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June 12, 2018

Local Sourcing Rules for the Illinois Retailers’ Occupation Tax

Authored by Christopher Lutz

 in State & Local Tax (SALT)

As we have discussed previously, Illinois localities have adopted a variety of unique taxes, such as the Chicago Personal Property Lease Transaction Tax, the Amusement Tax, and dozens more. But, like many other states, Illinois localities may also impose a local option tax which is imposed in addition to the state Retailers' Occupation Tax ("ROT"). Unlike many other states, however, Illinois localities use a unique sourcing methodology. Whereas sales of tangible personal property to Illinois are subject to a destination-based sourcing method under the Illinois Use Tax Act, the local ROT is an origin-based tax. Exactly where a sale originates, however, has been a source of much debate.

Background

Illinois Statutes and Regulations

Although the ROT is Illinois' analogue to a sales tax, the ROT is distinct. The ROT is a tax on the occupation of selling, not on the sale itself. See Standard Oil Co. v. Dep't of Finance, 383 Ill. 136 (1943). The state has a number of statutes that allow home rule county and municipal governments, as well as some other entities such as the Regional Transportation Authority ("RTA") to impose an ROT "upon all persons engaged in the business of selling tangible personal property" within the jurisdiction. 55 ILCS 5/5-1006; 65 ILCS 5/8-11-1; 70 ILCS 3615/4.03. Although the statutes made clear that the ROT could be imposed on those selling tangible personal property in the locality, they did not provide any other guidance on how the transaction should have been sourced. As a result, the Illinois Department of Revenue ("Department") promulgated regulations titled "Jurisdictional Questions" to illustrate where a sale should have been sitused for local ROT purposes.

Historically, the regulations adopted by the Department established a bright-line rule situsing sales to the location where the seller accepted a purchase order. Indeed, the original regulations stated that "mere solicitation and receipt of orders" was not enough to constitute "engaging in the business of selling within the jurisdiction." 86 Ill. Admin. Code 220.115(b) (as in place in 2013). The regulations went on to state that "the seller's acceptance of the purchase order or other contracting action in the making of the sales contract is the most important single factor in the occupation of selling." 86 Ill. Admin. Code 220.115(c) (as in place in 2013). 

Hartney Fuel Oil Co. v. Hamer

In 2013, the Illinois Supreme Court addressed the Department's "Jurisdictional Questions" regulation.  Hartney Fuel Oil Company was a retailer of fuel oil with its home office in Forest View, Illinois. It established a separate sales office which moved to a number of jurisdictions, ultimately Mark, Illinois. Hartney contracted with a local business, Putnam County Painting, which it paid a flat monthly rate for a nonexclusive lease of office space and the services of a clerk. Whenever a customer would contact the Forest View office to place an order, the caller was directed to call the Mark office, where purchase orders would be approved. Mark, Illinois had no local ROT, resulting in a 6.25% ROT rate, whereas Forest View, Illinois had combined local rates of 3.75%, resulting in an overall 10% ROT rate. Hartney Fuel Oil Co. v. Hamer, 376 Ill Dec 294 (2013).

The Department audited Hartney's selling activities, and concluded that its activities occurred in Forest View, not Mark. Hartney challenged the assessment, arguing that the "Jurisdictional Questions" regulation established a bright-line test of purchase acceptance to determine where a sale occurred for local ROT purposes. Agreeing with Hartney, the court stated that "[e]ven granting the Department considerable deference in interpreting its regulations[…] We conclude that the regulation, in subsection (c)(1), does define situs for retail occupation tax where purchase order acceptance occurs at the seller's place of business within the county, with sale at retail and the purchaser taking delivery within the state." Id

Notwithstanding the Illinois Supreme Court's agreement with Hartney as to the language of the "Jurisdictional Questions" regulation, the court could not reconcile the regulation with the state statute.  The court explained that "the business of selling is a composite of many activities." Id. (citing Ex-Cell-O Corp. v. McKibbin, 383 Ill. 316 (1943)). While agencies are afforded considerable deference in crafting regulations in order to implement a statute, they may not "narrow or broaden the scope of intended taxation under a taxing statute." Id. (citing Kean v. Wal-Mart Stores, Inc., 235 Ill. 2d 351 (2009)). Because the regulation impermissibly narrowed the legislation permitting localities to adopt local ROTs, it was invalid. In support of this conclusion, the court stated:

We are persuaded that this regulation impermissibly narrows the local ROT Acts, contrary to the legislature's intention to allow local governments to collect taxes from retailers in their jurisdictions. First, it does not amply prescribe the fact-intensive inquiry contemplated by this court in Ex-Cell-O. Second, by allowing for only one, potentially minor step in the business of selling to conclusively govern tax situs, this regulation impermissibly constricts the scope of intended taxation.

As such, the court struck down the "Jurisdictional Questions" regulation, requiring the Department to craft new regulations that did take the totality of circumstances into account in order to determine where a taxpayer's selling activities occurred.[1]

Present Day Local ROT Sourcing Rules

After considerable debate regarding the "Jurisdictional Questions" regulations, the Department adopted its finalized regulation on June 25, 2014. The regulation is split into three conceptual parts: (1) guiding principles; (2) identifying specific selling activities that result in situsing a particular sale to a jurisdiction; and (3) presumptions that apply to certain selling operations. These parts are addressed in turn.

