               IN THE SUPREME COURT OF IOWA
                              No. 09–1032

                         Filed December 30, 2010


KFC CORPORATION,

      Appellant,

vs.

IOWA DEPARTMENT OF REVENUE,

      Appellee.


      Appeal from the Iowa District Court for Polk County, Don C.

Nickerson, Judge.



      On review of agency action, the judgment of the district court is

affirmed. AFFIRMED.



      Paul H. Frankel, Craig B. Fields, and Mitchell A. Newmark of

Morrison & Foerster LLP, New York, New York, and John V. Donnelly of

Sullivan & Ward, P.C., West Des Moines, Iowa, for appellant.



      Thomas J. Miller, Attorney General, Donald D. Stanley, Jr., Special

Assistant Attorney General, and Marcia E. Mason, Assistant Attorney

General, for appellee.
                                    2

APPEL, Justice.

      In this case, we must determine whether the State of Iowa may

impose an income tax on revenue received by a foreign corporation that

has no tangible physical presence within the state but receives revenues

from the use of the corporation’s intangible property within the state.

After the Iowa Department of Revenue (IDOR) imposed an income tax

assessment against the out-of-state corporation, the taxpayer filed a

protest with the agency on constitutional and statutory grounds. IDOR

rejected the protest. On review of the agency’s action, the district court
affirmed. KFC appealed. For the reasons expressed below, we affirm the

judgment of the district court.

      I. Factual and Procedural Background.

      KFC Corporation (KFC) is a Delaware corporation with its principal

place of business in Louisville, Kentucky.   Its primary business is the

ownership and licensing of the KFC trademark and related system. KFC

licenses its system to independent franchisees who own approximately

3400 restaurants throughout the United States. While KFC also licenses

its system to related entities—including KFC National Management

Company—all KFC restaurants in Iowa are owned by independent

franchisees.   KFC owns no restaurant properties in Iowa and has no

employees in Iowa.

      On October 19, 2001, IDOR issued to KFC an assessment in the

amount of $284,658.08 for unpaid corporate income taxes, penalties,

and interest for 1997, 1998, and 1999. KFC filed a timely protest of the

assessment. IDOR answered the protest, and the matter was assigned

by the Iowa Department of Inspections and Appeals to an administrative
law judge (ALJ). Both sides filed motions for summary judgment.
                                     3

      In its motion for summary judgment, IDOR asserted that the

requirements of the Commerce Clause were satisfied. IDOR argued that

the “physical presence” requirement established in National Bellas Hess,

Inc. v. Department of Revenue of Illinois, 386 U.S. 753, 87 S. Ct. 1389, 18

L. Ed. 2d 505 (1967), as reaffirmed in Quill Corp. v. North Dakota, 504

U.S. 298, 112 S. Ct. 1904, 119 L. Ed. 2d 91 (1992), was not necessary

when a franchisor licensed intellectual property that generated income

for the franchisor within the state from operations of independent

franchisees.   IDOR asserted that KFC’s royalty income based on its
franchisees’ Iowa transactions was “taxable because it is derived from

Iowa customers and is made possible by Iowa’s infrastructure and legal

protection of the Iowa marketplace.”       IDOR further argued that the

imposition of the income tax was consistent with Iowa Code section

422.33(1) (1997) and its implementing administrative rules.

      KFC resisted and filed a summary judgment motion of its own.

KFC argued that its receipt of royalty income was not subject to tax by

the State of Iowa. KFC observed that in Quill, the United States Supreme

Court held that a use tax could not be imposed on a foreign corporation

that had no physical contact with the taxing state. KFC noted that the

Quill Court “did not state that its holding is limited to use tax collection

obligations.” KFC argued that, because it had no physical presence in

Iowa, the state could not constitutionally impose the income tax. In the

alternative, KFC pressed a statutory claim.      KFC asserted that under

Iowa Code section 422.33(1), KFC was not subject to tax because it

lacked property “located or having a situs in this state.”

      KFC did not raise any issue related to penalties in its motion for
summary judgment.       In its memorandum of points and authorities,

however, KFC asserted that the penalty assessed by IDOR should be
                                      4

waived under applicable statutes because it had substantial authority to

rely upon its position. See Iowa Code § 421.27(1)(h), (2)(f), (3)(d).

      The ALJ issued a detailed ruling in IDOR’s favor. The ALJ found

that KFC owned, managed, protected, and licensed KFC marks and

system during the years in question.         As part of its business, KFC

entered into franchise agreements with franchisees in Iowa who remitted

royalty and/or license income to KFC for the use of KFC marks and

system at a rate of four percent of gross revenues for each month, with a

minimum royalty amount adjusted for increases in the Consumer Price
Index. Throughout the period, KFC 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.

      Further, the ALJ found that Iowa franchisees were required by

their franchise agreements to adhere to KFC’s requirements regarding

menu items, advertising, marketing, and physical facilities. In order to

comply with applicable standards, Iowa franchisees were required to

purchase equipment, supplies, paper goods, and other products from

only KFC-approved manufacturers and distributors. Quality assurance

activities were performed in Iowa on behalf of KFC by employees of KFC’s

affiliates. The ALJ also found that KFC franchisees in Iowa could deduct

from their taxable income the royalty payments made to KFC.

      Applying law to these facts, the ALJ held that the IDOR

assessment did not violate the Commerce Clause or Iowa law.             With

respect to the Commerce Clause question, the ALJ concluded that

“physical presence” is not required when a state imposes taxation on

income. Further, the ALJ concluded IDOR demonstrated that KFC had a
sufficient nexus to Iowa to support IDOR’s assessment. According to the

ALJ, the franchise right was an intangible with a direct connection to
                                     5

Iowa. The imposition of tax on income generated by a franchisor within a

state was not an undue burden on commerce, but rather a payment to

government that provided the economic climate for the business to

prosper.

      On the state law question, the ALJ found that KFC was “deriving

income from sources within this state” as required by Iowa Code section

422.33(1).   According to the ALJ, KFC received such income when it

received royalty and/or license income from franchisees located within

the state. The ALJ determined that the provision of Iowa Code section
422.33(1) requiring a “situs in this state” did not require a physical situs,

but, citing Webster’s dictionary, included “the place where some thing

exists or originates; the place where something (as a right) is held to be

located in law.” The ALJ did not make a ruling of any kind or refer in

any way to the issue of penalties in the decision.

      On appeal, the director of IDOR affirmed the ALJ.        The director

characterized the issue on appeal as whether “KFC ha[d] sufficient nexus

with Iowa to be subject to Iowa corporation income tax?” The director

adopted and incorporated the findings of fact of the ALJ without

revisions. The director also adopted the conclusions of law made by the

ALJ with additions and modifications.      With respect to the Commerce

Clause issue, the director noted that several states have held that an

economic presence satisfies the “substantial nexus” requirement for

corporate income tax purposes. The director also found that, under Iowa

law, KFC owed corporate income tax under Iowa Code section 422.33(1).

Like the ALJ, the director made no findings on the penalty issue.

      KFC sought judicial review of the agency’s decision in district
court. The district court affirmed the director on the Commerce Clause

issue, finding that “physical presence” was not required under the
                                      6

Commerce Clause for the imposition of state income tax.         The district

court further found that, because KFC’s marks and trademarks were “an

integral part of business activity occurring regularly in Iowa,” the income

derived from the use of that property was taxable under Iowa law. On

the issue of penalties, the district court found the issue was not

preserved because KFC did not obtain a ruling on the issue from the

agency and also because KFC did not seek a ruling on the issue in its

motion for summary judgment.

      II. Standard of Review.
      The Iowa Administrative Procedure Act governs judicial review of

decisions of the Iowa Department of Revenue. See Iowa Code ch. 17A;

AOL LLC v. Iowa Dep’t of Revenue, 771 N.W.2d 404, 407 (Iowa 2009).

With respect to the constitutional questions in this case, the parties

agree that our review is de novo. See State v. Taeger, 781 N.W.2d 560,

564 (Iowa 2010).

      The parties contest the standard of review on the statutory issue

presented in this case.    KFC contends that the district court erred in

granting deference to IDOR’s legal conclusion on state law issues under

Iowa Code section 422.33(1) and that our review of IDOR’s legal

determinations is for errors at law.      IDOR contends that it has been

clearly vested with discretion to interpret the applicable provisions of law

and that, as a result, its determinations may be reversed only if

“irrational, illogical, or wholly unjustifiable.”   See Renda v. Iowa Civil

Rights Comm’n, 784 N.W.2d 8, 12–14 (Iowa 2010) (noting that the

question of whether the legislature has clearly vested an agency with

discretion to determine applicable provisions of law is generally to be
based upon an analysis of individual provisions of law, not upon a

wholesale conclusion regarding chapters of the Code); Iowa Ag Constr.
                                     7

Co. v. Iowa State Bd. of Tax Review, 723 N.W.2d 167, 173 (Iowa 2006)

(holding broad rule-making authority may give rise to deference to

administrative interpretations).

