IN THE COURT OF APPEALS OF IOWA

No. 16-0416

Filed May 3, 2017

ROMANTIX HOLDINGS, INC., ROMANTIX, INC., ABV MANAGEMENT, INC., 

BOOKS, INC., PPI, INC., PPA, INC., and SWAN BOOKS, INC.,

Petitioners-Appellants,

vs.

IOWA DEPARTMENT OF REVENUE,

Respondent-Appellee.

________________________________________________________________

Appeal from the Iowa District Court for Polk County, Richard G. Blane II

and Karen A. Romano, Judges.

A parent corporation and its subsidiaries appeal the district court’s ruling 

on judicial review affirming the Iowa Department of Revenue’s conclusions that 

the parent corporation was ineligible to join its subsidiaries’ consolidated Iowa 

income tax returns because it had no taxable income in Iowa and that its 

subsidiaries could not claim certain expenses incurred and paid by the parent 

corporation. AFFIRMED.

Ronald L. Mountsier of Dickinson, Mackaman, Tyler & Hagen, P.C., Des 

Moines, for appellants.
2

Thomas J. Miller, Attorney General, and Paxon J. Williams, Assistant 

Attorney General, for appellee.

Heard by Vogel, P.J., and Doyle and McDonald, JJ. Blane, S.J., takes no 

part.
3

DOYLE, Judge.

The Director (Director) of the Iowa Department of Revenue (Department) 

issued a final order concluding a parent corporation, Romantix Holdings, Inc. 

(Holdings), was ineligible to join its subsidiaries’ (Iowa Subsidiaries) consolidated 

Iowa income tax returns because Holdings was not doing business in Iowa for 

purposes of inclusion on a consolidated tax return. It also concluded the Iowa 

Subsidiaries were ineligible to deduct certain expenses incurred and paid by 

Holdings. Holdings and the Iowa Subsidiaries (collectively Petitioners) petitioned 

for judicial review. Following judicial review, the district court affirmed the 

agency’s final order. On appeal, Petitioners contend Holdings derived taxable 

income from the Iowa Subsidiaries entitling it to join the Iowa Subsidiaries’ Iowa 

consolidated income tax returns. Additionally, it is argued that the Iowa 

Subsidiaries properly claimed the expenses of Holdings because the Iowa 

Subsidiaries were jointly and severally liable for payment of the expenses and 

“paid” the expenses by allocation. Upon our review, we affirm the district court’s 

ruling denying and dismissing Petitioners’ petition for judicial review and affirming 

the Director’s order on remand.

I. Standard of Review.

Our review of final decisions of the Department is governed by the Iowa 

Administrative Procedure Act, codified at Iowa Code chapter 17A (2015). See 

Iowa Code § 422.29; KFC Corp. v. Iowa Dep’t of Revenue, 792 N.W.2d 308, 312 

(Iowa 2010). Under section 17A.19, we must determine “[t]he validity of agency 

action . . . in accordance with the standards of review” set forth in that provision. 

Iowa Code § 17A.19(8)(b). We “give appropriate deference to the view of the 
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agency with respect to particular matters that have been vested by a provision of 

law in the discretion of the agency.” Id. § 17A.19(11)(c). Section 422.68(1) gives 

the Director “the power and authority to prescribe all rules not inconsistent with 

the provisions of this chapter, necessary and advisable for its detailed 

administration and to effectuate its purposes.” Consequently, we will uphold the 

Department’s decision unless its interpretation is irrational, illogical, or wholly 

unjustifiable. See id. § 17A.19(10)(l); Myria Holdings Inc. v. Iowa Dep’t of 

Revenue, ___ N.W.2d ___, ___, 2017 WL 1103175, at *3 (Iowa 2017). A 

decision is “irrational” if it is “not governed by or according to reason,” illogical if it 

is “contrary to or devoid of logic,” and “unjustifiable” if “it has no foundation in fact 

or reason.” The Sherwin-Williams Co. v. Iowa Dep’t of Revenue, 789 N.W.2d 

417, 432 (Iowa 2010).

II. Background Facts and Proceedings.

Holdings is a holding company that owns and operates numerous 

subsidiaries as well as the Romantix trademark. Each individual subsidiary 

performs a function in the overall business. Some subsidiaries own RomantixTM 

adult book stores, nine of which are located in Iowa, which sell apparel, novelties, 

lubricants, lotions, books, magazines, and DVDs. Another subsidiary, Romantix 

Inc. (Inc.), acts as a management company. All the revenue from the stores is 

transferred to Inc. daily, and Inc. then uses this money to pay the stores’ 

expenses. Another subsidiary, RMI Aviation (RMI), owns an airplane and an 

airplane hangar. The airplane is used by the Midwest stores for business travel. 