Guiding Principles

The regulations begin by explaining that "the jurisdiction in which the sale tax place is not necessarily the jurisdiction where the local retailers' occupation tax is owed." 86 Ill. Admin. Code 270.115(b)(1). 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 sale by the passing of title and payment of the purchase price." 86 Ill. Admin. Code 270.115(b)(2) (citing Ex-Cell-O Corp., 383 Ill. At 321 (1943)). Therefore, a seller incurs local ROT in a jurisdiction "it its predominant and most important selling activities take place" in the jurisdiction. 86 Ill. Admin. Code 270.115(b)(5). Unlike the previous regulation, the new regulation requires the Department to examine substance over form in analyzing where the most selling activities occur. 86 Ill. Admin. Code 270.115(b)(6).

Selling Activities

The regulation states that a retailer engaging in three or more "primary selling activities" in one location should situs its sale to that location. 86 Ill. Admin. Code 270.115(c)(2). These primary selling activities include:

A) Location of sales personnel exercising discretion and authority to solicit customers on behalf of a seller and to bind the seller to the sale;

B) Location where the seller takes action that binds it to the sale, which 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;

C) Location where payment is tendered and received, or from which invoices are issued with respect to each sale;

D) Location of inventory if tangible personal property that is sold is in the retailer's inventory at the time of its sale or delivery; and

E) The location of the retailer's headquarters, which is the principal place from which the business of selling tangible personal property is directed or managed. In general, this is the place at which the offices of the principal executives are located. When executive authority is located in multiple jurisdictions, the place of daily operational decision making is the headquarters.

86 Ill. Admin. Code 270.115(c)(1)(A)-(E). The regulation further confirms that although selling activity may occur in multiple jurisdictions, it may only be sourced to one location for each sale. 86 Ill. Admin. Code 270.115(c)(1).

If the primary selling activities listed above occur in multiple jurisdictions, but three of the activities are not performed in a single jurisdiction, the regulation provides a number of "secondary selling activities" that must also be considered. These secondary selling activities include:

A) Location where marketing and solicitation occur;

B) Location where the seller engages in activities necessary to procure goods for sale;

C) Location of the retailer's officers, executives or employees with authority to set prices or determine other terms of sale if determinations are made in a location different than that identified in subsection (c)(1)(A);

D) Location where purchase orders or other contractual documents are received when purchase orders are accepted, processed, or fulfilled in a location or locations different from where they are received;

E) Location where title passes; and

F) Location where the retailer displays goods to prospective customers, such as a showroom.

86 Ill. Admin. Code 270.115(c)(4). In instances where a seller does not have three or more of its selling activities in any one jurisdiction, the seller must count its activities in one of two jurisdictions: (1) where its inventory is located, or (2) where its headquarters are located. Whichever of these two jurisdictions is where more selling activities occur, considering both primary and secondary selling activities, is the location where the sale should be sourced for local ROT purposes. 86 Ill. Admin. Code 270.115(c)(5).  If that location is outside of Illinois, the sale should not be subject to local ROT. 86 Ill. Admin. Code 270.115(b)(7).

Presumptions Applying to Certain Selling Operations

Without describing all presumptions provided by the regulation, there are two presumptions worth noting. First, when inventory is located in Illinois, but the selling activity occurs outside of Illinois, the jurisdiction where the property is located at the time of the sale will determine where the retailer is engaged in business with respect to the sale. 86 Ill. Admin. Code 270.115(d)(2). Because interstate and intrastate selling activities must be treated equally, this presumption should similarly apply if inventory is located outside of Illinois as well.  Therefore, where taxpayers keep their inventory may often be the most dispositive element in determining where to situs a sale for local ROT.

Next, selling activity where sales are made over the internet is presumed to take place outside of Illinois. Therefore, the sales over the internet will generally be considered to be subject to the Illinois Use Tax, not ROT. This presumption may be overcome if there is clear and convincing evidence the retailer's predominant selling activities take place in Illinois. 86 Ill. Admin. Code 270.115(d)(3).

Conclusion

The Illinois ROT functions differently than most state sales taxes. Rather than a tax on sales, the ROT is a tax on the business of selling. Determining where selling activity occurs requires a holistic analysis which looks to the location of salespeople, customers, inventory, and business operations. Taxpayers engaging in retail selling in Illinois should familiarize themselves with these rules. In some complicated cases, obtaining a Private Letter Ruling from the Department may be prudent. The Department has shown a willingness to issue such rulings, issuing at least seven such rulings since 2015.



[1] Notably, although not relevant to this discussion, the court did agree that Hartney was entitled to abatement of all tax for the years under protest. Regulations carry the force and effect of law, and under the Taxpayer Bill of Rights, the taxpayer was entitled to rely upon the written advice, albeit erroneous, in the Department's regulations.  20 ILCS 2520/4.

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