      In this case, however, we need not reach the issue of whether

IDOR is entitled to deference in its interpretation of Iowa Code section

422.33(1) because, even if deference were not afforded, we conclude, for

the reasons expressed in this opinion, that IDOR correctly interpreted

the applicable statutes.

      III. The Dormant Commerce Clause Claim.
      A. Introduction      to   Dormant     Commerce       Clause    Issues

Presented in This Case. In Bellas Hess and later in Quill, the United

States Supreme Court held under the dormant Commerce Clause that, in

order for a state to require an out-of-state entity to collect sales and use

taxes on transactions with in-state residents, the entity must have some

“physical presence” within the taxing jurisdiction. Bellas Hess, 386 U.S.

at 756–59, 87 S. Ct. at 1391–93, 18 L. Ed. 2d at 508–10; Quill, 504 U.S.

at 317–18, 112 S. Ct. at 1916, 119 L. Ed. 2d at 110. In this case, two

questions arise in light of Bellas Hess and Quill. The first question is

whether the State of Iowa satisfied the “physical presence” test of Bellas

Hess and Quill in this case.       The second question is whether the

“physical presence” test in Bellas Hess and Quill applies at all to cases

involving state income taxation.

      We begin our discussion with a survey of the dormant Commerce

Clause cases of the United States Supreme Court.        In our survey, we

focus on the nature of dormant Commerce Clause analysis and the

struggle between formalistic approaches and approaches that emphasize
economic substance in the context of both sales and use taxes and state

income taxes. We then examine state court cases after Quill grappling
                                    8

with the issues presented in this case.      Using these authorities to

illuminate our discussion, we analyze the dormant Commerce Clause

issues presented in this case.

      B. Approach of the United States Supreme Court to the

Dormant Commerce Clause.

      1. Evolution of Supreme Court “dormant” Commerce Clause doctrine

prior to Bellas Hess and Quill. The United States Constitution expressly

authorizes Congress to “regulate Commerce . . . among the several

States.” U.S. Const. art. I, § 8, cl. 3. Since the nineteenth century, the
United States Supreme Court has interpreted the Commerce Clause as

more than merely an affirmative grant of power, finding a negative sweep

to the Clause as well. See Brown v. Maryland, 25 U.S. (12 Wheat.) 419,

448–49, 6 L. Ed. 678, 688–89 (1827); Gibbons v. Ogden, 22 U.S. (9

Wheat.) 1, 72–78, 6 L. Ed. 23, 70–78 (1824). As a result, the Supreme

Court has applied the “negative” or “dormant” Commerce Clause to limit

state taxation powers notwithstanding the absence of congressional

legislation.

      Over time, the Supreme Court’s approach to state taxation under

the dormant Commerce Clause has evolved from a relatively strong

prohibition toward a more practical assessment that recognizes the

needs of the states to raise revenue.    The early view of the Supreme

Court was that “no state ha[d] the right to lay a tax on interstate

commerce in any form.” Leloup v. Port of Mobile, 127 U.S. 640, 648, 8

S. Ct. 1380, 1384, 32 L. Ed. 311, 314 (1888). The Supreme Court later

chiseled this broad prohibition into one that only precluded the states

from levying taxes that imposed “direct” burdens on interstate commerce.
See, e.g., Adams Express Co. v. Ohio State Auditor, 165 U.S. 194, 220, 17

S. Ct. 305, 309, 41 L. Ed. 683, 695 (1897); see also Freeman v. Hewit,
                                     9

329 U.S. 249, 257–58, 67 S. Ct. 274, 279, 91 L. Ed. 265, 274–75 (1946);

Felt & Tarrant Mfg. Co. v. Gallagher, 306 U.S. 62, 66–68, 59 S. Ct. 376,

378, 83 L. Ed. 488, 491–92 (1939).

      The “direct” vs. “indirect” distinction, however, was subject to

strong attack by Justice Stone.      In a classic dissent, Justice Stone

attacked the distinction as unrealistic and opined that, “[i]n . . . making

use of the expressions, ‘direct’ and ‘indirect interference’ with commerce,

we are doing little more than using labels to describe a result rather than

any trustworthy formula by which it is reached.”             Di Santo v.
Pennsylvania, 273 U.S. 34, 44, 47 S. Ct. 267, 271, 71 L. Ed. 524, 530

(1927) (Stone, J., dissenting), overruled by California v. Thompson, 313

U.S. 109, 116, 61 S. Ct. 930, 934, 85 L. Ed. 1219, 1223 (1941).

Eventually, the Supreme Court, apparently heeding Justice Stone’s call

for a more realistic and less formalistic approach, began to analyze the

validity of state taxes by applying a “nexus” doctrine under the Due

Process and dormant Commerce Clauses.

      Applying the “nexus” doctrine, the Supreme Court upheld sales

and use taxes when the taxpayer had some minimal physical presence

within the jurisdiction, even though the transactions leading up to the

imposition of the tax were not linked to the physical presence.        See

Scripto, Inc. v. Carson, 362 U.S. 207, 209–11, 80 S. Ct. 619, 620–22, 4

L. Ed. 2d 660, 663–64 (1960) (upholding use tax based on the physical

presence of ten advertising brokers conducting continuous solicitation in

the taxing state); Nelson v. Sears, Roebuck & Co., 312 U.S. 359, 364, 61

S. Ct. 586, 588–89, 85 L. Ed. 888, 892 (1941) (upholding use tax on

mail-order sales when the taxpayer had retail outlets in the state, even
though the retail outlets were not connected with mail-order sales).
                                     10

While none of these cases held that physical presence was required in

order for a state to require an out-of-state entity to collect sales and use

taxes from customers, the fact of physical presence in these sales and

use tax cases played a significant role in the analysis.

      While “physical presence” may have been a significant feature, if

not a requirement, in the Supreme Court’s dormant Commerce Clause

analysis in early sales and use tax cases, “physical presence” in the

narrow sense does not appear as an important factor in cases involving

state income taxation. See Nw. States Portland Cement Co. v. Minnesota,
358 U.S. 450, 464, 79 S. Ct. 357, 365–66, 3 L. Ed. 2d 421, 431 (1959)

(observing that income tax could be supported if the “activities form a

sufficient ‘nexus between such a tax and transactions within a state for

which the tax is an exaction’ ” (quoting Wisconsin v. J.C. Penney Co., 311

U.S. 435, 445, 61 S. Ct. 246, 250, 85 L. Ed. 267, 271 (1940)); Int’l

Harvester Co. v. Wis. Dep’t of Taxation, 322 U.S. 435, 441, 64 S. Ct.

1060, 1064, 88 L. Ed. 1373, 1379 (1944) (stating that “[p]ersonal

presence within the state of the stockholder-taxpayers is not essential to

the constitutional levy of a tax taken out of so much of the corporation’s

Wisconsin earnings as is distributed to them”); J.C. Penney Co., 311 U.S.

at 444, 61 S. Ct. at 250, 85 L. Ed. at 270 (holding that the income-tax

test under the dormant Commerce Clause is whether the state has

“exerted its power in relation to opportunities which it has given, to

protection which it has afforded, to benefits which it has conferred by the

fact of being an orderly, civilized society”); New York ex rel. Whitney v.

Graves, 299 U.S. 366, 372, 57 S. Ct. 237, 238, 81 L. Ed. 285, 288 (1937)

(holding that, with respect to intangible property such as a seat on the
New York Stock Exchange, the business situs of the intangible property
                                       11

may “grow out of the actual transactions of a localized business”).           In

these cases involving challenges to state income taxes, the Supreme

Court has not adopted a mechanical or formalistic approach to the

dormant Commerce Clause nexus requirement but, instead, has

emphasized a flexible approach based on economic reality and the nature

of the activity giving rise to the income that the state seeks to tax.

      2. Emergence of the Bellas Hess physical presence test for sales

and use taxes arising from mail-order sales. In Bellas Hess, the Supreme

Court considered a challenge to an Illinois statutory requirement that an
out-of-state entity collect and remit the use tax owed by consumers who

purchased goods for use within Illinois. Bellas Hess, 386 U.S. at 755, 87

S. Ct. at 1390, 18 L. Ed. 2d at 507–08. The out-of-state entity was a

mail-order   merchant     that   had    no   in-state   retail   outlets,   sales

representatives, or property.    Id. at 753–54, 87 S. Ct. at 1389–90, 18

L. Ed. 2d at 507. In Bellas Hess, the Supreme Court by a six-to-three

vote concluded that the use tax could not be constitutionally applied

under the dormant Commerce Clause if the taxpayer did not have

physical presence in the taxing jurisdiction. Id. at 759–60, 87 S. Ct. at

1392–93, 18 L. Ed. 2d at 510–11.

      The Bellas Hess majority first noted that the nexus requirements

under the Due Process and dormant Commerce Clauses were “closely

related” and “similar.” Id. at 756, 87 S. Ct. at 1391, 18 L. Ed. 2d at 508.

