Annette Nellen
Trademarks alone are not enough for income tax nexus

A recent West Virginia case is a reminder that the use of intangibles in a state does not automatically lead to a finding of income tax nexus.

July 12, 2012
by Annette Nellen, Esq., CPA

In May, the West Virginia Supreme Court, famous for its 2006 MBNA ruling on economic nexus, found that ConAgra Brands, which received royalties from intangible trademarks used in the state, satisfied neither the “purposeful direction” test under the Due Process Clause nor the “significant economic presence” test under the Commerce Clause to be subject to the state’s corporate net income or business franchise tax. This article summarizes the case and provides background on economic nexus cases and the issues they raise. (A reference section at the end of this article provides citations and links to cases mentioned in this article.)

Economic nexus and state income taxes

In Geoffrey (1993), the South Carolina Supreme Court held that a taxpayer that licensed intangibles for use in the state and derived income from their use could be found to have the requisite Commerce Clause “substantial nexus” in the state. The court also held that a “tangible, physical presence” was not necessary for income tax nexus, noting that in Quill (1992), the U.S. Supreme Court stated that the physical-presence requirement had not been extended to taxes other than sales and use tax.

Since then, several state court decisions have addressed variations on how intangibles are used, a taxpayer’s connection with any in-state entity, or the level of revenues generated. The common issue in these cases was whether there was sufficient “economic presence” to meet the Commerce Clause requirements for substantial nexus. In addition, economic-nexus cases are ones where P.L. 86-272 (the federal law that governs state taxation of interstate commerce) does not apply (such as because the taxpayer does not sell tangible personal property), and the taxpayer has no physical presence in the state.

The approaches for finding economic presence depend on the particular facts and can be summarized as follows. These categories are relevant in understanding why nexus was not found in ConAgra Brands:

  1. Affiliation and intercompany transactions: In some of the state income tax cases, the taxpayer was related to an in-state business. For example, Geoffrey, a Delaware corporation with no employees or tangible property in South Carolina, was a wholly owned subsidiary of Toys R Us Inc., which operated stores in South Carolina and paid royalties to Geoffrey for the use of trademarks, trade names, and know-how. Similar affiliations existed in the Lanco (New Jersey) and A&F Trademark (North Carolina) cases.
  2. No affiliation but direct connections: In the 2010 KFC case, the Iowa court found that Kentucky-based KFC had income tax nexus through the licensing of its intangibles to independent franchisees in Iowa. While KFC had no ownership relationship with in-state restaurants, it “had the right to control the use of its marks by Iowa franchises and the right to control the nature and quality of goods sold under the marks by them.” The in-state entities were required to meet certain KFC requirements regarding menus and advertising and to purchase equipment and supplies from entities approved by KFC. The court also noted that while a physical presence is not required for income tax nexus, the intangibles had “a sufficient connection to Iowa to amount to the functional equivalent of ‘physical presence’ under Quill.”
  3. No affiliation but in-state customers: In the MBNA West Virginia case, the taxpayer did not have in-state affiliates. MBNA contacted West Virginia residents from outside of the state via phone and letters. In analyzing substantial nexus per the Complete Auto Transit Commerce Clause analysis, the court noted that MBNA did not need physical presence to generate revenue in the state. The court found that a physical-presence standard for substantial nexus was outdated in the modern economy. “The development and proliferation of communication technology exhibited, for example, by the growth of electronic commerce now makes it possible for an entity to have a significant economic presence in a state absent any physical presence there. For this reason, we believe that the mechanical application of a physical-presence standard to franchise and income taxes is a poor measuring stick of an entity’s true nexus with a state.”

ConAgra Brands

ConAgra Brands (CB), a Nebraska corporation, is a wholly owned subsidiary of ConAgra Foods (CF). CB owned various trademarks and trade names, such as Healthy Choice, Kid Cuisine, and Morton. CB had licensing agreements with both CF-affiliated and third-party licensees. CB had no physical property, employees, or agents in West Virginia. CB did not manufacture or sell products. Products with CB trademarks and trade names were manufactured by licensees outside of West Virginia and sold to West Virginia wholesalers and retailers. Licensees did not operate any retail stores in West Virginia. CB did not provide services to any sellers or impose product distribution requirements on licensees. CB incurred costs to protect its intangibles and promote them nationally. CB “obtained substantial royalties related to product sales” in West Virginia.

The state argued that income tax nexus existed because CB purposefully directed its intangibles toward the state and that part of its royalty income “was rationally related to benefits provided by” the state. However, the court found that CB “did not engage in the solicitation noted in MBNA.” The court also found it important that CB did not provide services to licensees in West Virginia and “did not direct or dictate how the licensees distributed the products bearing the trademarks and trade names” (emphasis in the original). In addition, CB’s business activities related to the licenses took place outside of the state, and legal protection of those assets fell under federal law.

Neither did the court find that a “stream of commerce” argument justified due process nexus. The court noted the confusion that exists with this theory as to whether knowing that your actions could lead to activity in the state is enough to show purposeful direction. The court found that CB’s facts were not similar to an earlier application of the theory by the court.

The court also distinguished CB’s facts from those in the Geoffrey and KFC cases. CB had arrangements with both unrelated and related entities, and the relationship between CB and its licensees was not the same as in KFC.

It is important to note that the court did not find that either Due Process or Commerce Clause nexus requirements were met. CB had not purposefully directed activity toward West Virginia and did not have a “significant economic presence” in the state. Basically, the court did not find any of the prior economic-nexus theories and fact patterns present in this case.

Looking forward

ConAgra Brands is a reminder that merely having a manifestation of a company’s intangibles in the state is not enough for a finding of income tax nexus. It is also a reminder that while recent cases have focused on the substantial-nexus requirement for a Commerce Clause analysis, the Due Process Clause is still relevant. That is, a taxpayer must have purposefully tried to make a market in the state as evidenced by its activities or relationships.

ConAgra Brands is also a reminder of the many challenges of the economic-nexus approach. These challenges include:

  • Uncertainty: As noted by the West Virginia Supreme Court, “a topic with varying levels of abstraction does not lend itself to black-letter law. There is no ‘one size fits all’ line of precedent.” How minor of a change in the ConAgra facts would lead a court to find nexus? Uncertainty increases compliance and administrative costs for taxpayers and state tax agencies. While many states have adopted economic-nexus approaches, they are not necessarily easy to apply, and the states do not interpret them consistently.
  • Constitutionality: Is economic nexus constitutional? While several state courts and legislatures have taken this approach for income taxes, the U.S. Supreme Court and Congress have remained silent. What is “substantial nexus” for Commerce Clause purposes in today’s marketplace? Do all three of the approaches described earlier support substantial nexus? For example, for approach No. 3 (no affiliation, but in-state customers), does the presence of customers and generation of revenues satisfy the due process purposeful-direction test or does it also satisfy the economic-presence test, evidenced by some amount of revenue for Commerce Clause purposes? Note that in ConAgra, concurring Justice Brent Benjamin wrote separately to call for overruling the MBNA case.

The key issues and uncertainties lie with the Commerce Clause rather than the Due Process Clause. Thus, Congress needs to resolve them.


Cases cited in this article are listed alphabetically by taxpayer name.

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Annette Nellen, CPA, Esq., is a tax professor and director of the MST Program at San José State University. Nellen is an active member of the tax sections of the AICPA, ABA, and California State Bar. She chairs the AICPA’s Individual Income Taxation Technical Resource Panel. She has several reports on tax reform and a blog.