in the state. The legislation also provides that information on all payments from franchisees to franchisors and records of all sales from franchisors to their franchisees will be required.

An even more onerous situation has evolved in California, where the California Franchise Tax Board has begun contacting non-resident franchisors about their nexus status for tax purposes.

State regulators are taking the position that non-resident franchisors must either register as resident corporations with the Secretary of State or have their California franchisees withhold seven percent of royalty payments.

Section 18662-2 of California's tax code is being cited as justification for this interpretation. Specifically:

Withholding at source is also required in the case of rentals or royalties for the use of, or for the privilege of using in this State, patents, copyrights, secret processes and formulas, good will, trademarks, brands, franchises, and other like property of such intangible property having a business or taxable situs as defined in Regs. 17951-1 through 17951-5, 17952 and 17953 in this State, and payments of prizes, premiums, rewards, winnings, etc., to nonresidents

“Constructive” Wrongful Termination, Attorneys Fees, and Expert Fees

On occasion, the issue under wrongful termination statutes is whether or not there has been a “constructive” wrongful termination. A recent New Jersey case is instructive.

In Maintainco, Inc. v. Mitsubishi Caterpillar Forklift (CCH Business Franchise Guide ¶14,195) a forklift manufacturer's forcing out an authorized dealer was held to have amounted to “constructive” termination in violation of the New Jersey Franchise Practices Act (NJFPA). The manufacturer argued that the NJFPA prohibited only actual terminations; thus, because the dealer was never terminated, there was no violation.

However, the record established that the manufacturer’s officers were well aware that the NJFPA prohibited them from terminating the dealer unless they could establish "good cause," and the court rejected the manufacturer's assertion that the dealer had breached a best efforts provision in the parties' agreement.

The court held that a dealer's loss of an exclusive territory, in and of itself, could qualify as a constructive termination. Therefore, the trial court’s ruling and its award of compensatory damages for lost profits to the dealer in the amount of $679,414 were affirmed. Additionally, the trial court's substantial award of attorney fees to the dealer in the amount of $3,533,642 was also upheld, but an award of $477,611 in expert witness fees was reversed.

Termination: The Insurance Agent Cases

It started with a Connecticut case against Nationwide Insurance, alleging that a terminated agent was entitled to the protection afforded a franchisee under Connecticut law. It was imperfectly resolved. There were similar cases in Missouri and Washington.

This was recently followed by Michigan, in a case of first impression, holding that an insurance agent could maintain a cause of action under the Michigan Franchise Investment Law if it could show it paid a franchise fee (which the court thought to be unlikely but could not so rule on the pleadings).Bucciarelli v. Nationwide Mutual Insurance Co.(E.D. Mich. 2009) CCH Business Franchise Guide ¶14,200.

In another insurance agent case, a California appellate court overturned a trial court holding that the relationship between an insurance company and one of its agents was that of franchisor/franchisee, entitling the agent to the protections of the California Franchise Investment Law and the California Franchise Relations Act. The court found there was no actual, present controversy, which was a requirement to bring the claim as a declaratory judgment action.

Thus, the trial court erred in reaching the merits of the agent’s claims and was ordered to vacate its summary judgment to the insurance company on the merits (Business Franchise Guide 2008-2009 New Developments Transfer Binder ¶13,897). The court was directed to issue a new order granting summary judgment on the sole ground that declaratory relief was not appropriate. Vice v. State Farm Mutual Automobile Insurance Co. (Cal. Ct. App. 2009)CCH Business Franchise Guide ¶14,219.
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Additional information on the issues discussed above is available in CCH Franchise Regulation and Damages by Byron E. Fox and Bruce S. Schaeffer.

New York State Requires Franchisors to Report Franchisees’ Sales

This posting was written by Pete Reap, Editor of CCH Business Franchise Guide, and John W. Arden.

New York State has enacted legislation requiring all franchisors having franchisees within the state to file annual information returns with the State Department of Taxation and Finance, reporting the gross sales of each franchisee within the state, as well as the sales by the franchisor to the franchisee and any franchisee income reported to the franchisor. The franchisor must also report such information to the relevant New York franchisees.

The new requirements were contained in amendments to Section 1136 of the New York Tax Law. The legislation, one of the state’s voluminous budget bills (A. 157, Chapter No. 57), became effective on April 7, 2009.

Filing Requirement

The returns must be filed annually on or before March 20 and must cover the four sales tax quarterly periods immediately preceding that date. The returns must be filed electronically, in a manner prescribed by the Commissioner of the Department of Taxation and Finance.

However, the law provides that the first returns must be filed on or before September 20, 2009 and cover the period of March 1, 2009 through August 1, 2009. The returns filed on or before March 20, 2010 shall cover the period from September 1, 2009 to February 28, 2010.

A further amendment—Section 1145(i)—sets out penalties for failure to provide the required information.

In a May 27, 2009 letter to franchisors, the New York State Department of Taxation and Finance said that it was contacting franchisors to make them aware of the new requirement. The department stated that directions for filing the returns are being written and asked franchisors to provide lists of New York-based franchisees.

New York is the first jurisdiction to require such reporting by franchisors. Text of the provisions—New York Tax Law, Article 28, Sections 1136(i) and 1145(i)—appear at CCH Business Franchise Guide ¶4321.

Reaction of Franchise Bar

The enactment of these new requirements “is unprecedented, aberrant, anomalous and could prove deeply threatening to franchisees and franchising,” wrote New York franchise lawyer David J. Kaufmann in a column (“Many Unhappy Returns”) to be published in the New York Law Journal.

The new reporting requirement will allow the New York State Department of Taxation and Finance to compare the revenue figures from the franchisor with that reported by franchisees on their New York tax returns. If the franchisees are found to underreport revenues, the state will pursue them “through audits and resulting civil—or even criminal—actions."

Although New York is the first jurisdiction to impose such a reporting requirement, “we imagine many other states, and perhaps even the Internal Revenue Service, will follow New York’s lead by enacting similar franchisor reporting requirements,” wrote Kaufmann.

He further warned that franchisees may perceive franchisor reporting as interference in their businesses and that the reporting requirement may establish a new type of “tax nexus” between out-of-state franchisors and New York State.

In a June 9 Franchise & Distribution Bulletin, the law firm of Sonnenschein Nath & Rosenthal noted that reporting requirements “are similarly being considered in other states and are consistent with recent trends showing that states have been very aggressively pursuing all opportunities for additional tax revenue in order to relieve huge budget deficits.”