The Illinois Department of Revenue recently has adopted final rules1 concerning the sourcing of sales for local retailers' occupation tax (ROT) purposes that are designed to implement the Illinois Supreme Court's ruling in Hartney Fuel Oil Co. v. Hamer.2 In Hartney, the Court struck down the Department's long-standing rules governing the sourcing of sales for local ROTs. The Court held that the bright-line purchase order acceptance test contained in the rules was contrary to law. Also, the Court held that the determination of the proper location for sourcing local ROTs requires a fact-specific inquiry into the totality of a retailer's selling activities. The final rules, which differ from the emergency and proposed rules issued earlier this year, are intended to provide guidance for retailers in sourcing local sales to the location where they are "engaged in the business of selling tangible personal property."

Background

In Illinois, retailers are subject to a state-level ROT, as well as locally-imposed ROTs. The major issue for Illinois retailers is that the local ROT rates are not uniform within the state. In some jurisdictions, the combination of state and locally-imposed taxes can approach 9.5 percent, while in other jurisdictions, no local taxes are imposed and the rate consists only of the state rate, 6.25 percent. To further complicate matters, unlike most other states, Illinois law provides that sales are sourced to the location of the seller.

For almost 60 years, Department rules provided a bright-line test for determining the proper location for sourcing locally-imposed taxes – the location where the purchase order was accepted. The Department's local sourcing rules provided that in sourcing sales between those local jurisdictions in which selling activities occur, "the most important single factor in the occupation of selling" was the "acceptance" of the purchase order.3 In Hartney, the Illinois Supreme Court concluded that the definition of selling for purposes of the local ROTs is determined by a composite of many activities requiring a fact-intensive inquiry.4 After Hartney invalidated the existing rules, the Department adopted emergency rules on January 22, 20145 and proposed permanent rules on February 7, 20146 to implement the Court's holding. Prior to adopting the final rules,7 the Department made a number of changes in response to comments received, as well as additional changes agreed upon with the Illinois General Assembly's Joint Committee on Administrative Rules (JCAR).

Selling Activities Determine Taxing Jurisdiction

The final rules explain that selling activities, rather than actual sales, determine the jurisdiction in which a retailer is subject to local ROTs.8 Thus, the jurisdiction in which the sale takes place is not necessarily the jurisdiction where the tax is owed. The occupation of selling is comprised of "the composite of many activities extending from the preparation for, and the obtaining of, orders for goods to the final consummation of the sale by the passing of title and payment of the purchase price."9 Thus, establishing where "the taxable business of selling is being carried on" requires a fact-specific inquiry into the composite of activities that comprise the retailer's business.10

A seller incurs ROT in the county (taxing jurisdiction) in which its predominant and most important selling activities take place.11 Isolated or limited business activity within a jurisdiction does not constitute engaging in the business of selling in that jurisdiction when other more significant selling activities occur elsewhere. The Department may look through the form of a transaction to its substance in determining where the retailer is subject to tax.12

The rules clarify that the same sourcing standards apply to both intrastate and interstate retailers.13 Also, because it is not feasible for retailers to divide their tax among competing jurisdictions, a retailer subject to tax is engaged in the business of selling in only one location in Illinois for each sale.14

Composite of Selling Activities Test

The rules establish five primary selling activities to consider in determining where the retailer engages in selling activity. Also, the rules provide six secondary selling activities to be reviewed if a company does not have three of the five primary factors in any one location.

Primary Selling Activities

A retailer that engages in three or more of the following primary selling activities at a location must source the sales to that location:

  • Location of sales personnel exercising discretion and authority to solicit customers on the seller's behalf;
  • Location where the seller takes action that binds it to the sale;15
  • Location where payment is tendered and received, or from which invoices are issued for each sale;
  • Location of the inventory if the tangible personal property is in the retailer's inventory at the time of its sale or delivery; and
  • Location of the retailer's headquarters, which is the principal place from which the business of selling tangible personal property is directed or managed.16

The rules provide for the application of the primary selling activities to common selling operations such as over-the-counter sales, sales through vending machines, and sales from vehicles carrying an uncommitted stock of goods and identify the location where the Department will presume the seller is engaged in the business of selling with respect to each sale.17

Secondary Selling Activities

If the primary selling activities occur in multiple jurisdictions, but no jurisdiction has more than two primary selling activities, the following additional activities should be considered in determining the jurisdiction where the retailer is engaged in the business of selling:

