If an out-of-state company only licenses patents to an affiliate, and the affiliate's downstream sales eventually reach Tennessee, does the patent licensor owe Tennessee franchise and excise tax?

Plain-English summary

Company A is an out-of-state corporation whose business is holding, managing, and licensing patents covering certain products. It has no office or employees in Tennessee, owns no property there, and doesn't solicit licensing business in the state. Company A licenses its patents to Company B, an affiliate, which arranges for another affiliate (Company C) to manufacture the products outside Tennessee. Company C sells the products to Company B at arm's length, and Company B ships them to its own out-of-state warehouse. Company B then sells the products to Partnership D (1% owned by yet another Company A affiliate, 99% by an unrelated party), which distributes them throughout the U.S. — including into Tennessee. Company A's only stake in any of this is a royalty Company B pays it, based on a percentage of Company B's sales to Partnership D.

The question: does Company A's patent licensing make it "doing business" in Tennessee — and therefore subject to Tennessee franchise and excise (F&E) tax — simply because products made using its patents eventually get sold in Tennessee by other companies?

The Department's answer: no. Tennessee F&E tax applies to a "person" (including a corporation) that is "doing business in Tennessee," meaning any activity purposefully engaged in, within Tennessee, with the object of gain, benefit, or advantage (§ 67-4-2004(14)(A)). Company A satisfies the "purposeful" and "object of gain" pieces — it deliberately licenses its patents for royalty income — but not the "within Tennessee" piece. It has no people or property in the state and doesn't seek licensees there. Its only connection to Tennessee runs through a chain of other companies' independent decisions: Company B licenses the patents, Company C manufactures elsewhere, Company B sells to Partnership D, and Partnership D — on its own — chooses to sell into Tennessee along with the rest of the country. The Department called this chain "too remote and indirect" to count as Company A purposefully engaging in activity within Tennessee. Because Company A wasn't "doing business in Tennessee" under the statute, the ruling didn't even need to reach the separate question of whether taxing Company A would violate the Due Process or Commerce Clauses.

A footnote flags the boundary: if Company A had licensed its patents to an affiliate that used them in a Tennessee manufacturing facility, the analysis would likely flip — citing a New Jersey case, Praxair Tech., Inc. v. Dir., Div. of Taxation, where a patent licensor was found to be doing business in-state because its licensee manufactured there.

What this means for you

Out-of-state patent or IP licensors with affiliates that sell into Tennessee

Licensing IP to an affiliate that eventually leads to downstream Tennessee sales doesn't, by itself, create Tennessee F&E nexus for the licensor — as long as the licensor itself has no people, property, or solicitation activity in the state, and the connection to Tennessee runs through several layers of other entities' independent business decisions. The more direct the licensor's own ties to in-state activity (e.g., a licensee that manufactures in Tennessee using the patents), the weaker this protection gets.

Multi-entity corporate groups structuring IP-holding companies

This ruling is a useful nexus marker for IP holding companies in affiliated groups, but it's fact-intensive — the Department leaned heavily on the number of steps between the licensor and the Tennessee activity (manufacture out of state, sale to one affiliate, resale to a partnership, then that partnership's own choice to distribute into Tennessee). Closer or more direct chains likely come out differently, as the Praxair footnote signals.

Accountants and tax professionals

Note this ruling only addresses "doing business in Tennessee" under § 67-4-2004(14)(A) — it expressly declines to reach the constitutional Due Process/Commerce Clause nexus question (Complete Auto Transit, Inc. v. Brady) because the statutory threshold wasn't met. Don't read this as broader nexus guidance than that narrow statutory holding.

Common questions

Q: Does an out-of-state patent licensor automatically avoid Tennessee F&E tax if it has no Tennessee office or property?
A: Not automatically — it depends on how directly the licensor's own activity connects to Tennessee. Here, the chain through multiple affiliates' independent sales decisions was "too remote and indirect," but a more direct tie (like a licensee manufacturing in Tennessee) could change the result.

Q: Why didn't the Department address the Due Process and Commerce Clause questions?
A: Because Company A failed the threshold "doing business in Tennessee" statutory test, the constitutional nexus questions were unnecessary to resolve.

Q: Can I rely on this revenue ruling for my own situation?
A: No. Revenue rulings are advisory only and are not binding on the Department — even the requesting taxpayer can't rely on them. This summary is informational, not legal or tax advice.

