Tennessee: Foreign corporation with no effectively connected income not subject to franchise tax

The Tennessee Department of Revenue recently ruled that a foreign corporation with no effectively connected income was not subject to Tennessee’s franchise tax. The taxpayer, a foreign entity classified as a corporation for federal income tax purposes, was registered with the Tennessee Secretary of State. The taxpayer’s business activities in Tennessee involved storing inventory at a toll manufacturer’s facility in the state. The taxpayer’s Tennessee inventory included raw materials used by the toll manufacturer, as well as finished goods. The finished goods were stored at the Tennessee manufacturer’s facility until the taxpayer shipped the goods to its customers, some of which were in Tennessee. The taxpayer stated that it had no effectively connected income for purposes of Internal Revenue Code § 864(c).

Under Tennessee law, franchise tax is imposed on the net worth of “[a]ll persons doing business in this state and having a substantial nexus in this state or any person exercising the corporate franchise.”  However, a taxpayer “that is treated as a foreign corporation under the Internal Revenue Code and that has no income effectively connected with a United States trade or business” is considered not to have “substantial nexus” with Tennessee. As such, although the taxpayer was doing business in Tennessee, it lacked substantial nexus and was therefore not subject to the franchise tax on this basis. The Department next addressed whether the taxpayer was “exercising its corporate franchise.” This language, the Department determined, imposed the franchise tax on persons implementing the terms of their government-conferred privilege to exercise corporate powers. However, the statute was unclear as to whether the relevant corporate franchise must be conferred by Tennessee or whether it can be conferred by another jurisdiction. After reviewing the legislative history, the Department found that the General Assembly intended the phrase “exercising the corporate franchise” as a way to impose the franchise tax on Tennessee-chartered and Tennessee-organized business entities that confer limited liability protection on their owners. Please contact Loren Chumley at 615-248-5565 with questions on Revenue Ruling #20-08.