The Bellas Hess Court observed that the “same principles have been held

applicable in determining the power of a State to impose the burdens of

collecting use taxes upon interstate sales.”      Id.   Thus, at the time of

Bellas Hess, there was no material distinction between the nexus
required by due process and the nexus required by the dormant

Commerce Clause. See id.
                                         12

      Turning to whether Illinois met its burden of showing an adequate

nexus, the Bellas Hess majority noted that the Court had “never held

that a State may impose the duty of use tax collection and payment upon

a seller whose only connection with customers in the State is by common

carrier or the United States mail.”           Id. at 758, 87 S. Ct. at 1392, 18

L. Ed. 2d at 509. The Bellas Hess majority emphasized that over 2300

jurisdictions could impose sales and use taxes and that, with many local

variations   in    rates   of   use    tax    and   allowable   exemptions,   the

administrative burdens could impede interstate business.             Id. at 759–
760 & n.12, 87 S. Ct. at 1392–93 & n.12, 18 L. Ed. 2d at 510 & n.12. In

addition, the Illinois statute imposed the burden of requiring the vendor

to provide each purchaser with a receipt showing payment of the tax, as

well as keep “such records, receipts, invoices and other pertinent books,

documents, memoranda and papers as the [State] shall require in such

form as the [State] shall require.” Id. at 755, 87 S. Ct. at 1390, 18 L. Ed.

2d at 508. Before the state could impose the administrative burdens of

determining, collecting, and documenting the myriad different taxes from

the thousands of jurisdictions that could be imposed, the Bellas Hess

majority held that some sort of physical nexus with the taxing state was

required. Id. at 758, 87 S. Ct. at 1392, 18 L. Ed. 2d at 509–10.

      Justice Fortas, joined by Justices Black and Douglas, dissented.

Id. at 760, 87 S. Ct. at 1393, 18 L. Ed. 2d at 511 (Fortas, J., dissenting).

Justice   Fortas     stated     that   “large-scale,   systematic,   continuous

solicitation and exploitation of the Illinois consumer market” was a

sufficient basis for supporting the tax. Id. at 761–62, 87 S. Ct. at 1394,

18 L. Ed. 2d at 511. On the question of benefits from the state, Justice
Fortas asserted that, if Bellas Hess had a retail store in Illinois, or

maintained resident sales personnel in the state, the benefit it received
                                       13

from the State of Illinois would not be affected. Id. at 762–64, 87 S. Ct.

at 1394–95, 18 L. Ed. 2d at 512–13. Conversely, the burden on Bellas

Hess is no different than on a local retailer with comparable sales. Id. at

766, 87 S. Ct. at 1396, 18 L. Ed. 2d at 514. Justice Fortas presciently

warned that the approach of the majority would open a sizable “haven of

immunity” that would increase dramatically in the future. Id. at 764, 87

S. Ct. at 1395, 18 L. Ed. 2d at 513.

      Nothing in Bellas Hess, however, altered the relationship between

the Due Process and dormant Commerce Clause nexus requirements or
explicitly overruled the principles expressed in the state income tax

nexus cases. Instead, Bellas Hess seems to represent the development of

a strand of authority under the dormant Commerce Clause with at least

some formalism in its categorical approach to the dormant Commerce

Clause nexus requirement in the field of sales and use taxes.

      After Bellas Hess, the Supreme Court considered the nexus issue

in a number of cases. In general, the cases stand for the proposition that

constitutionally required “physical presence” (1) is not “the slightest

physical presence,” but nonetheless need not be very substantial to

satisfy the requirements of both due process and the dormant Commerce

Clause, and (2) need not be related to the transaction giving rise to tax

liability. See, e.g., Trinova Corp. v. Mich. Dep’t of Treasury, 498 U.S. 358,

373–74, 384–87, 111 S. Ct. 818, 829, 835–37, 112 L. Ed. 2d 884, 904–

05, 911–13 (1991) (upholding a value added tax imposed on entities

having “business activity” within the state and noting that the nexus

requirement under the dormant Commerce Clause “encompasses” the

due process requirement); Nat’l Geographic Soc’y v. Cal. Bd. of
Equalization, 430 U.S. 551, 556, 97 S. Ct. 1386, 1390, 51 L. Ed. 2d 631,

637 (1977) (rejecting “slightest presence test,” but holding California
                                     14

could impose use tax on mail-order sales of an out-of-state vendor who

maintained two offices within the state, even though the offices had

nothing to do with mail-order operations); Standard Pressed Steel Co. v.

Wash. Dep’t of Revenue, 419 U.S. 560, 563–64, 95 S. Ct. 706, 709, 42 L.

Ed. 2d 719, 723–24 (1975) (holding in-state presence of one full-time

employee sufficient to support imposition of gross receipts tax on sales to

out-of-state entity).

      3. Complete Auto: The demise of formalism in favor of a multifactor

test. After Bellas Hess, the United States Supreme Court revisited the
requirements of the dormant Commerce Clause in Complete Auto Transit,

Inc. v. Brady, 430 U.S. 274, 97 S. Ct. 1076, 51 L. Ed. 2d 326 (1977). In

Complete Auto, the Supreme Court, in an opinion by Justice Blackmun,

repeated the observation by Justice Holmes that “interstate commerce

may be made to pay its way” through the imposition of state taxes.

Complete Auto, 430 U.S. at 281, 284, 97 S. Ct. at 1080, 1082, 51 L. Ed.

2d at 332, 334.         In order for such taxes to pass Commerce Clause

muster, however, Justice Blackmun concluded that the tax must be (1)

applied to an activity having a “substantial nexus” with the taxing state,

(2) be “fairly apportioned,” (3) not “discriminate against interstate

commerce,” and (4) be “fairly related to the services provided by the

State.” Id. at 279, 97 S. Ct. at 1079, 51 L. Ed. 2d at 331.

      Justice Blackmun’s opinion in Complete Auto has emerged as a

landmark in dormant Commerce Clause jurisprudence. What precisely

was meant by the term “substantial nexus” was unclear and left for

further case law development.       The Complete Auto opinion, however,

emphasizes the practical effects of state taxing statutes on interstate
commerce and avoids formal distinctions and abstractions.         Id.   The

dormant Commerce Clause worm seemed to have turned once again in
                                      15

Complete Auto in favor of utilization of a realistic assessment of economic

impacts rather than formal doctrinal categories.

      Additional dormant Commerce Clause cases after Complete Auto

confronted the nexus issue. For instance, in Tyler Pipe Industries, Inc. v.

Washington State Department of Revenue, 483 U.S. 232, 107 S. Ct. 2810,

97 L. Ed. 2d 199 (1987), the Supreme Court, in a challenge to a state’s

business and occupation tax, rejected the notion that the actions of sales

representatives within a state could not be attributed to the out-of-state

taxpayer for purposes of determining substantial nexus because they
were independent contractors. Tyler Pipe Indus., Inc., 483 U.S. at 250,

107 S. Ct. at 2821, 97 L. Ed. 2d at 215. The Supreme Court further

cited with approval the observation made by the Washington Supreme

Court that “the crucial factor governing nexus is whether the activities

performed in this state on behalf of the taxpayer are significantly

associated with the taxpayer’s ability to establish and maintain a market

in this state for the sales.” Id.

      4. Post-Bellas Hess developments in due process.           In Complete

Auto, the Court imported into the Commerce Clause analysis the same

kind of thinking reflected in the evolving due process cases. Originally,

under Pennoyer v. Neff, 95 U.S. (5 Otto) 714, 723–24, 24 L. Ed. 565, 569

(1877), physical presence was central in determining whether a party

had sufficient minimum contacts with a forum to submit to its

jurisdiction.   The physical presence test was famously abandoned by

Justice Stone in International Shoe Co. v. Washington, 326 U.S. 310, 66

S. Ct. 154, 90 L. Ed. 95 (1945).       In International Shoe, the Supreme

Court rejected any requirement of physical presence in favor of minimum
contacts that allowed the assertion of state judicial power consistent with

“ ‘traditional notions of fair play and substantial justice.’ ” Int’l Shoe, 326
                                    16

U.S. at 316, 66 S. Ct. at 158, 90 L. Ed. at 102 (quoting Milliken v. Meyer,

311 U.S. 457, 463, 61 S. Ct. 339, 343, 85 L. Ed. 278, 283 (1940)).

      In rejecting the physical presence test, Justice Stone noted in

International Shoe that the “corporate personality” was a fiction of the law

because a corporation is not physically present anywhere. Id. Yet, citing

Learned Hand, Justice Stone observed that “the terms ‘present’ or

‘presence’ are used merely to symbolize          those     activities of the

corporation’s agent within the state which courts will deem to be

sufficient to satisfy the demands of due process.” Id. at 316–17, 66 S.
Ct. at 158, 90 L. Ed. at 102 (citing Hutchinson v. Chase & Gilbert, 45

F.2d 139, 141 (2d Cir. 1930)). In International Shoe, the activities carried

on within Washington “in behalf” of the corporate respondent were

“systematic and continuous” and therefore sufficient to satisfy due

process. Id. at 320, 66 S. Ct. at 160, 90 L. Ed. at 104.