Citations and references

Tennessee statutes (Tenn. Code Ann.):

• § 67-4-2004(37) (2011) (definition of "persons" subject to F&E tax, including corporations)
• § 67-4-2007(a) (2011) (6.5% excise tax on net earnings of persons doing business in Tennessee)
• §§ 67-4-2105(a), -2106(a) (2011) ($0.25 per $100 franchise tax on net worth)
• § 67-4-2004(14)(A) (definition of "doing business in Tennessee")
• § 67-4-2108(a)(1) (2011) (franchise tax base floor based on Tennessee real/tangible property)

Case law:

• Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 279 (1977) (Commerce Clause nexus framework, referenced but not reached)
• Praxair Tech., Inc. v. Dir., Div. of Taxation, 988 A.2d 92, 99 (N.J. 2009) (patent licensor doing business in-state where licensee manufactured there — footnoted boundary case)

Source

• Landing page: https://www.tn.gov/revenue/tax-resources/legal-resources/tax-rulings.html
• Original PDF: https://www.tn.gov/content/dam/tn/revenue/documents/rulings/fae/12-27fe.pdf

Original ruling text

TENNESSEE DEPARTMENT OF REVENUE
REVENUE RULING # 12-27
WARNING
Revenue rulings are not binding on the Department. This ruling is based on the particular
facts and circumstances presented, and is an interpretation of the law at a specific point in
time. The law may have changed since this ruling was issued, possibly rendering it obsolete.
The presentation of this ruling in a redacted form is provided solely for informational
purposes, and is not intended as a statement of Departmental policy. Taxpayers should
consult with a tax practitioner before relying on any aspect of this ruling.
SUBJECT
Whether the licensing of patents, the use of which gives rise to Tennessee sales by an affiliated
licensee, causes the licensor to be subject to the Tennessee franchise and excise taxes.
SCOPE
Revenue Rulings are statements regarding the substantive application of law and statements of
procedure that affect the rights and duties of taxpayers and other members of the public. Revenue
Rulings are advisory in nature and are not binding on the Department.
FACTS
Company A is a [STATE – NOT TENNESSEE] corporation that is principally engaged in the
business of holding, managing, and licensing certain patents. Company A is a member of an
affiliated group of companies that manufacture and sell [TYPE OF] products.1
Patents held by Company A cover the use, manufacture, and sale of [TYPE OF] products (the
“Products”). Company A maintains an office in [STATE – NOT TENNESSEE], where it incurs
payroll and other operating expenses. Company A has no office or employees in Tennessee, and
does not own or lease tangible property in Tennessee. Company A does not solicit licensing
opportunities in Tennessee. [REDACTED].
Patents owned by Company A are licensed to Company B, an affiliated business entity.
Company B arranges for the manufacture of the Products by Company C, another affiliate.
Company C manufactures the Products in [VARIOUS LOCATIONS – NOT TENNESSEE] and
then sells them to Company B at an arm’s length price. Company C then ships the Products to
Company B’s warehouse in [STATE – NOT TENNESSEE]. All of Company B’s employees and
its [REDACTED] warehouse and distribution facility are located in [STATE – NOT
TENNESSEE]. Company B does not have any employees in Tennessee and does not have any
property in Tennessee.
Company B has entered into a product supply agreement with Partnership D under which
Company B agrees to supply Partnership D’s requirements for the Products. Company E, another
1

The taxpayer has requested a revenue ruling only with respect to Company A.

1

affiliated entity, owns a 1% interest in Partnership D; an unrelated third party owns the other
99% interest in Partnership D. Company B sells the Products to Partnership D and then ships the
Products via common carrier to Partnership D’s warehouse facilities in [LOCATIONS – NOT
TENNESSEE], and/or Tennessee. Partnership D then sells and distributes the Products
throughout the United States, including the State of Tennessee.
Company B pays a royalty to Company A for use of the patents, based on a percentage of
Company B’s sales to Partnership D. The royalty is due and payable once Partnership D has sold
the Products to its customers.
RULING
Is Company A subject to the Tennessee franchise and excise taxes based solely on its licensing
of patents, the use of which gives rise to Tennessee sales by a related licensee?
Ruling: No. Company A is not subject to the Tennessee franchise and excise taxes under
the facts presented, where Company A’s contact with Tennessee arises solely from the
eventual sale and delivery by Company B into Tennessee of Products manufactured
outside the state using Company A’s patents.
ANALYSIS
Tennessee imposes an excise tax at the rate of 6.5% on the net earnings of all persons, as defined
under TENN. CODE ANN. § 67-4-2004(37) (2011), doing business within Tennessee. TENN. CODE
ANN. § 67-4-2007(a) (2011). Tennessee also imposes a franchise tax at the rate of $0.25 per
$100, or major fraction thereof, on the net worth of a person doing business in Tennessee,
pursuant to TENN. CODE ANN. §§ 67-4-2105(a), -2106(a) (2011).2 Persons subject to the
Tennessee franchise and excise taxes include, but are not limited to, corporations and limited
liability companies. TENN. CODE ANN. § 67-4-2004(37).
“Doing business in Tennessee” is defined for franchise and excise tax purposes as “any activity
purposefully engaged in, within Tennessee, by a person with the object of gain, benefit, or
advantage,” to the extent permitted by the United States Constitution and the Constitution of
Tennessee. TENN. CODE ANN. § 67-4-2004(14)(A). Tennessee’s power to tax out-of-state sellers
is limited by both the Due Process Clause of the Fourteenth Amendment and the Commerce
Clause of Article I, Section 8, of the United States Constitution. See Complete Auto Transit, Inc.
v. Brady, 430 U.S. 274, 279 (1977).
Therefore, for Company A to have a Tennessee franchise and excise tax filing obligation, the
following requirements must be met: (1) Company A must be “doing business” in Tennessee;
and (2) Tennessee’s power to tax Company A must not be prohibited by the Due Process Clause
or the Commerce Clause of the United States Constitution.
2

