Does an out-of-state franchisor have Colorado sales- or income-tax nexus, and which of its franchise revenues count toward the income-tax thresholds?

Plain-English summary

An out-of-state C-corporation franchisor sells franchises for a business that cleans cooking oils in restaurants. It asked whether it has sales-tax or income-tax nexus in Colorado. The Department split the two:

• Sales-tax nexus — declined. Determining sales-tax nexus is too fact-intensive for a general information letter, so the Department wouldn't address it.
• Income-tax nexus — explained with a revenue-by-revenue walk-through. A company has Colorado income-tax nexus if it exceeds Public Law 86-272 and meets any one of the thresholds ($50,000 property, $50,000 payroll, $500,000 sales, or 25%). The franchisor had no Colorado payroll or property, so the question was sales. Under the market-based sourcing rule (Rule 39-22-301.1), the Department sorted the franchisor's revenue streams:
• Equipment, supplies, and goods shipped to franchisees in other states — don't count (not received in Colorado).
• Royalty and territory fees under the franchise agreement — the agreement is an intangible (rights to the trademark/tradename) used primarily in Colorado, so these likely count.
• Monthly advertising fees — a service, apportioned by where the service is used if it's used in more states than Colorado.
• Training fees — a service performed entirely out of state, so sourced elsewhere.
• Equipment and supplies shipped to a Colorado franchisee — count, because the franchisee's business address is in Colorado.

So a franchisor with no people or property in Colorado can still hit the $500,000 (or 25%) sales threshold largely through royalties on a Colorado-used trademark and goods delivered to Colorado franchisees. As a GIL, this is general guidance only — the Department made no determination.

This pairs with [[gil-16-001-lcc-employee-in-colorado]] (the same nexus thresholds and the P.L. 86-272 overlay) and the pass-through nexus analysis in [[gil-21-004-colorado-nexus-for-out-of-state-pass-through-entity]].

What this means for you

Franchisors and licensors of intangibles

You can owe Colorado income tax with no office, staff, or property in the state. Royalties and territory fees for a trademark used in Colorado are sourced to Colorado and count toward the sales threshold — that alone can create nexus. Map each revenue stream (goods, royalties, advertising, training) to where it's received or used, not where you sit.

Businesses selling both goods and services across state lines

Different rules per stream: tangible goods count where received/delivered; services and intangibles count where primarily used (apportioned across states if used in several); training performed out of state is sourced out of state. Keep records that show the purchaser's location and use.

Accountants and tax professionals

Income-tax nexus = P.L. 86-272 exceeded and a Rule 39-22-301.1 threshold met. The sourcing subrules (39-22-301.1(2)(c)(iii)(C)–(F)) drive which receipts count: TPP by delivery/receipt; software/digital and services/intangibles by primary use, with a fallback to the purchaser's address of record. Sales-tax nexus is a separate, fact-intensive inquiry the Department won't resolve in a GIL.

Common questions

Q: Can a franchisor with no Colorado office or employees owe Colorado income tax?
A: Yes, if it exceeds P.L. 86-272 and meets a threshold. Royalties on a trademark used in Colorado and goods delivered to Colorado franchisees count toward the $500,000 (or 25%) sales threshold.

Q: Do goods I ship to franchisees in other states count?
A: No. They're not received in Colorado, so they don't count toward the Colorado sales threshold.

Q: How are franchise royalties sourced?
A: The franchise agreement is an intangible (trademark/tradename). Royalty and territory fees are sourced to where the mark is primarily used — here, Colorado — so they likely count.

Q: Did the Department decide sales-tax nexus?
A: No. It said sales-tax nexus is too fact-intensive for a general information letter and declined to address it.

Q: Can I rely on this letter?
A: No. It's a General Information Letter — general guidance only, not binding on the Department. A binding answer requires a private letter ruling.

