New Illinois sourcing rules will impact retailers and purchasers alike

On Jan. 22, 2014, the Illinois Department of Revenue (IDOR) filed emergency sales tax rules to comply with the Illinois Supreme Court’s decision in Hartney Fuel Oil Co. v. Hamer, 2013 IL 115130 (Nov. 21, 2013). The new rules provide guidance on the manner in which an Illinois business should allocate local sales tax collected from its customers.

The rules clarify that sales tax must be paid in the community in which the bulk of business activity takes place. Various factors are provided in the new rules, including the location of company executives possessing authority to consummate sales, the location of inventory sold, and the location of order acceptance. Importantly, merely relocating purchase order acceptance to a local jurisdiction without conducting any other business in that locality does not suffice to allocate sales to that location.

Background

Generally, Illinois Retailers’ Occupation Tax (ROT) applies to retail sales of tangible property delivered to an Illinois location. Out-of-state retailers that have Illinois nexus are subject to ROT even if they have no Illinois office or other business location in the state. For ROT purposes, Illinois is one of a minority of jurisdictions that sources sales based on the retailer’s location rather than the location of delivery. Local governments are also permitted to impose their own ROT. There are, therefore, multiple levels and varying ROT rates throughout the state. The applicable rate depends on the location at which a retailer conducts business.

Historically, IDOR has taken the position that, for purposes of sourcing ROT, retailers operating in multiple locations are considered to be conducting business at the location from which they accept sales orders. In response, some retailers have engaged in tax planning whereby they (i) accept orders in a local jurisdiction with a lower (or no) sales tax rate in which they have not engaged in any other business activity or (ii) established a purchasing company in a lower tax jurisdiction and worked with retailers to accept purchase order in such jurisdictions.

In Hartney, Illinois audited and challenged a taxpayer’s claim that its sales were sourced to an office with a relatively low sales tax rate (Village of Mark, Putnam County), rather than the location in which its office was located that imposed a much higher sales tax rate (Forest View, Cook County). The taxpayer used an unrelated party to accept orders in Putnam County. IDOR distanced itself from its prior stance requiring the sourcing of sales to the location of order acceptance. Now, IDOR claimed, its sourcing regulation called for a more holistic analysis that examines a taxpayer’s entire business operations. Using this approach, IDOR reasoned, the taxpayer’s sales should have been sourced to Cook County. The Illinois Supreme Court disagreed, finding that the regulation clearly established that the location of order acceptance was the single controlling factor. Nonetheless, the court then invalidated the regulation on the basis that the statute that imposed the tax was intended to grant local governments broader ability to tax retail businesses than the “order-acceptance test” permitted. The emergency regulations are an attempt to address the court’s holding.

Timing

The emergency rules are in effect for 150 days (from Jan. 22, 2014), unless the Illinois General Assembly’s Joint Committee on Administrative Rules votes by a three-fifths majority to suspend them. In addition, IDOR filed proposed permanent rules that will replace the emergency rules following the Joint Committee’s review. There is a 45-day First Notice period, during which local governments, industry groups, and concerned members of the public may file comments or request a public hearing. During the Second Notice period, also 45 days long, the rules will be reviewed by the Joint Committee. If the Joint Committee takes no action, the rules become permanent and any further changes must be filed through a new rulemaking process. To stop a rule from becoming permanent, two-fifths of the panel must vote to overturn the rule.

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The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely.  The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.