Inc. uses the funds received from the stores that utilized their services to pay 
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RMI’s expenses. Holdings does not, by itself, sell products or provide services in 

Iowa.

The current owner of Petitioners, Steven Brown, acquired ownership in a 

transaction dated September 26, 2007. As part of the acquisition transaction, a 

number of documents and agreements were executed, including a stock 

redemption agreement, a loan agreement, a redemption note, a subsidiary 

guaranty, and a security agreement. The transaction involved two steps: Brown 

personally bought 100 shares of stock in Holdings from Edward Wedelstedt, and 

Holdings redeemed from Wedelstedt the remaining shares Wedelstedt owned in 

Holdings. The redemption was financed by debt incurred by Holdings; the debt

was payable in monthly installments over a course of 15 years and had an 

interest rate of 8.5%. None of the subsidiaries owned by Holdings bought any of 

the shares from Wedelstedt, but all the Iowa Subsidiaries agreed to guaranty the 

debt. Also, included in the stock redemption agreement was a covenant not to 

compete. The covenant prohibited Wedelstedt from opening a competitive store 

within 25 miles of any of the stores that were part of the purchase agreement, 

including the nine Iowa stores. In exchange for the covenant not to compete, 

Holdings agreed to pay $100,000 per year for 15 years. The Iowa Subsidiaries

guaranteed this debt as well.

At issue here are the 2009 and 2010 consolidated Iowa income tax returns 

of the Iowa Subsidiaries. The 2009 Iowa consolidated return included Holdings

and all of its subsidiaries (including non-Iowa subsidiaries), but did not include 

the interest and amortization as an expenses for the subsidiaries because the 

entirety of the expense was allocated to Holdings. The 2010 consolidated Iowa 
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return included Holdings’ Iowa subsidiaries, but not Holdings, and the interest 

and amortization expenses were allocated to the Iowa Subsidiaries based on a 

percentage of revenue approach. The Department apparently disallowed the 

expenses, and Petitioners filed a protest. A hearing was held before an 

administrative law judge (ALJ). The ALJ reversed the Department’s income tax 

assessments pertaining to the expenses. The Department appealed the ALJ’s 

proposed decision to the Director. The Director issued a final order ruling that 

Holdings should not be included on the Iowa Subsidiaries’ consolidated Iowa 

income tax returns and that the Iowa Subsidiaries were not allowed to deduct 

Holdings’ acquisition debt and covenant not to sue expenses because the 

subsidiaries did not owe and did not pay the expenses.

Petitioners filed a petition for judicial review. The district court found that 

“the Director’s finding that Iowa Subsidiaries did not owe the [acquisition and 

covenant not to compete] debt is not supported by substantial evidence.” The 

court remanded the matter to the Director “to give more specific reasoning for 

why the individual statutes and rules cited by Petitioners when applied to the 

facts of this matter do not allow Petitioners to make the desired deduction.” The 

court affirmed the Director’s finding that Holdings is not subject to Iowa income 

tax and is therefore prohibited from being included in the Iowa Subsidiaries’ 

consolidated tax return.

On remand, the Director concluded in her final order that “[b]ecause the 

Iowa subsidiaries are not the primary obligors under the Loan Agreement, 

[Petitioners] fail the first test for deductibility of the acquisition interest.” The 

Director also concluded “[Petitioners] have failed to meet their burden to 
7

establish that the covenant not to compete was acquired, directly or indirectly, by 

the Iowa [S]ubsidiaries.” The Director ordered that the Iowa Subsidiaries were 

not entitled to deduct interest and amortization expenses related to redemption of 

Holdings stock.

Taking issue with a number of the Director’s conclusions, Petitioners again 

filed a petition for judicial review. The district court concluded:

While the Director erred in failing to recognize the Iowa 

Subsidiaries as primary obligors of the acquisition debt, the 

Director, in noting the Iowa Subsidiaries’ failure to pay the 

expenses originally allocated to Holdings, provided a proper basis 

for the Iowa Subsidiaries to nevertheless be unable to deduct the 

expenses.

The court denied and dismissed Petitioner’s petition and affirmed the Director’s 

order on remand.

Petitioners appeal.

III. Discussion.

On appeal, Petitioners argue that because the Iowa Subsidiaries do 

business within Iowa, Holdings, in effect, does business within Iowa and should 

therefore be included for taxation purposes in the consolidated Iowa tax returns. 