      Cases decided after International Shoe further reinforced the

pragmatic nature of the due process question and lessened the role of

“physical presence.” See Burger King Corp. v. Rudzewicz, 471 U.S. 462,

476, 105 S. Ct. 2174, 2184, 85 L. Ed. 2d 528, 543 (1985) (holding that

jurisdiction under due process may not be avoided merely because the

defendant “did not physically enter the forum State”); World-Wide

Volkswagen Corp. v. Woodson, 444 U.S. 286, 297–98, 100 S. Ct. 559,

567, 62 L. Ed. 2d 490, 502 (1980) (finding that due process was satisfied

when an out-of-state corporation “delivers its products into the stream of

commerce with the expectation that they will be purchased by

consumers in the forum State”); McGee v. Int’l Life Ins. Co., 355 U.S. 220,

223, 78 S. Ct. 199, 201, 2 L. Ed. 2d 223, 226 (1957) (finding sufficient
minimum contacts for purposes of due process when the suit was based

on a contract that had substantial connection with the forum state even
                                    17

though there was no evidence of physical presence in the forum state).

Citing prior case law, the Burger King Court declared that the Court had

long ago abandoned “mechanical tests” based on “ ‘conceptualistic . . .

theories of the place of contracting or of performance.’ ” Burger King, 471

U.S. at 478–79, 105 S. Ct. at 2185, 85 L. Ed. 2d at 544–45 (quoting

Hoopeston Canning Co. v. Cullen, 318 U.S. 313, 316, 63 S. Ct. 602, 605,

87 L. Ed. 777, 782 (1943)).

      5. Squaring Bellas Hess with Complete Auto and evolving due

process precedent: Quill.     After Complete Auto and Burger King, a
substantial question that emerged was whether the life blood had been

drained from Bellas Hess by subsequent developments. The mail-order

industry had grown rapidly and, much as Justice Fortas had feared in

his Bellas Hess dissent, a large tax haven had been created. See Bellas

Hess, 386 U.S. at 762–64, 87 S. Ct. at 1394–95, 18 L. Ed. 2d at 512–13

(Fortas, J., dissenting). Indeed, mail-order sales amounted to only $2.4

billion four years prior to Bellas Hess, but had grown to $150 billion by

1983. See Martin L. McCann, Note, Use Tax, Mail Order Sales, and the

Constitution:   Recent Developments in Connecticut, 12 U. Bridgeport L.

Rev. 137, 149 (1991). The question arose whether the Court in Bellas

Hess had inadvertently opened a tax avoidance scheme that needed to be

closed. Further, technological developments made the physical presence

requirement look rather quaint. Out-of-state mail order marketers now

availed themselves of sophisticated technology to sell their products. Id.

at 151–52. In addition, the Supreme Court in its personal jurisdiction

cases, such as International Shoe, McGee, World-Wide Volkswagen, and

Burger King, had eviscerated the physical presence requirement for due
process, which for all practical purposes was thought to be coextensive

with any restraints under the dormant Commerce Clause.         Id. at 153.
                                   18

Finally, although there had been a number of twists and turns, it seemed

that the era of formalism or mechanical tests under the dormant

Commerce Clause was over after Complete Auto.           In light of these

factors, many observers thus heard, or at least hoped they heard, a

death rattle for the “physical presence” holding of Bellas Hess.      See

Paul J. Hartman, Collection of the Use Tax on Out-of-State Mail-Order

Sales, 39 Vand. L. Rev. 993, 1006–14 (1986); Sandra B. McCray,

Overturning Bellas Hess: Due Process Considerations, 1985 BYU L. Rev.

265, 295–96 (1985); Donald P. Simet, The Concept of “Nexus” and State
Use and Unapportioned Gross Receipts Taxes, 73 Nw. U. L. Rev. 112,

112–14 (1978).

      Certainly the North Dakota Supreme Court was prepared to give

Bellas Hess a decent burial. In State ex rel. Heitkamp v. Quill Corp., 470

N.W.2d 203 (N.D. 1991), the North Dakota Supreme Court considered

the validity of the imposition of a use tax on an out-of-state seller who

lacked physical presence in the state. Heitkamp, 470 N.W.2d at 204–05,

overruled by Quill, 504 U.S. at 301–02, 112 S. Ct. at 1907, 119 L. Ed. 2d

at 99–100.       The North Dakota Supreme Court declared that the

“economic, social, and commercial landscape upon which Bellas Hess

was premised no longer exist[ed],” which made it inappropriate to follow

Bellas Hess. Id. at 208–09. The North Dakota Supreme Court cited the

staggering growth in the mail-order business and the advance in

computer technology, which made compliance more practical.             Id.

Further, the North Dakota Supreme Court noted that the legal

environment had changed in light of Complete Auto and its progeny,

which indicated that the United States Supreme Court was moving in a
direction away from the “physical presence” test in favor of a more

flexible approach. Id. at 209–13. Applying the test of Complete Auto, the
                                     19

North Dakota Supreme Court found the test was satisfied in light of the

fact that North Dakota provided an “economic climate that fostere[d]

demand” for Quill products and maintained a legal system that

supported business within the state. Id. at 218.

      The United States Supreme Court granted certiorari and reversed

the North Dakota Supreme Court. Justice Stevens wrote for the majority

that “[w]hile we agree with much of the state court’s reasoning,” the

Supreme Court nonetheless was required to reverse. Quill, 504 U.S. at

302, 112 S. Ct. at 1907, 119 L. Ed. 2d at 99.
      Justice Stevens began the substantive discussion by canvassing

the existing case law regarding due process and concluding that

“physical presence” was not required to support taxation if a corporation

“purposefully avails itself of the benefits of an economic market in the

forum State.” Id. at 307, 112 S. Ct. at 1910, 119 L. Ed. 2d at 103. Thus,

to the extent Bellas Hess required “physical presence” to satisfy due

process, it was overruled. See id.

      Justice Stevens then turned to the dormant Commerce Clause

issue. After reviewing the evolution of the dormant Commerce Clause

doctrine, Justice Stevens observed that, “[w]hile contemporary Commerce

Clause jurisprudence might not dictate the same result were the issue to

arise for the first time today,” the Bellas Hess approach to Commerce

Clause nexus was not inconsistent with Complete Auto. Id. at 311, 112

S. Ct. at 1912, 119 L. Ed. 2d at 105.       In order to reach that result,

Justice Stevens concluded the “minimum contacts” test under due

process and the “substantial nexus” test under the Commerce Clause,

“[d]espite the similarity in phrasing,” were “not identical.” Id. at 312, 112
S. Ct. at 1913, 119 L. Ed. 2d at 106. Unlike the Due Process Clause, the

nexus requirement under the Commerce Clause does not serve as “a
                                      20

proxy for notice, but rather a means for limiting state burdens on

interstate commerce.” Id. at 313, 112 S. Ct. at 1913, 119 L. Ed. 2d at

107. In a footnote, Justice Stevens noted, absent the physical presence

rule of Bellas Hess, a vendor might be required to comply with tax

obligations in 6000-plus taxing jurisdictions with many variations in rate

of tax, allowable exemptions, and in administrative duties. See id. at 313

n.6, 112 S. Ct. at 1914 n.6, 119 L. Ed. 2d at 107 n.6.

        Turning to the decision of the North Dakota Supreme Court on the

Commerce Clause issue, Justice Stevens recognized the state supreme
court’s emphasis on the Supreme Court’s “ ‘retreat from the formalistic

constrictions of a stringent physical presence test in favor of a more

flexible substantive approach.’ ”    Id. at 314, 112 S. Ct. at 1914, 119

L. Ed. 2d at 107 (quoting Heitkamp, 470 N.W.2d at 214). Yet, Justice

Stevens concluded that, “[a]lthough we agree with the state court’s

assessment of the evolution of our cases, we do not share its conclusion

that this evolution indicates that the Commerce Clause ruling of Bellas

Hess is no longer good law.” Id. at 314, 112 S. Ct. at 1914, 119 L. Ed.

2d at 107–08.

        Justice Stevens recognized that “we have not, in our review of

other    types   of   taxes,   articulated   the     same   physical-presence

requirement.” Id. But, Justice Stevens reasoned that the “silence does

not imply repudiation of the Bellas Hess rule.” Id. at 314, 112 S. Ct. at

1914, 119 L. Ed. 2d at 108.

