United States

Wisconsin: Tax Appeals Commission Applies Income-Producing Activity Test to Royalty Income

Aug 17, 2015
From KPMG TaxWatch

Transcript Only

Recently, the Wisconsin Tax Appeals Commission was asked to determine whether the state could subject an intangible holding company to corporate income and franchise tax for the 2000-2003 tax years. The taxpayer, the owner of intellectual property associated with a shoe brand, received royalties from a related operating company, as well as from unaffiliated third parties. These entities used the licensed intellectual property throughout the United States, including in Wisconsin.  During the relevant tax years, the taxpayer had no property or employees in Wisconsin. Following an audit, the Department of Revenue asserted nexus over the taxpayer seeking to tax its royalty income. In the alternative, the Department denied the operating company’s royalty deductions; however, those assessments were held in abeyance pending the outcome of the instant case.  The taxpayer protested the matter, which was the first case of its kind to come before the Commission.

The parties’ briefs focused largely on the nexus issue—notably, whether a business with no physical presence in Wisconsin and whose activities consisted largely of licensing intangible property to others that sold products in the state, had nexus with the state.  Observing that this was a complex issue that it would likely someday be called upon to address, the Commission concluded that because the statutes in effect for the tax years at issue resulted in no Wisconsin tax being imposed for other reasons, it would not address the nexus question. Specifically, during the audit years, sales of other than tangible personal property (including receipts from licensing intangible property) were sourced based on where the relevant income-producing activities occurred, measured by costs of performance.  A long-standing departmental regulation provided that “income producing activity” means “the act or acts directly engaged in by the taxpayer for the ultimate purpose of obtaining gains or profit.”  The Department of Revenue argued that the income producing activity was the sale of the shoes for which the license fee was paid. According to the Commission, however, the taxpayer (the intellectual property company) did not sell shoes.  Instead, the activity in which it directly engaged was the licensing of intellectual property, and this activity did not occur in Wisconsin.  Because the taxpayer engaged in no income producing activities in Wisconsin, it had a zero sales factor for the tax years at issue and therefore owed no Wisconsin tax.  The Commission noted that the law was amended in 2009 to provide that royalty income is sourced based on the location of the licensee’s sales.  If it adopted the Department’s position, it would render the legislative change moot, and would conflict with legislative history indicating that the law change was intended to fix perceived shortcomings in the income-producing activity test as applied to royalty income.  The Commission also rejected the Department’s reliance on two cases where the income-producing activity test had been interpreted to assign receipts to Wisconsin, despite the taxpayers having significant out of state activities. In those cases, however, in contrast to the instant case, the taxpayers had direct activities in Wisconsin.  Please contact Brian Kuler at 312-665-5110 with questions on Skechers USA, Inc. v. Wisconsin Dep’t of Revenue.


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The following information is not intended to be "written advice concerning one or more federal tax matters" subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.