Additionally, Petitioners argue that even if Holdings is not included, the Iowa 

Subsidiaries are responsible for and paid the disputed expenses. We address 

their arguments in turn.

A. Including Holdings in Consolidated Return.

Petitioners contend Holdings is not exempt from taxation under Iowa Code 

section 422.34A(5) because it “directly owned intangible property that was 

utilized by its subsidiaries in the subsidiaries’ Iowa business activity,” which they
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argue “has the functional equivalent of physical presence in the state that relates 

to the ownership or control of the subsidiary.” A similar argument was raised and 

recently rejected by the Iowa Supreme Court in Myria Holdings Inc., ___ N.W.2d 

at ___, 2017 WL 1103175, at *6.

In Myria Holdings Inc., Myria and its subsidiaries argued Myria had a 

taxable nexus with Iowa because its subsidiaries did business in Iowa and 

because it owned “two types of intangible property with a situs in Iowa: shares of 

stock and money.” Id. at *7. First, the court concluded that the activities Myria 

performed for its Iowa subsidiaries “were all activities of owning and controlling a 

subsidiary corporation,” removing Myria from the safe harbor of section 

422.34A(5), since the “legislature has exempted from income taxation the 

activities of owning and controlling a subsidiary corporation under Iowa Code 

section 422.34A(5).” Id. at *7-8. Second, the court concluded section 

422.34A(5)

clearly contemplates that an entity engaging in activities of owning 

a subsidiary corporation necessarily holds some evidence of its 

ownership interest. If the statute is to have any meaning or effect 

as a safe harbor, the certificates evidencing Myria’s ownership 

interest in [its subsidiaries] cannot themselves create a taxable 

nexus with the state sufficient to remove Myria from the safe 

harbor.

Id. at *7. Similarly, the court determined Myria did not establish a taxable nexus 

with the state by permitting its subsidiaries to use its “money” under the tax 

allocation agreement, explaining “the quarterly payments by the subsidiaries of 

amounts equal to their respective shares of [Myria’s and its subsidiaries’] income 

tax obligation did not constitute Myria’s money with a situs in Iowa under rule 

701-52.1(1)(d) promulgated by the Department.” Id. at *8. The court therefore 
9

concluded “all of Myria’s activities with its subsidiaries doing business in Iowa 

were activities of owning and controlling [its subsidiaries] within the meaning of 

section 422.34A(5) and Myria did not acquire a taxable nexus by virtue of owning 

‘shares of stock’ or ‘money’ in Iowa.” Id.

Based upon the court’s ruling in Myria Holdings Inc., it is clear the Iowa 

Subsidiaries and their intangible property are not enough to establish a taxable 

nexus with Iowa sufficient to remove Holdings from the safe harbor. See id. at 

*7-8. Like Myria, by electing to have the Iowa Subsidiaries taxed as 

corporations, Holdings chose to receive not only the tax advantages of corporate 

taxation but any disadvantages as well. All of Holdings’s activities with its 

subsidiaries doing business in Iowa in the relevant tax years were activities of 

owning and controlling a subsidiary corporation within the meaning of Iowa Code 

section 422.34A(5). Holdings has not otherwise established a taxable nexus with 

the state. Thus, because Holdings lacked a taxable nexus with the State of Iowa 

in relevant tax years, the Department correctly concluded Holdings could not join 

the consolidated return. We therefore affirm on this issue.

B. Payment of Expenses by the Iowa Subsidiaries.

Petitioners also argue that regardless of whether Holdings could join the 

consolidated return, the Iowa Subsidiaries should be able to claim the disputed 

expenses for several reasons. First, Petitioners assert Holdings allocated the 

disputed expenses to the Iowa Subsidiaries for tax purposes. However, mere 

allocation is not enough under Iowa’s taxation structure, as detailed by the 

Director:
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The allocation of expenses by Holdings is not binding on Iowa for 

tax purposes. See Iowa Admin. Code r. 701-53.15(6)(c) (stating 

that no agreement entered into among members of the affiliated 

group shall have the effect of reducing the Iowa tax liability of the 

members subject to Iowa’s income tax). The way [Holdings] may 

choose to treat [Holdings’s] expenses on internal reports or reports 

to creditors is not binding on Iowa for tax purposes. See [id.]

Additionally, Petitioners contend the Iowa Subsidiaries could claim the 

disputed expenses because the expenses were paid by the Iowa Subsidiaries. 