        Justice Stevens then considered justifications for the continued

application of the Bellas Hess approach.           He noted that Bellas Hess

created a “discrete realm of commercial activity that is free from
interstate taxation” and a “safe harbor” for vendors from state-imposed

duties to collect sales and use taxes. Id. at 315, 112 S. Ct. at 1914, 119
                                      21

L. Ed. 2d at 108. While he recognized that the physical-presence rule,

like all bright-line rules, “appears artificial at its edges,” the artificiality

was offset by the benefits of a “clear rule.”      Id. at 315, 112 S. Ct. at

1914–15, 119 L. Ed. 2d at 108.

      Justice Stevens further emphasized that one of the benefits in

affirming Bellas Hess was that reaffirmance of the established rule

“encourages settled expectations.” Id. at 316, 112 S. Ct. at 1915, 119

L. Ed. 2d at 109. According to Justice Stevens, it is not unlikely that the

dramatic growth of the mail-order industry “is due in part to the bright-
line exemption from state taxation created from Bellas Hess.” Id. As a

result, Justice Stevens concluded that the Bellas Hess rule “has

engendered substantial reliance and has become part of the basic

framework of a sizeable industry.” Id. at 317, 112 S. Ct. at 1916, 119

L. Ed. 2d at 110. According to Justice Stevens, the value of a bright-line

test and the doctrine and principles of stare decisis indicate that Bellas

Hess remains good law. See id.

      Justice Stevens closed his opinion by noting that the decision,

apparently a difficult one, was “made easier” by the fact Congress, which

“may be better qualified to resolve” the issue, could have the last word.

Id. at 318, 112 S. Ct. at 1916, 119 L. Ed. 2d at 110.          In light of the

reversal of the due process holding of Bellas Hess, Congress is “now free

to decide whether, when, and to what extent the States may burden

interstate mail-order concerns with a duty to collect use taxes.” Id.

      Justice Scalia, joined by Justices Kennedy and Thomas, concurred

in part and concurred in the judgment. Id. at 319, 112 S. Ct. at 1923,

119 L. Ed. 2d at 111 (Scalia, J., concurring). Justice Scalia concurred in
the majority opinion regarding due process.          Id.   On the Commerce

Clause question, Justice Scalia noted that Congress had the power to
                                    22

change the result of Bellas Hess through legislation.     Id. at 320, 112

S. Ct. at 1923, 119 L. Ed. 2d at 111–12.      As a result, Justice Scalia

further noted that stare decisis applies with special force where Congress

retains the power to override a court decision. Id. Justice Scalia would

not have engaged in any revisiting of the merits of the holding. Id.

      Justice White concurred in part and dissented in part. Id. at 321,

112 S. Ct. at 1916, 119 L. Ed. 2d at 112 (White, J., concurring in part

and dissenting in part).    He agreed that physical presence was not

required for due process, but also asserted that it was not required
under the Commerce Clause. Id. at 321–22, 112 S. Ct. at 1916–17, 119

L. Ed. 2d at 113.   In particular, Justice White noted that, in National

Geographic Society, the Court decoupled any notion of transactional

nexus from the inquiry and focused solely on whether there were

sufficient contacts with the jurisdiction imposing the tax. Id. at 323–24,

112 S. Ct. at 1918, 119 L. Ed. 2d at 114.         Further, Justice White

concluded that cases subsequent to Bellas Hess undermine its continued

vitality and that the rule should be abandoned in its entirety. Id. at 326–

27, 112 S. Ct. at 1919–20, 119 L. Ed. 2d at 115–16. Justice White would

jettison the formalism in the physical presence test for the functionality

of Justice Rutledge’s concurring opinion in Freeman. Id. at 325–27, 112

S. Ct. at 1918–20, 119 L. Ed. 2d at 115–16 (citing Freeman, 329 U.S. at

259, 67 S. Ct. at 280, 91 L. Ed. at 275 (Rutledge, J., concurring)). He

noted the illogic of imposing a tax on a small, out-of-state vendor with

one employee residing in the taxing state, while allowing a large vendor

with no employees to escape the tax. Id. at 328–29, 112 S. Ct. at 1920,

119 L. Ed. 2d at 117.
      6. Post-Quill developments.    After Quill, the Supreme Court has

generally avoided Commerce Clause cases involving the authority of
                                     23

states to impose taxes other than sales and use taxes on out-of-state

entities with or without “physical presence.”   While there have been a

number of cases in which the question has been squarely posed, the

Supreme Court has repeatedly denied certiorari on them. See, e.g., A & F

Trademark, Inc. v. Tolson, 605 S.E.2d 187, 194–95 (N.C. Ct. App. 2004),

cert. denied, 546 U.S. 821 (2005); Geoffrey, Inc. v. S.C. Tax Comm’n, 437

S.E.2d 13, 18–19 (S.C.), cert. denied, 510 U.S. 992 (1993); J.C. Penney

Nat’l Bank v. Johnson, 19 S.W.3d 831, 836–42 (Tenn. Ct. App. 1999),

cert. denied, 531 U.S. 927 (2000).
      C. Approach of State Appellate Courts to Nexus Requirement

Under Dormant Commerce Clause for State Taxation of Income.

Geoffrey is the first state case considering the question of whether

“physical presence” was required for the imposition of state taxes other

than sales or use taxes. Geoffrey, 437 S.E.2d at 18 & n.4. In Geoffrey,

the South Carolina Supreme Court considered whether state income

taxes could be imposed on out-of-state franchisors who earned income

based on franchise activities within the state. Id. at 15. In concluding

that a state had such power, the Geoffrey court relied upon the notion

that intangible property acquired a “business situs” in a state where it is

used by a local business. Id. at 18–19; see also Wheeling Steel Corp. v.

Fox, 298 U.S. 193, 210, 56 S. Ct. 773, 777, 80 L. Ed. 1143, 1148 (1936).

Further, the Geoffrey court cited International Harvester for the

proposition that a state may impose a tax on

      such part of the income of a non-resident as is fairly
      attributable either to property located in the state or to
      events or transactions which, occurring there, are within the
      protection of the state and entitled to the numerous other
      benefits which it[] confers.
                                    24

Geoffrey, 437 S.E.2d at 18 (citing Int’l Harvester, 322 U.S. at 441–42, 64

S. Ct. at 1063–64, 88 L. Ed. at 1379).

      As an alternative ground, the Geoffrey court, in summary fashion,

concluded that the physical presence requirement of Bellas Hess and

Quill was not required. Id. According to Geoffrey, “any corporation that

regularly exploits the markets of a state should be subject to its

jurisdiction to impose an income tax even though not physically present.”

Id.; see I Jerome R. Hellerstein & Walter Hellerstein, State Taxation

¶ 6.11, at 6-54 to -83 (3d ed. 2006).        Further, the Geoffrey court
concluded that the presence of intangible property of the taxpayer within

the state was a sufficient nexus to support the imposition of state income

taxes under the Commerce Clause. Geoffrey, 437 S.E.2d at 18.

      While the reasoning of Geoffrey has been criticized as cursory and

conclusory, see Richard H. Kirk, Note, Supreme Court Refuses to Re-

Examine Whether Physical Presence is a Prerequisite to State Income Tax

Jurisdiction: Geoffrey, Inc. v. South Carolina Tax Commission, 48 Tax

Law. 271, 276 (1994), the result has been embraced by other state courts

considering whether the licensing of intangible property, such as

trademarks and business methods, for use within a state provides a

sufficient nexus for income taxation. For example, in A & F Trademark,

the court emphasized that the language of Quill is cramped and limiting,

that Quill was driven largely by considerations of stare decisis that were

inapplicable outside the sales and use tax context, and that the burdens

of sales and use taxes are more substantial than other taxes, such as

state income taxes. A & F Trademark, 605 S.E.2d at 194–95; see also

Comptroller of the Treasury v. SYL, Inc., 825 A.2d 399, 416–17 (Md. 2003)
(citing Geoffrey with approval); Lanco, Inc. v. Dir., Div. of Taxation, 908

A.2d 176, 177 (N.J. 2006), cert. denied, 551 U.S. 1131 (2007)
                                    25

(interpreting Quill narrowly and noting that the Quill Court “carefully

limited its language to a discussion of sales and use taxes”).

      A number of state courts have gone even further than the cases

dealing with intangible property and have held that even banking

transactions within a state satisfy the nexus demands of the Commerce

Clause for purposes of imposition of state taxes other than those on sales

and use. See Capital One Bank v. Comm’r of Revenue, 899 N.E.2d 76,

84–87 (Mass. 2009) (adopting flexible economic substance analysis

rather than physical presence test in context of financial institution
excise taxes); Tax Comm’r v. MBNA Am. Bank, N.A., 640 S.E.2d 226, 234–

36 (W. Va. 2006) (adopting an economic presence analysis in context of

franchise and income taxes). These cases represent the frontier of state

assertions of nexus to tax out-of-state entities in contexts other than

sales or use taxes.