Citations and references

Statutes and rules:
- § 39-26-102(3), C.R.S. ("doing business in this state" — sales tax)
- 1 CCR 201-2, Rule 39-22-301.1 (income-tax nexus thresholds; sourcing of receipts), incl. (2)(c)(iii)(C)–(F)
- 15 U.S.C. § 381 (Public Law 86-272)
- 1 CCR 201-1, Rule 24-35-103.5 (GIL/PLR procedure)

Source

• Landing page: https://tax.colorado.gov/all-letter-rulings
• Original PDF: https://tax.colorado.gov/sites/tax/files/documents/GIL-16-004.pdf

Original ruling text

Office of Tax Policy
P.O. Box 17087
Denver, CO 80217-0087
[email protected]

GIL-16-004
May 3, 2016
XXXXXXXXXXXXXXXXX
Attn: XXXXXXXXXXXXX
XXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXX
Re: Sales and Income Tax Nexus
Dear XXXXXXXXXXX,
You submitted on behalf of XXXXXXXXXXXXXXXX (“Company”) a request for guidance to
determine whether Company has sales or income tax nexus in Colorado.
The Colorado Department of Revenue (“Department”) issues general information letters and
private letter rulings. A general information letter provides a general overview of the relevant tax
issues and is not binding on the Department. A private letter ruling provides a specific
determination for a specific set of facts, is binding on the Department but not on the taxpayer, and
requires payment of a fee. For more information about general information letters and private
letter rulings, please see Department Rule 1 CCR 201-1, 24-35-103.5.
The Department treats your request as a general information letter. It is important to remember
that general information letters, such as this one, are general discussions of tax law and are not a
determination of the tax consequence of any particular action or inaction. If you would like the
Department to issue a private letter ruling on the issues you raise, you must submit a new request
and provide the fee in compliance with Department Rule 1 CCR 201-1, 24-35-103.5.
Issue
Does Company have sales or income tax nexus in Colorado?
Background
Company is a C-Corporation located outside of Colorado. Company is a franchisor, which sells
franchises that sell products that clean cooking oils in restaurants and other commercial cooking
facilities. The business encompasses four sales lines:
1. Company advertises its franchises on websites where prospective franchisees can find
information about the company, request information, or request someone to contact them.

They then attend a discovery day in a state other than Colorado to see the business and
discuss the opportunity. Once a franchisee decides to purchase, they complete an application,
pay a deposit, and wait for their application to be approved. If the applicant is approved,
Company prepares a franchise agreement in a state other than Colorado and the franchisee
comes to such state to sign the agreement, receive training in such state, and pay the
franchise fee for their machine, training, and territory rights. The franchisee also brings a
franchisee-owned van to the warehouse in such state to have the equipment installed and
advertising placed on the van.
2. After the franchisee begins operations, there are additional services and supplies that are
purchased. These consist of filters for the machine, spare parts as needed, monthly royalty
fees, and monthly advertising fees.
3. There are other items that the franchisee could purchase from Company that would be resold
to the franchisee customers. These include cooking oil, cleaning chemicals, and trays and
filters for restaurant refrigerators.
4. Lastly, Company also offers a service of disposal of used cooking oil. The cooking oil is
collected by the franchisee and picked up by a disposal company and the franchisee and
Company share the profits of the sale of such oil.