Petitioners first assert they were not on notice that the Department’s decision 

was based upon the Iowa Subsidiaries’ failure to pay the expenses; rather, they 

argue the Department only provided notice that its decision was based upon the 

fact the Iowa Subsidiaries did not owe the expenses. Petitioners claim their

alleged lack of notice meant the Department, and then the district court on 

review, could not reject the expenses because the Iowa Subsidiaries did not pay 

the expenses.

Upon our review of the record, it is clear the Department’s position was 

that expenses not owed1and paid by the subsidiaries could not be claimed as 

expenses of the subsidiaries. In fact, there is nothing in the record that indicates 

Petitioners ever claimed, until the hearing, that the Iowa Subsidiaries paid the 

 

1 The district court found that “the Director’s findings that the Iowa Subsidiaries did not 

owe the debt is not supported by substantial evidence, as the security agreement shows 

that all of the individual subsidiaries which make up the Iowa Subsidiaries agreed to the 

terms and conditions set out in the loan agreement.” The Director’s order on remand 

ignored this ruling. In its ruling on judicial review from the Director’s order on remand, 

the district court reversed the Director’s ruling that the Iowa Subsidiaries are not primary 

obligors and did not owe the acquisition debt. No doubt the Department did not appeal 

from this adverse ruling because the district court denied and dismissed Petitioners’ 

petition for judicial review. On appeal, the Department continues to assert that “[b]eing

guarantors for the loan from Wedelstedt to Holdings does not entitle the [Iowa 

Subsidiaries] to deduct the loan expenses as their own.” Having concluded the Iowa 

Subsidiaries did not pay the disputed expenses, we need not decide the issue of 

whether the Iowa Subsidiaries, as guarantors, were entitled to take a deduction for the 

interest on the loan obligation.
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disputed expenses. The Department could not formally reject an assertion that 

was never made by Petitioners. Moreover, Petitioners had the burden of proving 

the Iowa Subsidiaries actually paid the disputed expenses. See Iowa Code 

§ 421.60(6)(c).

At the hearing before the ALJ, counsel for the Department, in her opening 

statement, explained the Department’s position was that because the Iowa 

Subsidiaries did not pay the claimed expenses—rather Holdings paid the 

expenses—the Iowa Subsidiaries were not permitted to deduct the expenses. 

The president of Holdings, Steven Brown, testified at the hearing that Holdings 

itself did not conduct business directly as an entity, explaining, “Well, there’s no 

sales and no checks being written other than for the notes. The line of credit is 

held by [Holdings] because that’s the ultimate company. The bank wants it that 

way.” The Department tried to clarify whether Holdings or one of its subsidiaries 

paid the claimed expenses, and the following exchange with Brown occurred:

Q. And you stated [Holdings] has no sales, writes no checks, 

except for it has a line of credit, and then also it, I think you 

testified—and I just want to clarify—that they did write checks, then, 

on the acquisition, and for that you’re referring to these various 

agreements that are exhibits, the stock redemption agreement and 

the loan agreement and the loan that was taken—the note that was 

taken? A. The loan payments—well—

Q. Were made by [Holdings]? A. Again, let me clarify. They 

don’t write the checks. Romantix, Inc., writes the checks, but it’s

charged to them because the notes are set up in the Holdings.

Q. Right. It’s Romantix— A. We have an intercompany 

transaction.

Q. [Holdings] gets paid? A. [Holdings], that’s paid from 

Romantix.

Q. Correct. A. Yeah.

Q. Okay. I think we’re— A. Yeah.

Q. So in the [Holdings]’s exhibits, when it allocates interest—

the interest that’s at issue here, then it’s based on something other 

than the amounts that those subsidiaries actually wrote checks for 
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and paid. A. I’m going to tell you how I think it is, and then maybe 

[the CPA that completed the tax returns] can make sure that I’m 

right.

The CPA was not specifically asked if Holdings or its subsidiaries paid the 

disputed expenses.

The ALJ found “Holdings makes payments on the principal and interest 

through funds generated by its subsidiaries.” However, he concluded ultimately 

Petitioners “cannot be barred from claiming expenses paid by subsidiaries or the 

parent company that are part of the greater corporate structure doing business in 

Iowa,” reversing the Department’s tax assessments pertaining to the claimed 

expenses.

After the Department appealed the ruling to the Director, the Director 

factually found, in part of its ruling, that

[a]ll revenue from sales by the stores comes into the subsidiaries 

that own them and then is transferred to [Inc.] on a daily basis. 