      While most state courts limit Quill to the specific context of sales

and use taxes, a few state court cases seem more sympathetic to

applying Quill outside the sales and use tax context.      In Johnson, the

Tennessee Court of Appeals considered the validity of franchise and

excise taxes imposed against an out-of-state corporation engaged in

credit card activities within the taxing jurisdiction. Johnson, 19 S.W.3d

at 832. While there is language in Johnson that indicated there was no

basis for distinguishing between sales and use taxes and the franchise

and excise taxes involved in the case, the court declined to determine

“whether ‘physical presence’ is required under the Commerce Clause.”

Id. at 842.    A subsequent unpublished opinion of the same court

expresses doubt on the issue.      See Am. Online, Inc. v. Johnson, No.
M2001-00927-COA-R3-CV, 2002 WL 1751434, at *2 (Tenn. Ct. App. July

30, 2002). Further, it is not clear how the Johnson court would have
                                    26

treated a case involving use of intellectual property such as trade names

and trademarks, which arguably have a stronger nexus to the host

jurisdiction than credit cards and other lending transactions.

      In Rylander v. Bandag Licensing Corp., 18 S.W.3d 296 (Tex. App.

2000), the court considered the validity of a tax based solely on the

taxpayer’s possession of a license to do business in Texas. Rylander, 18

S.W.3d at 298. As in Johnson, the court noted that it saw no principled

basis for distinguishing between the sales and use taxes and other types

of state taxes.   Id. at 299–300.   The court, however, did not consider
whether income taxes could be imposed on an out-of-state corporation

from income related to royalty payments arising from the licensing of

intangibles. See id.

      On the precise issue of whether licensing of intangibles for use in a

state that produces income within a state for an out-of-state corporation

is subject to income tax, the weight of state authority is that it does,

either on the ground that physical presence has been satisfied or that the

physical presence requirement does not apply outside the context of

sales or use taxes. In both Bellas Hess and Quill, however, the Supreme

Court reversed judgments of state supreme courts that expansively

applied the “substantial nexus test” of Complete Auto through an

economic impact analysis.      Further, it might be argued that state

supreme courts are inherently more sympathetic to robust taxing powers

of states than is the United States Supreme Court.

      D. Analysis of Constitutionality Under Dormant Commerce

Clause of State Income Tax Assessments in this Case.

      1. Introduction. At the outset, it is important to identify our task
in this case. Our function is to determine, to the best of our ability, how

the United States Supreme Court would decide this case under its case
                                     27

law and established dormant Commerce Clause doctrine. In performing

this task, we do not engage in independent constitutional adjudication,

and we do not seek to improve or clarify Supreme Court doctrine. We

simply do our best to predict how the Supreme Court would decide the

issues presented in this case.

       Based upon our analysis of the above authorities and our

understanding of the underlying constitutional purposes of the dormant

Commerce Clause, we conclude that the district court, in light of the

available Supreme Court precedents, adopted a sound approach when it
held that the dormant Commerce Clause is not offended by the

imposition of Iowa income tax on KFC’s royalties earned from the use of

its intangibles within the State of Iowa. We reach this conclusion for the

reasons expressed below.

       2. Application of Quill “physical presence” test to use of intangible

property to revenue within a state for an out-of-state entity.     We first

consider whether the Quill “physical presence” test is satisfied in this

case. Unlike in Quill, where the only presence in the state, except for

“title to ‘a few floppy diskettes,’ ” resulted from the use of United States

mail and common carriers, this case involves the use of KFC’s intangible

property within the State of Iowa to produce royalty income for KFC. See

Quill, 504 U.S. at 315 n.8, 112 S. Ct. at 1914 n.8, 119 L. Ed. 2d at 108

n.8.

       The United States Supreme Court has not considered this precise

question post-Quill.   In Quill, the majority dismissively referred to the

vendor’s “title to ‘a few floppy diskettes’ ” but recognized that the

diskettes “might constitute some minimal nexus.” Id. Apparently, the
Court believed that the minimal physical presence presented by title to a
                                    28

few floppy diskettes was not “substantial” enough to satisfy Complete

Auto. See id.

      Here, however, the nexus presented by the use of KFC’s intangible

property within the State of Iowa strikes us as far more than title to a few

floppy diskettes. In this case, KFC has licensed its valuable intellectual

property for use within the geographic boundaries of the State of Iowa to

produce income. This case thus does not involve the arguably “slightest

presence” of intangible property within Iowa, but a far greater

involvement with the forum state.
      Under the applicable pre-Quill case law, the use of intangibles

within a state to generate revenue for an out-of-state entity was generally

regarded as a sufficient nexus under the dormant Commerce Clause to

support the imposition of a state income tax. For instance, in Whitney,

noted above, the Court upheld a Commerce Clause challenge to the

taxation of profits made from the sale of a seat on the New York Stock

Exchange. Whitney, 299 U.S. at 374, 57 S. Ct. at 239, 81 L. Ed. at 289.

Although the taxpayer had no physical presence in New York, the Court

reasoned intangibles may be sufficiently localized “to bring it within the

taxing power” of the state. Id. We view the intangibles in this case to be

sufficiently “localized” under Whitney to provide a “business situs”

sufficient to support an income tax on revenue generated by the use of

the intangibles within Iowa. See id.; see also Mobil Oil Corp. v. Comm’r of

Taxes, 445 U.S. 425, 445–46, 100 S. Ct. 1223, 1235–36, 63 L. Ed. 2d

510, 526 (1980) (holding intangibles may be located in more than one

state depending upon their use); Wheeling Steel Corp., 298 U.S. at 213–

14, 56 S. Ct. at 778–79, 80 L. Ed. at 1149–50 (1936) (concluding that
accounts receivable and bank deposits have business situs in host state);

Sheldon H. Laskin, Only a Name?          Trademark Royalties, Nexus, and
                                     29

Taxing That Which Enriches, 22 Akron Tax J. 1, 16–21 (2007) [hereinafter

Laskin].

      Similarly, the presence of transactions within the state that give

rise to KFC’s revenue provide a sufficient nexus under established

Supreme Court precedent.         In International Harvester, the Court

considered whether Wisconsin could impose an income tax on dividends

received by out-of-state stockholders. Int’l Harvester, 322 U.S. at 438,

64 S. Ct. at 1062, 88 L. Ed. at 1377. The Court concluded that personal

presence within the state is not essential, and that:

      A state may tax such part of the income of a non-resident as
      is fairly attributable either to property located in the state or
      to events or transactions which, occurring there, are subject
      to state regulation and which are within the protection of the
      state and entitled to the numerous other benefits which it
      confers.

Id. at 441–42, 64 S. Ct. at 1064, 88 L. Ed. at 1379 (emphasis added); see

also Curry v. McCanless, 307 U.S. 357, 368, 59 S. Ct. 900, 906, 83 L. Ed.

1339, 1348 (1939) (reasoning that income may be taxed on the basis of

source as well as residence); Shaffer v. Carter, 252 U.S. 37, 57, 40 S. Ct.

221, 227, 64 L. Ed. 445, 458–59 (1920) (same); Jerome R. Hellerstein &

Walter Hellerstein, State and Local Taxation: Cases and Materials 368–69

(7th ed. 2001) [hereinafter Hellerstein & Hellerstein, State and Local

Taxation] (citing Curry, 307 U.S. at 368, 59 S. Ct. at 906, 83 L. Ed. at

1348).

      As a result, we conclude that the Supreme Court would likely find

intangibles owned by KFC, but utilized in a fast-food business by its

franchisees that are firmly anchored within the state, would be regarded

as having a sufficient connection to Iowa to amount to the functional
equivalent of “physical presence” under Quill. Furthermore, the fact that

the transactions that produced the revenue were based upon use of the
                                    30

intangibles in Iowa also provides a sufficient basis to support the tax

under the Commerce Clause.

      3. Extension of “physical presence” nexus requirement to state

taxation of income based on use of intangibles within forum state. In the

alternative, even if the use of intangibles within the state in a franchised

business does not amount to “physical presence” under Quill, the

question arises whether the Supreme Court would extend the Quill

“physical presence” requirement to prevent a state from imposing, on

out-of-state residents, an income tax based on revenue generated from
the use of intangibles within the taxing jurisdiction.    For the reasons

expressed below, we do not believe the Supreme Court would extend the

rule beyond its established moorings in Quill.

      The lynchpin of the Supreme Court’s opinion in Quill was not logic,

or the developing Commerce Clause jurisprudence, but stare decisis.

See Quill, 504 U.S. at 317, 112 S. Ct. at 1915–16, 119 L. Ed. 2d at 109–

10. The prior Bellas Hess standard created an incentive for consumers

to purchase goods from an out-of-state entity, an incentive which in turn

contributed to the dramatic growth of the mail-order business.          See

Michael T. Fatale, Geoffrey Sidesteps Quill:         Constitutional Nexus,

Intangible Property and the State Taxation of Income, 23 Hofstra L. Rev.