Structure of Analysis
To determine whether a Company is obligated to pay taxes in Colorado, the Department will
examine the following questions:
1) Is Company “doing business in this state” pursuant to § 39-26-102(3), C.R.S.?
2) Does Company have substantial nexus in Colorado pursuant to Department Rule 1 CCR 2012, 39-22-301.1, Doing Business in Colorado?
Discussion
1. Sales Tax Nexus
A determination of nexus for sales tax is a fact-intensive process that cannot be adequately
addressed in a general information letter. Therefore, the Department cannot address the issue in
this letter.
2. Income Tax Nexus
A company is presumed to have nexus for purposes of Colorado income tax if it exceeds the
minimum standards of Public Law 86-272 (15 U.S.C. 381) and meets any one of the four thresholds
below. Department Rule 1 CCR 201-2, 39-22-301.1 states in pertinent part,
(b) Substantial nexus is established if any of the following thresholds is exceeded
during the tax period:
(i) a dollar amount of $50,000 of property1; or
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Property in this rule is defined as follows: “(i) Property counting toward the threshold is the
average value of the taxpayer's real property and tangible personal property owned or rented
and used in this State during the tax period. Property owned by the taxpayer is valued at its
original cost basis. Property rented by the taxpayer is valued at eight times the net annual rental
rate. Net annual rental rate is the annual rental rate paid by the taxpayer less any annual rental
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(ii) a dollar amount of $50,000 of payroll2; or
(iii) a dollar amount of $500,000 of sales; or
(iv) twenty-five percent of total property, total payroll or total sales.
Company represents that it does not have payroll in Colorado. Company also appears not to have
have property3 in Colorado. Company, however, may have sufficient sales in Colorado. In
Department Rule 1 CCR 201-2, 39-22-301.1, the Department describes how the sales factor is
computed.
(iii) Sales counting toward the threshold include the total dollar value of the
taxpayer’s gross receipts from
…
(B) the lease or license of tangible personal property located in this State;
(C) the sale of tangible personal property … received in this State as
indicated by receipt at a business location of the seller in this State or by
instructions, known to the seller, for delivery or shipment to a purchaser
(or to another at the direction of the purchaser) in this State;
(D) the sale of software or digital products for primary use by a purchaser
known to the seller to be in this state; and
(E) the sale, lease or license of services and intangibles for primary use
by a purchaser known to the seller to be in this State. If the seller knows
that a service or intangible will be used in multiple States because of
separate charges levied for, or measured by, the use at different
locations, because of other contractual provisions measuring use, or
because of other information provided to the seller, the seller shall
apportion the receipts according to usage in each State.
(F) If the seller does not know where a service or intangible will be used
or where a tangible (including software or a digital product) will be
received, the receipts shall count toward the threshold of the State
indicated by an address for the purchaser that is available from the
business records of the seller maintained in the ordinary course of
business when such use does not constitute bad faith. If that is not
known, then the receipts shall count toward the threshold of the State
indicated by an address for the purchaser that is obtained during the
consummation of the sale, including the address of the purchaser’s
payment instrument, if no other address is available, when the use of this
address does not constitute bad faith.

rate received by the taxpayer from subrentals. The average value of property shall be determined
by averaging the values at the beginning and ending of the tax period; but the executive director

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may require the averaging of monthly values during the tax period if reasonably required to reflect properly
the average value of the taxpayer's property.”
Payroll in this rule is defined as follows: “(ii) Payroll counting toward the threshold is the total amount paid
by the taxpayer for compensation in this State during the tax period. Compensation means wages, salaries,
commissions and any other form of remuneration paid to employees and defined as gross income under
Internal Revenue Code § 61. Compensation is paid in this State if:
(A) the individual's service is performed entirely within the State;
(B) the individual's service is performed both within and without the State, but the service performed
without the State is incidental to the individual's service within the State; or
(C) some of the service is performed in the State and (1) the base of operations or, if there is no base
of operations, the place from which the service is directed or controlled is in the State, or (2) the base
of operations or the place from which the service is directed or controlled is not in any State in which
some part of the service is performed, but the individual's residence is in this State.”
Intangible property is not included in the definition of property under this rule.
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Company’s sales of equipment, supplies and other tangible personal property delivered to
franchisees in other states are not counted toward the sales threshold because they are not
received in Colorado. Company’s franchise agreement, which includes contractual rights and
licenses to use Company’s trademark and tradename, is an intangible. Payments received from
franchisees pursuant to this agreement, including royalty payments and territory fee, will likely be
counted in computing the sales threshold because the trademark or tradename is primarily used in
Colorado. The monthly fee received from franchisees for advertising is likely treated as a sale of a
service and therefore is apportioned according to Department Rule 1 CCR 201-2, 39-22301.1(2)(c)(iii)(E), as set forth above, if the service is performed in more states than Colorado.
Training is also a service but likely allocated entirely to another state because Company
represents that all training is performed in another state. Sales of the equipment and supplies
shipped by Company to a Colorado franchisee in Colorado will also count toward this threshold
because the franchisee’s business address is in Colorado.
Miscellaneous
This letter represents the good faith opinion of Department personnel who are knowledgeable on
state taxes issues. However, the Department does not make a specific determination here on any
of the issues raised and the Department is not bound by this general information letter.
The Department administers state and state-administered local sales and use taxes. This letter
does not address sales and use taxes administered by home-rule cities and home-rule
counties. You may wish to consult with local governments which administer their own sales or use
taxes about the applicability of those taxes. Visit our web site at www.colorado.gov/tax for more
information about state and local sales taxes.
Enclosed is a redacted version of this letter. Pursuant to statute and regulation, this redacted letter
will be made public within 60 days of the date of this letter. Please let me know in writing within
that 60 day period whether you have any suggestions or concerns about this redacted letter.
Sincerely,

Office of Tax Policy
Colorado Department of Revenue

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