  • Location where marketing and solicitation occur;
  • Location where the seller engages in activities necessary to procure goods for sale;
  • Location of the retailer's officers, executives or employees to set prices or determine other terms of sale if this differs from the location of the primary selling activities of the sales personnel;
  • Location where purchase orders or other contractual documents are received when the purchase orders are accepted, processed or fulfilled in a location different from where they are received;
  • Location where title passes; and
  • Location where the retailer displays goods to prospective customers, such as a showroom.18

If a retailer is not engaged in selling in a jurisdiction based on its primary selling activities, it is engaged in selling in the jurisdiction where its inventory is located, or where its headquarters is located, depending on which location more primary and secondary selling activities occur.19 If a retailer is not engaged in selling in a jurisdiction under an evaluation using the primary or secondary factors, it is presumed to be engaged in selling at the location of its headquarters, absent clear and convincing evidence to the contrary.20

Presumptions for Certain Selling Operations

The rules conclude with a set of presumptions that apply to the following selling operations: in-state inventory/out-of-state selling activity, sales over the Internet, leases with an option to purchase, and sales of coal or other minerals.21

In the case of in-state inventory/out-of-state selling activity, if the selling activities occur outside Illinois, but the property sold is in a seller's Illinois inventory, the location of the inventory is the location of local tax sourcing.22

For sales over the Internet, the Department will presume that the retailer's predominant selling activity takes place outside Illinois, but the presumption may be overcome if the tangible personal property is in Illinois inventory at the time of the sale and the customer takes possession of the property at the retailer's place of business in Illinois.23

A lease with an option to purchase is considered to be a conditional sale subject to tax.24 Persons selling tangible personal property to a nominal lessee for use under a conditional sales agreement are presumed to be engaged in the business of selling at the property's physical location at the time the parties enter into the conditional sales agreement. Special rules also are provided for sales of coal or other minerals.25 Generally, a retail sale by a producer of coal or other mineral mined in Illinois is a sale at retail in the jurisdiction where the coal or other mineral is extracted.

Commentary

Compared to the emergency and proposed rules that were issued earlier this year, the final rules provide additional guidance to retailers with multiple locations. Both sets of rules provide primary and secondary factors, but the final rules expressly provide that a sale should be sourced to the location where three or more of the five primary factors occur. If no jurisdiction has more than two primary factors, the retailer is directed to consider the secondary factors. Thus, the final rules provide additional guidance on the operation of the primary and secondary factors. Also, unlike the emergency and proposed rules, the final rules do not include a provision allowing the Department to override the factors if the determination of the jurisdiction "presents a close question."

The final rules also provide additional clarity in comparison to the emergency and proposed rules with respect to sales over the Internet and leases with an option to purchase by establishing presumptions. The Internet rules begin with a presumption that purchases through a consumer-based Web site available on the World Wide Web where the retailer ships the property to the customer in Illinois take place outside Illinois, because the Department will presume the retailer's predominant selling activities take place outside Illinois. The rules include a non-exclusive description of the evidence needed to rebut the presumptions. There is a notable impact of the application of these presumptions. To the extent the sales are sourced to out-of-state locations, the sales are subject to the Use Tax and not the ROT and retailers do not charge and collect local ROTs.

Similar to the emergency and proposed rules, the language in the final rules providing a bright-line test for out-of-state sellers of inventory maintained in an Illinois warehouse could arguably be contrary to the fact-intensive inquiry required by Hartney. The bright-line criterion for sourcing this transaction is very similar to the order acceptance standard that Hartney struck down.

The final rules provide additional clarity as compared to the emergency and proposed rules with respect to the application of the local sourcing rules. A retailer's determination of the application of the primary and secondary factors to its particular facts necessarily involves an analysis of the type where reasonable persons could reach differing conclusions. Rather than awaiting validation of a retailer's conclusions in the context of a Department audit, certain multi-location taxpayers should consider submitting a request for a private letter ruling to the state if they are unsure of their tax obligations. Because there is some remaining uncertainty in sales sourcing, taxpayers must take action to ensure that they remain compliant with developments in this area.

Finally, this may not be the end of the story despite the adoption of final rules. The Regional Transportation Authority (RTA) has expressed its displeasure with the final rules and has filed a lawsuit in the Cook County Circuit Court seeking a preliminary and permanent injunction to bar enforcement of the rules.26 According to the RTA, the new rules are invalid because they exceed the Department's regulatory authority.