407, 409–10 (1994) [hereinafter Fatale]. The Quill Court was unwilling to

upset the settled expectations of a huge mail-order industry after its

growth was spawned by a prior court decision. See Quill, 504 U.S. at

316, 112 S. Ct. at 1915, 119 L. Ed. 2d at 109. Despite this, the Supreme

Court repeatedly recognized that the tides of due process and Commerce

Clause jurisprudence tugged strongly in the opposite direction and that
the issue may have been decided differently if it was one of first

impression. Id. at 311, 112 S. Ct. at 1912, 119 L. Ed. 2d at 105.
                                    31

      Further, it appears that the Court may have been concerned about

the potential of retroactive application if Bellas Hess were reversed. See

id. at 318 n.10, 112 S. Ct. at 1916 n.10, 119 L. Ed. 2d at 110 n.10. This

prospect may have been particularly daunting in Quill, as a reversal of

Bellas Hess could have created a huge tax liability imposed upon out-of-

state vendors for their failure to collect sales and use taxes owed by

others. Here, however, there is no vicarious liability for taxes that should

have been imposed on third parties. Instead, in the income-tax context,

the tax is either owed by the taxpayer or it is not. See 2 Paul J. Hartman
& Charles A. Trost, Federal Limitations on State & Local Taxation 2d

§ 10:7, at 12–13 (Supp. 2010).

      In this case, there is simply no similar reliance interest.      With

respect to state taxation of income whose source is the employment of

intangibles within the taxing jurisdiction, there is simply no Bellas Hess

precedent that gives rise to reliance interests. As demonstrated by the

income-tax nexus cases discussed above, the majority in Quill correctly

noted that “we have not, in our review of other types of taxes, articulated

the same physical-presence requirement that Bellas Hess established for

sales and use taxes.” Quill, 504 U.S. at 314, 112 S. Ct. at 1914, 119

L. Ed. 2d at 108.    To the extent there are any antecedents for state

income taxes, they are International Harvester and Whitney, which do not

require physical presence. Although these cases are due process cases,

they were decided at a time when the nexus requirements of the Due

Process Clause and the dormant Commerce Clause were thought to be

interchangeable.

      In addition, the Supreme Court in Quill sought to defend its
Commerce Clause based physical-presence test with a burdens-type

analysis, noting that if a state could be required to collect and remit use
                                    32

taxes, it might be required to comply with potentially differing

requirements in 6000 or more jurisdictions. Id. at 313 n.6, 112 S. Ct. at

1914 n.6, 119 L. Ed. 2d at 107 n.6.         The burden of state income

taxation, however, is substantially less when far fewer jurisdictions are

involved, when the taxpayer does not become a virtual agent of the state

in collecting taxes from thousands of individual customers, and when tax

assessments are only made periodically.       Indeed, in cases involving

income taxes, the Court has not seemed overly concerned with the

compliance burdens. See Barclays Bank PLC v. Franchise Tax Bd., 512
U.S. 298, 313–14, 114 S. Ct. 2268, 2277–78, 129 L. Ed. 2d 244, 259–60

(1994); Nw. States Portland Cement Co., 358 U.S. at 462–63, 79 S. Ct. at

364–65, 3 L. Ed. 2d at 429–30.

      Advocates of extension of the physical presence test to income

taxes stress the potential burdens on small out-of-state sellers.        A

hypothetical often cited is the author of a book whose work is sold within

a state where the author has never had a physical presence. To impose

income tax on royalties earned by such a transaction, according to some,

would be absurd.

      The hypothetical fails for several reasons. First, slight presence in

a state has never been held sufficient to establish a “substantial nexus”

under the dormant Commerce Clause, and a truly de minimus economic

presence by a book author should not be subject to tax.          See Nat’l

Geographic Soc’y, 430 U.S. at 556, 97 S. Ct. at 1390, 51 L. Ed. 2d at

637. Moreover, royalties earned by an author of a book are ordinarily

paid by a publisher to the author, not by a local retailer. The income

from a book deal thus arises out of the contract between the publisher
and the author. The relationship between the publisher and the local

retailer has no relevance for purposes of income taxation. See Fatale, 23
                                    33

Hofstra L. Rev. at 450; Laskin, 22 Akron Tax J. at 25–26. Further, if

states become overly aggressive in their tax policy, Congress has the

express authority to intervene under the Commerce Clause.

      We also doubt that the Supreme Court would extend the “physical

presence” rule outside the sales and use tax context of Quill. The use of

a “physical presence” test does, of course, limit the power of the state to

tax out-of-state taxpayers, but it does so in an irrational way.       For

example, while in Quill the Court was concerned about the undue burden

on interstate commerce caused by enforcement of sales and use taxes,
“physical presence” within the state does not reduce that burden. See

John A. Swain, State Sales and Use Tax Jurisdiction: An Economic Nexus

Standard for the Twenty-First Century, 38 Ga. L. Rev. 343, 361–62 (2003)

[hereinafter Swain].    Further, the “physical presence” test may protect

small vendors, but it also protects large vendors who are not unduly

burdened. Id. at 363.

      In fact, “physical presence” in today’s world is not “a meaningful

surrogate for the economic presence sufficient to make a seller the

subject of state taxation.” Id. at 392. “Physical presence” often reflects

more the manner in which a company does business rather than the

degree to which the company benefits from the provision of government

services in the taxing state. Does it really make sense to require Barnes

and Noble to collect and remit use taxes, but not impose the same

obligation on Amazon.com, based on the difference in their business

methods?    See H. Beau Baez III, The Rush to the Goblin Market:       The

Blurring of Quill’s Two Nexus Tests, 29 Seattle U. L. Rev. 581, 582 n.8

(2006) [hereinafter Baez]; Bradley W. Joondeph, Rethinking the Role of
the Dormant Commerce Clause in State Tax Jurisdiction, 24 Va. Tax Rev.

109, 135 (2004).
                                          34

       It also seems that, to the extent the Court desired to achieve a

“bright line,” it may not have achieved its objective. As Justice White

predicted in his separate opinion in Quill, the “physical presence” test

has not put an end to dormant Commerce Clause litigation in the sales

and use tax area. Quill, 504 U.S. at 329–30, 112 S. Ct. at 1921, 119

L. Ed. 2d at 118. Quill clearly established that a small sales force, plant,

or office is enough to satisfy the nexus test under the dormant

Commerce Clause. See id. at 315, 112 S. Ct. at 1914–15, 119 L. Ed. 2d

at 108. Nevertheless, the question of how much “physical presence” is
required to establish a “substantial nexus” has still proven problematic.

Compare Orvis Co. v. Tax Appeals Tribunal, 654 N.E.2d 954, 961 (N.Y.)

(holding that occasional traveling personnel entering jurisdiction is

sufficient), cert. denied sub nom. Vt. Info. Processing, Inc. v. Comm’r, 516

U.S. 989 (1995), with Johnson, 19 S.W.3d at 840 & n.18 (reasoning that

physical presence of thousands of credit cards was “constitutionally

insignificant”).    Many other cases grapple with the question of what

amounts to sufficient physical presence to satisfy Quill.1 See Hellerstein

& Hellerstein, State and Local Taxation at 352–54 (citing cases); see also

Baez, 29 Seattle U. L. Rev. at 595–600; Matthew T. Troyer, Note, Mail

Order Retailers and Commerce Clause Nexus: A Bright Line Rule or an

Opaque Standard?, 30 Ind. L. Rev. 881, 897 (1997)                           (asserting

“ ‘[s]ubstantial nexus’ is too vague to function as a bright-line rule”).



         1In a pre-Quill case, we grappled with the problem of physical presence when an

Illinois retailer’s contact with Iowa was incidental general advertising and occasional
deliveries via employee-driven, company-owned trucks. Good’s Furniture House, Inc. v.
Iowa State Bd. of Tax Review, 382 N.W.2d 145, 146–47 (Iowa), cert. denied, 479 U.S.
817 (1986). We concluded that the requisite physical presence under Bellas Hess was
established. Id. at 150. Our ruling was criticized for eroding the physical presence
nexus standard. See Chris M. Amantea, Use Tax Collection Jurisdiction: Retail Stores
on a State Border Held Hostage, 63 Chi.-Kent L. Rev. 747, 759–64 (1987).
                                    35

      There is also the difficult question of when the physical presence of

third parties should be attributed to an out-of-state party for purposes of

establishing a substantial nexus under Complete Auto.       The cases are

hardly uniform. Compare Syms Corp. v. Comm’r of Revenue, 765 N.E.2d

758, 766 (Mass. 2002) (precluding deduction from taxable income royalty

payments made to a passive investment company), with Sherwin-

Williams Co. v. Comm’r of Revenue, 778 N.E.2d 504, 518–19 (Mass. 2002)

(permitting deduction from taxable income royalty payments made to a

passive investment company). See generally Laskin, 22 Akron Tax J. at
7 n.24, 8–13.