[Inc.] uses those funds to pay expenses and allocates a paper 

expense to each subsidiary. Some of the expenses are directly 

related to the subsidiary, e.g., salaries for employees who work at a 

store. Other expenses are more general, such as accounting and 

management, and are apportioned to subsidiaries based on a 

proportion of the revenue produced by the subsidiary.

(Emphasis added.) The Director went on to find, like the ALJ, that “Holdings 

makes payments on the principal and interest through funds generated by its

subsidiaries.” The Director concluded:

The amounts at dispute include expenses for amortization of 

a non-compete agreement for the previous owner, [Wedelstedt], 

and expenses for interest on the debt from the acquisition of the 

business. The legitimate expenses incurred and paid by Holdings, 

pursuant to the redemption loan and agreement, cannot be 

deducted by other corporations. Neither the ALJ nor [Petitioners]

have cited any federal or Iowa statute or rule that allows the 
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subsidiaries subject to Iowa income tax to deduct expenses that 

they never paid and that were not legally owed by them.

The Director explained the Department appropriately allowed the Iowa 

Subsidiaries to claim expenses they paid to another of Holdings’s subsidiaries 

that did not do business in Iowa because they were the Iowa Subsidiaries’ 

expenses, which they themselves paid.

Although the Department allowed expenses related to Inc. and 

[RMI] as deductions for Holdings’ subsidiaries subject to Iowa’s 

income tax, they are easily distinguished from Holdings’ interest

and amortization expenses. The expenses allowed were for 

expenses of the subsidiaries and were paid by the Iowa 

[S]ubsidiaries for services received by the subsidiaries that were 

necessary for and benefitted the affiliates’ business activities. As 

part of the management services, Inc.’s employees came into the 

state and oversaw activities of stores in Iowa. In the case of [RMI, 

RMI] owns an airplane that was used primarily for the . . . stores

located in the Midwest. The Iowa [S]ubsidiaries pay [RMI] for its 

services and the Department allowed the subsidiaries to deduct 

their own expenses paid to [RMI] for services it provided to the 

subsidiaries, not Holdings’ expenses.

We surmise from the above quoted paragraph that the Director was 

distinguishing Inc.’s payment of the subsidiaries’ expenses from the expenses 

related to Holdings. Although Inc. may have actually cut the checks for 

Holdings’s interest and amortization expenses, the Director did not find that Inc. 

paid Holdings’s expenses.

The district court agreed with this distinction, finding “that these cases are 

different, as Iowa Subsidiaries pay the RMI related expense while Iowa 

Subsidiaries do not pay Holdings’s expenses,” and the court concluded 

substantial evidence showed “the checks written to pay the debt were charged to 

Holdings and Inc. only supplied the money to pay the debt.” The court reasoned 

that because
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deductibility requires that a taxpayer both owe the expense and pay 

it . . . , a taxpayer cannot claim a right to a deduction for expenses 

they owe but have not paid. Payment by the Iowa Subsidiaries was 

something Petitioners had to prove in order to clearly establish that 

the Iowa Subsidiaries were entitled to a deduction and that the 

Department acted erroneously. Petitioners did not do this.

The court concluded the Director’s finding that the Iowa Subsidiaries failed to pay 

the expenses originally allocated to Holdings “provided a proper basis for the 

Iowa Subsidiaries to nevertheless be unable to deduct the expenses.” Further, 

even if the internal allocation of the amortization expense amongst the Iowa 

Subsidiaries constituted “payment” of the expenses, the agency was correct in 

disallowing the deductions because the amortization expenses were not a 

“necessary and reasonable expense” of the subsidiaries in generating taxable 

income. See I.R.C. § 162 (allowing for deductions against income the 

“necessary and reasonable expenses” incurred in generating the income); see

also In re US Bancorp Piper Jaffray, Inc. v. Dep’t of Revenue & Fin., No. 

2002DORFC005, 2002 WL 32931969, at *3 (Iowa Dep’t Inspections & App. May 

14, 2002) (stating the general rule). Based on the record before us and the 

reasons stated by the district court, we agree. We therefore affirm on this issue.

IV. Conclusion.

Because Holdings lacked a taxable nexus with the State of Iowa in 

relevant tax years, the Department correctly concluded Holdings could not join 

the consolidated return. Additionally, Petitioners did not establish the disputed

expenses were paid by the Iowa Subsidiaries. Accordingly, we affirm the ruling 

of the district court denying and dismissing Petitioners’ petition for judicial review

and affirming the Director’s order on remand.

AFFIRMED.