Note that, under TENN. CODE ANN. § 67-4-2108(a)(1) (2011), the franchise tax base “shall in no case be less than
the actual value of the real or tangible property owned or used in Tennessee, excluding exempt inventory and
exempt required capital investments.” For purposes of this section, “property” is to be “valued at cost less
accumulated depreciation in accordance with generally accepted accounting principles.” TENN. CODE ANN. § 67-42108(a)(3).

2

Company A is not “doing business in Tennessee” as the term is defined under TENN. CODE ANN.
§ 67-4-2004(14)(A). As noted above, “doing business in Tennessee” is defined for franchise and
excise tax purposes as (1) any activity purposefully engaged in (2) within Tennessee (3) by a
person with the object of gain, benefit, or advantage. TENN. CODE ANN. § 67-4-2004(14)(A).
While Company A does purposefully engage in patent licensing activities with the object of gain,
benefit, or advantage, it does not do so within Tennessee.
Under the facts as presented, Company A has no office or employees in Tennessee and does not
own or lease tangible property in Tennessee. Company A does not solicit licensing opportunities
in Tennessee. Company A licenses its patents to Company B, an affiliated business entity. All of
Company B’s employees and its sole warehouse and distribution facility are located in [STATE
– NOT TENNESSEE]. Company B arranges for the manufacture of the Products by Company C,
another affiliate. Company C manufactures the Products outside Tennessee and then sells them
to Company B at an arm’s length price. Company C ships the Products to Company B’s
warehouse in [STATE – NOT TENNESSEE]. Company B sells the Products to Partnership D,
which is 1% owned by another affiliate of Company A. Company B then ships the Products via
common carrier to Partnership D’s warehouse facilities in [VARIOUS LOCATIONS – NOT
TENNESSEE] and/or Tennessee. Partnership D then sells and distributes the Products
throughout the United States, including the State of Tennessee. Company B pays a royalty to
Company A for use of the patents, based on a percentage of Company B’s sales to Partnership D.
The facts indicate that Company A’s contact with Tennessee arises solely from the eventual sale
and delivery by Company B into Tennessee of Products manufactured outside the state using
Company A’s patents. Under these facts, Company A’s contact with Tennessee is too remote and
indirect so as to be characterized as an activity “purposefully engaged in” within the state with
the object of gain, benefit, or advantage.3
Company A is therefore not “doing business in Tennessee” as the term is defined under TENN.
CODE ANN. § 67-4-2004(14)(A).
Because Company A is not “doing business in Tennessee” for purposes of the Tennessee
franchise and excise taxes, this revenue ruling will not address whether Tennessee’s power to tax
Company A is limited by the Due Process Clause of the Fourteenth Amendment and the
Commerce Clause of Article I, Section 8, of the United States Constitution.
In summary, Company A is not subject to the Tennessee franchise and excise taxes under the
facts presented, where Company A’s contact with Tennessee arises solely from the eventual sale
and delivery by Company B into Tennessee of Products manufactured outside the state using
Company A’s patents.

3

Note that if Company A licensed its patents to an affiliate that used the patents in a manufacturing facility in
Tennessee, Company A could be characterized as doing business in Tennessee. See Praxair Tech., Inc. v. Dir., Div.
of Taxation, 988 A.2d 92, 99 (N.J. 2009) (holding that a corporation with no physical presence in New Jersey was
doing business in the state where the corporation licensed patents to an affiliate for use in the manufacture of
products in New Jersey).

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Kristin Husat
General Counsel

APPROVED:

Richard H. Roberts
Commissioner of Revenue

DATE:

11-14-12

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