      Moreover, if a “bright line” test is needed in the income tax arena,

it may not be physical location but something else, particularly when

taxation is based upon the source of the income. For example, the three-

factor formula behind the Uniform Division of Income for Tax Purposes

Act has been called “something of a benchmark.” Container Corp. of Am.

v. Franchise Tax Bd., 463 U.S. 159, 170, 103 S. Ct. 2933, 2943, 77

L. Ed. 2d 545, 556 (1983).

      We also note that the Quill decision impliedly suggests a desire on

the part of the Supreme Court to defer to Congress on most nexus

issues.   We find significant the holding of the Quill Court that the

imposition of sales and use taxes by states on out-of-state residents who

utilize only mail and common carriers did not violate due process. By

removing the due process impediment to state taxation of mail-order

sales when physical presence was lacking, the Quill Court opened the

door to congressional action.

      It seems clear that the Quill majority recognized that difficult
issues of determining the extent to which the states should be allowed to

impose tax obligations on comparatively remote entities was infused with
                                      36

policy and legislative-type judgments that could not be resolved in the

context of judicial determination of a particular case. Certainly Justice

Scalia and Justice Thomas would not extend the line drawing under the

dormant Commerce Clause outside what is required by stare decisis.

See, e.g., Am. Trucking Ass’ns v. Scheiner, 483 U.S. 266, 304, 107 S. Ct.

2829, 2851, 97 L. Ed. 2d 226, 256 (1987) (Scalia, J., dissenting)

(asserting judicial intervention under dormant Commerce Clause should

be limited to cases involving discrimination against interstate commerce).

      We recognize that a counterargument could be made that
aggressive judicial intervention is required to prevent states from shifting

tax burdens onto out-of-state parties who lack political power in the

taxing jurisdiction. We question, however, whether out-of-state entities

are as powerless in the halls of state legislatures as they once were in

light of the growth of national advocacy groups that protect the local

interests of their members and the involvement of national political

parties in state political affairs.   In addition, in this case, the in-state

presence of franchisees, whose interest in tax matters are likely to be

aligned with the franchisor, are well positioned to participate in the local

political process.   We further note that the mechanism to control any

improper shifting     of tax burdens       onto out-of-state taxpayers is

enforcement of the discrimination and apportionment prongs of Complete

Auto, not the nexus requirement.

      Another factor that suggests the physical-presence test should not

be extended outside its sales and use tax confines is the potential for tax

evasion that the test engenders. Obviously, this concern did not carry

the day in Quill. But experience should be instructive; namely, the result
in Bellas Hess created a huge loophole in the tax structure that, twenty-

five years later was practically impossible to close. Further, extension of
                                    37

the “physical presence” approach in Quill would be an incentive for entity

isolation in which potentially liable taxpayers create wholly owned

affiliates without physical presence in order to defeat potential tax

liability.   See Swain, 38 Ga. L. Rev. at 366–68.      We doubt that the

Supreme Court would want to extend such form-over-substance activity

into the income tax arena where substance over form has been the

traditional battle cry. Scripto, Inc., 362 U.S. at 211, 80 S. Ct. at 622, 4

L. Ed. 2d at 664 (noting that to permit the fine distinction between

employees and independent contractors to control the result of taxation
under the Commerce Clause would “open the gates to a stampede of tax

avoidance”).

       Finally, we think taxation of the income here is most consistent

with the now prevailing substance-over-form approach embraced in most

of the modern cases decided by the Supreme Court under the dormant

Commerce Clause.      When a company earns hundreds of thousands of

dollars from sales to Iowa customers arising from the licensing of

intangibles associated with the fast-food business, we conclude that the

Supreme Court would        engage in a     realistic   substance-over-form

assessment that would allow a state legislature to require the payment of

the company’s fair share of taxes without violating the dormant

Commerce Clause.

       For the above reasons, we hold that a physical presence is not

required under the dormant Commerce Clause of the United States

Constitution in order for the Iowa legislature to impose an income tax on

revenue earned by an out-of-state corporation arising from the use of its

intangibles by franchisees located within the State of Iowa. We hold that,
by licensing franchises within Iowa, KFC has received the benefit of an

orderly society within the state and, as a result, is subject to the
                                    38

payment of income taxes that otherwise meet the requirements of the

dormant Commerce Clause. As a result, the district court judgment on

the dormant Commerce Clause issues in this case is affirmed.

      IV. State Law Claims.

      A. State Law Claim Under Iowa Code Section 422.33. In the

alternative to its constitutional attack under the dormant Commerce

Clause, KFC argues that the imposition of tax in this case is not

authorized by the provisions of Iowa law and related administrative

regulations that authorize the imposition of income tax on corporations
because of the lack of physical presence within Iowa.

      We do not agree. The applicable provision of the Code, Iowa Code

section 422.33(1) (1997), imposes an income tax on each corporation

“doing business in this state, or deriving income from sources within this

state.”   Iowa Code § 422.33(1).    Iowa Code section 422.33(1) further

provides that “income from sources within the state” includes “income

from real, tangible, or intangible property located or having a situs in the

state.” Id. § 422.33(1)(d). The reference to “intangible property” located

or “having a situs in the state” is a clear reference to the applicable case

law dealing with taxation of income arising from the use of intangibles in

connection with transactions within a state.        See, e.g., Nw. States

Portland Cement Co., 358 U.S. at 464–65, 79 S. Ct. at 365–66, 3

L. Ed. 2d at 430–31; Int’l Harvester, 322 U.S. at 442, 64 S. Ct. at 1064,

88 L. Ed. at 1379–80; Whitney, 299 U.S. at 371–72, 57 S. Ct. at 238, 81

L. Ed. at 287–88. Therefore, the tax at issue in this case falls squarely

within the intended scope of Iowa Code section 422.33.

      This interpretation is not diminished by, nor is there anything
invalid about, the administrative regulations promulgated pursuant to

the statute. IDOR has promulgated regulations implementing Iowa Code
                                    39

section 422.33(1).    Under the applicable rules, the statutory phrase

“intangible property located or having a situs in this state” is further

defined to include intangible property that “has become an integral part

of some business activity occurring regularly in Iowa.” Iowa Admin. Code

r. 701—52.1(1)(d), (4) (1997).     Citing Geoffrey, the rules specifically

provide that, if a corporation owns trademarks and trade names that are

used in Iowa, a business situs for purposes of taxation may be present

even though the corporation has no physical presence or other contact

with Iowa. See Iowa Admin. Code r. 701—52.1(4) (Example 4); see also
Geoffrey, 437 S.E.2d at 18–19.        The administrative regulations are

simply a logical interpretation of the statute with citation to the evolving

case law on the taxation of revenues earned or arising out of intangible

property.

      B. Other State Law Claims.         KFC raises two other state law

claims on appeal. First, it claims that a policy letter issued by IDOR is

contrary to the position IDOR has taken in this case and that IDOR has

not provided an adequate explanation for its departure from its

established policy.   Second, KFC claims that IDOR erred by assessing

penalties against KFC for its failure to pay the asserted taxes.

      Neither of these issues, however, has been preserved for our

review.     KFC claims that the issues were properly raised before the

agency. Even if the issues were properly raised before the agency, KFC

was required to file a motion for rehearing under Iowa Code section

17A.16(2) (2009) to preserve the issues when the agency issued a final

order that did not address them. This KFC did not do. As a result, when

KFC filed its appeal of the administrative action with the district court,
there was no ruling on the policy letter or penalty issues for the district

court to review.
                                     40

      When an agency fails to address an issue in its ruling and a party

fails to point out the issue in a motion for rehearing, we find that error

on these issues has not been preserved.           Our respect for agency

processes in administrative proceedings is comparable to that afforded to

district courts in ordinary civil proceedings. Just as we do not entertain

issues that were not ruled upon by the district court and that were not

brought to the district court’s attention through a proper posttrial

motion, Meier v. Senecaut, 641 N.W.2d 532, 540 (Iowa 2002), we decline

to entertain issues not ruled upon by an agency when the aggrieved
party failed to follow available procedures to alert the agency of the issue.

See Soo Line R.R. v. Iowa Dep’t of Transp., 521 N.W.2d 685, 688 (Iowa

1994) (stating that the scope of administrative review is limited to

questions that were actually considered by the agency); Chi. & Nw.

Transp. Co. v. Iowa Transp. Regulation Bd., 322 N.W.2d 273, 276 (Iowa

1982) (finding that an issue first raised in motion for rehearing and

considered by the agency is preserved); Charles Gabus Ford, Inc. v. Iowa

State Highway Comm’n, 224 N.W.2d 639, 647 (Iowa 1974) (discussing

requirement of exhaustion of administrative remedies when agency has

primary or exclusive jurisdiction over controversy).

      V. Conclusion.

      For the above reasons, we conclude that the assessment of income

tax liability made by IDOR against KFC does not violate the dormant

Commerce Clause or any provision of Iowa law.          We further conclude

that the issues related to the policy letter and the assessment of

penalties have not been preserved. As a result, we affirm the judgment

of the district court upholding the action of IDOR in all respects.
      AFFIRMED.

      All justices concur except Wiggins, J., who concurs in result.
