Franchisors beware. Ditto franchisees. Like New York, California wants to tax out-of-state franchisors with franchisees operating in the Golden State, with the result that their franchisees may have to act as the state's tax collectors.
 
With almost no fanfare, the California Franchise Tax Board has begun arguing that state income tax laws apply to non-resident franchisors who receive royalty, rent, or lease income from California sources, and if the FTB gets its way, non-resident franchisors will face an ugly choice. If they don't register with the California Secretary of State and pay taxes on California-source income at corporate rates, the FTB will require that their franchisees withhold 7 percent of all payments made to their franchisors on royalties, rents, or leases.
 
Now, make no mistake. Seven percent is a huge number, and the FTB surely wants to help solve California's extraordinary revenue problems. But the object of the game in floating that 7 percent number is to scare non-resident franchisors into making no fuss about paying taxes at corporate rates.
 
The Franchise Tax Board's argument may well stand up to legal challenge, and it one-ups a similar effort by New York's tax collectors. As I noted in my August newsletter, the Empire State's tax collectors succeeded in getting that state's legislature to pass a bill requiring that out-of-state franchisors report sales and royalty data on their New York operations - clearly, a prelude to taxing non-resident franchisors operating in that state.
 
The threat to non-resident California franchisors is more imminent. The Franchise Tax Board argues that state tax law already applies to royalty, rent or lease income paid to non-resident franchisors who have a "business situs" in the state - a complex legal notion centering on how franchisors make use of intangible property such as trademarks, trade names, and franchises.
 
Worse, the Franchise Tax Board wants franchisees to start making quarterly withholding payments this year and, adding to their bookkeeping burdens, to start sending annual statements to their franchisors detailing the income subject to withholding, plus the taxes actually withheld, by Jan. 31.
 
It is not a given that all non-resident franchisors with operations in California have a business situs in the state, however. But given the apparent strength of the Franchise Tax Board's argument, franchisors ought to waste no time finding out where they stand, not to mention what they can do about it.