Footnotes

1. ILL. ADMIN. CODE tit. 86 §§ 220.115; 270.114; 320.115; 370.115; 395.115; 630.120; 670.115; 690.115; 693.115, effective June 25, 2014. The text of these rules is available in the Illinois Register, Vol. 38, Issue 28, page 14292, July 11, 2014. Note that Illinois authorizes a variety of local ROTs, including the Home Rule County ROT, Home Rule Municipal ROT, Regional Transportation Authority ROT, Metro East Mass Transit District ROT, Metro-East Park and Recreation District ROT, County Water Commission ROT, Special County ROT for Public Safety, Salem Civic Center ROT, and Non-Home Rule Municipal ROT.

2. 998 N.E.2d 1227 (Ill. 2013). For a discussion of this case, see GT SALT Alert: Illinois Supreme Court Holds Regulation Sourcing Sales Tax to Order Acceptance Location Invalid Under State Law; Keith Staats, Illinois Supreme Court Changes Local Sales Tax Sourcing, State Tax Today, Tax Analysts (2014 STT 19-5), Jan. 27, 2014.

3. ILL. ADMIN. CODE tit. 86 §§ 220.115; 270.114; 320.115; 370.115; 395.115; 630.120; 670.115; 690.115; 693.115, prior to amendment.

4. See Ex-Cell-O Corp. v. McKibbin, 384 Ill. 316 (1943).

5. Illinois Register, Vol. 38, Issue 6, page 4047, Feb. 7, 2014. The emergency rules were effective from Jan. 22, 2014 through June 20, 2014.

6. Illinois Register, Vol. 38, Issue 6, page 3502, Feb. 7, 2014. For a discussion of the emergency and proposed rules, see GT SALT Alert: Illinois Department of Revenue Issues New Draft Rules for Sourcing of Local Sales Tax; Stanley R. Kaminski & Keith Staats, New Illinois Sales Tax Regulations Illustrate Need for Legislative Action, State Tax Today, Tax Analysts (2014 STT 46-9), Feb. 20, 2014.

7. On March 21, 2014, the Department withdrew the original proposed rules and issued revised proposed rules. Illinois Register, Vol. 38, Issue 12, pages 6549 and 6748, March 21, 2014.

8. ILL. ADMIN. CODE tit. 86 § 220.115(b)(1). For purposes of this alert, we are citing to the rule for the Home Rule County ROT. The other locally imposed ROTs have parallel provisions.

9. ILL. ADMIN. CODE tit. 86 § 220.115(b)(2), quoting Ex-Cell-O Corp. v. McKibbin, 384 Ill. 316 (1943).

10. Id., quoting Hartney Fuel Oil Co. v. Hamer, 998 N.E.2d 1227 (Ill. 2013) (citing Ex-Cell-O Corp.).

11. ILL. ADMIN. CODE tit. 86 § 220.115(b)(5).

12. ILL. ADMIN. CODE tit. 86 § 220.115(b)(6).

13. ILL. ADMIN. CODE tit. 86 § 220.115(b)(7).

14. ILL. ADMIN. CODE tit. 86 § 220.115(b)(8).

15. This may be acceptance of purchase orders, submission of offers subject to unilateral acceptance by the buyer, or other actions that bind the seller to that sale.

16. ILL. ADMIN. CODE tit. 86 § 220.115(c)(1), (c)(2).

17. ILL. ADMIN. CODE tit. 86 § 220.115(c)(3).

18. ILL. ADMIN. CODE tit. 86 § 220.115(c)(4).

19. ILL. ADMIN. CODE tit. 86 § 220.115(c)(5).

20. ILL. ADMIN. CODE tit. 86 § 220.115(c)(6).

21. ILL. ADMIN. CODE tit. 86 § 220.115(d).

22. ILL. ADMIN. CODE tit. 86 § 220.115(d)(2).

23. ILL. ADMIN. CODE tit. 86 § 220.115(d)(3). Evidence to overcome the presumption includes, but is not limited to, the following circumstances: (1) the tangible personal property is in the retailer's inventory in Illinois at the time of its sale, in which case the retailer is engaged in the business of selling in the jurisdiction where the property is located at the time of the sale; or (2) the customer takes possession of the tangible personal property at the retailer's place of business in Illinois, in which case the retailer is engaged in the business of selling in the jurisdiction where the customer takes possession of the property. Id.

24. ILL. ADMIN. CODE tit. 86 § 220.115(d)(4).

25. ILL. ADMIN. CODE tit. 86 § 220.115(d)(5).

26. Press Release, Illinois Regional Transportation Authority, June 27, 2014.

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