As anticipated after the Illinois Supreme Court decision in Hartney Fuel1 described in our November 25, 2013 alert, the Illinois Department of Revenue (the "Department") has decided to issue emergency regulations (the "Rules") to provide guidance to taxpayers in determining their local retailer’s occupation tax ("ROT") liabilities.2 The Rules provide an analytical structure to determine the jurisdiction to which ROT is due on a sale of tangible personal property. The Rules provide definitive sourcing for over-the-counter sales, for sales filled with in-state inventory, for excavated mineral sales, and for vending machine sales. For multi-jurisdictional sales operations, the Rules provide a protocol for identifying competing sourcing jurisdictions, and a principle-based tie-breaker among the competing jurisdictions, based on government services enjoyed by the retailer. For sales that have been sourced to a local jurisdiction solely on the basis that order acceptance occurred in that location, the Rules also provide objective and definitive criteria to determine whether that order acceptance site remains the sourcing location for periods after the Hartney Fuel decision.
Sourcing with Multiple Jurisdictions
Where the seller is doing business in multiple jurisdictions, the Rules identify primary factors that determine where the seller is engaged in the business of selling. These categories identify the following activities that lead to the determination: (i) location of offices, executives and employees with discretion to negotiate and bind the seller, (ii) where the offers are prepared and made, (iii) where purchase orders are accepted, and (iv) the location of inventory. It is pertinent to note that the Rules do not weight any one criterion over another, so one could identify two or more primary factors occurring at different locations and not have a definitive sourcing answer. Therefore, the Rules set forth secondary factors to determine the location where the seller is engaged in the business of selling, similarly unranked in priority. These secondary factors are: (i) the location where marketing and solicitation occur, (ii) where purchase orders and other contractual documents are received when they are accepted, processed or fulfilled in a location other than where received, (iii) the location of delivery to the purchaser, (iv) the location where title passes, and (v) the location of the retailer’s administrative functions. If the location where the seller is engaged in the business of selling is still unclear after applying these secondary factors, the Rules provide a final tie-breaker that requires that sales be sourced to the location where the seller enjoyed the greater part of governmental protection, and benefitted by being conducted under that protection. While this tie-breaker may appear to require a subjective determination, it is unlikely to be administered as such, and more guidance in the application of the tie-breaker is likely when permanent rules are proposed.
Order Acceptance Location Is Insufficient On Its Own
The Rules make it clear that order acceptance alone does not constitute engaging in the business of selling. This should put to final rest the planning schemes that instigated litigation on the sourcing issue. In particular, the Rules provide that the jurisdiction in which order acceptance occurs is not an eligible sourcing location when the seller has no other selling activity in the jurisdiction; the orders are submitted via phone or Internet; and the seller’s employees or agents that accept the purchase order do not negotiate or exercise discretion on behalf of the seller. This provision directly affects the sourcing that heretofore may have been in use by taxpayers or agents of taxpayers who located "order acceptance" in a favorable rate or tax-sharing jurisdiction, and it should prevent retailers from sourcing sales to a jurisdiction based merely on the presence in the jurisdiction of a "push-the-button" employee or agent, located in a one room office.
The way in which the Rules handle intercompany sales suggest that the sourcing of such sales could be a future focus of Department audits. The Rules quote from the Hartney Fuel decision that the Department "may look through the form of a putatively [multijurisdictional] transaction to its substance" in order to determine where "enough of the business of selling took place." As an example, the Rules state that the Department "will not look to the location of a party that is owned by or has common ownership with a supplier or purchaser if that party does not, in substance, conduct the selling activities identified" in the Rule. This provision would certainly apply to a captive purchasing or sales company for a corporate group, as well as other arrangements. However, the Department and taxpayers should keep in mind that the Hartney Fuel decision does not bar a taxpayer from organizing its business in such a manner that its sales are sourced to lower tax jurisdictions. In fact, in the final footnote of the Hartney Fuel decision, the court reiterated that Hartney’s arrangement was not without economic substance, and that "[t]he legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted."3
It bears emphasizing that the Illinois Supreme Court decision in Hartney Fuel contains valuable guidance for what activities do and do not constitute engaging in the business of selling at a given location, and a review of the decision can prove a useful tool for application of the Rules to a well-developed set of facts.
The Rules will be effective for 150 days, unless the Joint Committee on Administrative Rules ("JCAR") votes by a 3/5 majority to suspend them. In addition to the Rules, the Department has filed proposed permanent rules to replace the Rules after the JCAR review process. The permanent rules contain the same language as the Rules, plus some additional provisions. For instance, the permanent rules address the sourcing for long-term or blanket contracts. When dealing with such contracts, sales are to be sourced to the location of the seller where the subsequent specific orders under the contract are placed. If there are no subsequent orders, the place of business is determined under the sourcing test set forth above.
Issuing the Rules also closes the broadest possible period during which taxpayer reliance on the previous regulations would support an abatement of tax, penalty and interest under the Taxpayers’ Bill of Rights.4 Under the Taxpayers’ Bill of Rights, the Department is obligated to abate any tax, penalty or interest that results from taxpayer reliance on erroneous written information provided by the Department, such as a regulation, form instruction, or informational bulletin. Arguably, taxpayers could rely on the Department’s sourcing regulation until the Rules were issued, notwithstanding the Illinois Supreme Court decision in Hartney Fuel. However, a narrower interpretation of the Taxpayers’ Bill of Rights would limit the period that a taxpayer could rely on the Department’s old sourcing regulation to the period ending on the date of the court’s Hartney Fuel decision.
1. Hartney Fuel Oil Co. v. Hamer, Ill., No. 2013 IL 115130 (Nov. 21, 2013).
2. The Rules, in Title 86 of the Illinois Administrative Code, in specific parts of the Title 86, will provide identical sourcing criteria for the following 10 taxes : Part 220 – Home Rule County Retailers’ Occupation Tax, Part 270 – Home Rule Municipal Retailers’ Occupation Tax, Part 320 – Regional Transportation Authority Retailers’ Occupation Tax, Part 370 – Metro East Mass Transit District Retailers’ Occupation Tax, Part 395 – Metro East Park and Recreation District Retailers’ Occupation Tax, Part 630 – County Water Commission Retailers’ Occupation Tax, Part 670 – Special County Retailers’ Occupation Tax For Public Safety, Part 690 – Salem Civic Center Retailers’ Occupation Tax, Part 693 – Non-Home Rule Municipal Retailers’ Occupation Tax, and Part 695 – County Motor Fuel Tax.
3. Hartney Fuel Oil v. Hamer, fn.6; quoting Gregory v. Helvering, 293 U.S. 465, 469 (1935).
4. 20 ILCS 2520/1 et seq.