August 04, 2017

Illinois Appellate Court Issues Decision on Temporary Storage Exemption

Authored by David  Hughes  and Samantha Breslow

 in State & Local Tax (SALT)

On June 28, 2017, the Illinois Appellate Court in Shared Imaging, LLC v. Hamer, 2017 IL App (1st) 152817, P1 (Ill. App. Ct. 1st Dist. June 28, 2017) reversed the Circuit Court's decision and held that Shared Imaging, LLC (the "Taxpayer") is entitled to a depreciation deduction on the selling price of units of equipment that occurred prior to their return to Illinois, a credit for taxes paid to other states for the periods before the units were returned to Illinois, and abatement of penalties on those units of equipment that were acquired outside of Illinois but returned to Illinois after the initial storage.

As background, the case addressed whether 11 medical equipment units, which were acquired both within Illinois and outside the state, stored within Illinois, and then leased outside the state were subject to Illinois use tax. On appeal, the Taxpayer made several arguments including: (1) several of the units were  not subject to the use tax because they were subject to the temporary storage exemption under the Use Tax Act ("Act") (35 ILCS 105/3-55(e); (2) other units that were acquired within Illinois were not subject to the use tax because they were subject to the expanded temporary storage exemption under the Act (35 ILCS 105/3-55(j); (3) the Department's assessment of taxes was unconstitutional because it is not fairly apportioned under the commerce clause of the U.S. Constitution; (4) if the Taxpayer does owe use tax, it is entitled to a credit for taxes paid to other states; (5) if the Taxpayer does owe use tax, the tax base must be reduced for depreciation, and (6) all late filing and late payment penalties should be abated.

The Appellate Court broke from the Circuit Court with respect to the applicability of the depreciation deduction. The Act provides that "[i]f the property that is purchased at retail from a retailer is acquired outside Illinois and used outside Illinois before being brought to Illinois for use here and is taxable under this Act, the 'selling price' on which the tax is computed shall be reduced by an amount that represents a reasonable allowance for depreciation for the period of prior out-of-state use." 35 ILCS 105/3-10. The Appellate Court held that although storage may constitute use within the meaning of the Act, the initial temporary storage of property prior to out-of-state use is not counted as the "first use" of the property for determining whether the depreciation deduction applies. Therefore, in a key victory for taxpayers, the Appellate Court determined that taxpayers are entitled to a deduction, which is calculated by use of the straight line method, on the selling price of depreciation that occurs during the period prior to the property's return to Illinois.

Additionally, the Appellate Court awarded the Taxpayer credit for taxes paid to other jurisdictions. Under the Act, the use tax does not apply to:

The use, in this State, of tangible personal property that is acquired outside this State and caused to be brought into this State by a person who has already paid a tax in another State in respect to the sale, purchase, or use of that property, to the extent of the amount of the tax properly due and paid in the other State.

35 ILCS 105/3-55(d). Again holding in opposition to the Circuit Court, the Appellate Court held that to the extent the Taxpayer paid taxes to other states on the sale or use of the property prior to their return to Illinois, the Taxpayer is entitled to a credit for taxes paid to the other states.        

However, the Appellate Court affirmed the Circuit Court's decision that although the temporary storage exemption initially applies to items bought outside of Illinois and stored in Illinois for less than two months before being leased exclusively outside of Illinois, their return to Illinois for further storage is taxable use, defeating the exemption's requirement of use solely outside of Illinois. The Act provides that use tax does not apply under the following circumstances:

The temporary storage, in this State, of tangible personal property that is acquired outside this State and that, after being brought into this State and stored here temporarily, is used solely outside this State or is physically attached to or incorporated into other tangible personal property that is used solely outside this State, or is altered, by converting, fabricating, manufacturing, printing, processing, or shaping, and, as altered, is used solely outside this State.

35 ILCS 105/3-55(e). This finding is significant because the Appellate Court establishes that a period of less than two months is "temporary" within the meaning of the Act, whereas Illinois law was previously silent as to the definition of the term. The Appellate Court acknowledges the "absence of guiding case law", by abating the late filing and payment penalties assessed on units that were acquired outside Illinois.  Further, the Appellate Court codifies a "one-time" rule for purposes of the temporary storage exemption, meaning that if items return to the state subsequent to their initial storage, even if just for purposes of additional storage, the items are not eligible for either the temporary or expanded temporary storage exemption. This is significant for lessors who have a storage facility located in the state, because if an item of property returns to the facility beyond the initial period of storage, the temporary and expanded temporary storage exemption no longer applies. 

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