Illinois Supreme Court invalidates local sales tax sourcing rule
TAX ALERT |
UPDATE: On June 2, 2014, the Joint Committee on Administrative Rules (JCAR) issued a notice announcing that it will hold a hearing on June 17, 2014, to consider proposed rules on how a business should determine where to source its sales for local sales tax purposes. Given the May 29 clarifications to the proposed regulations, it is likely that the JCAR will vote to approve the proposed regulations.
UPDATE: On May 29, 2014, the Illinois Department of Revenue withdrew proposed permanent regulations that it had previously filed with the JCAR to address how a business should determine where to source its sales for local sales tax purposes and filed new proposed permanent regulations with the JCAR. The new proposed regulations eliminate the four primary and five secondary factors for consideration that were provided in the withdrawn proposed permanent regulations and replace those factors with a five primary factor test and a series of fall-back tests. Under this new test, a sale must be sourced to the location that meets three or more of the following five primary factors:
- The location where sales personnel exercise discretion and authority to solicit customers on behalf of a seller and to bind the seller to a sale
- The 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 the sale
- The location where payment is tendered and received, or from which invoices are issued
- The location of inventory, if the tangible personal property that is sold is in the retailer's inventory at the time of its sale or delivery
- 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
If a seller does not meet three or more of these five factors in any jurisdiction, but one or two of these factors are present in multiple jurisdictions, the following secondary factors must be considered in determining where to source a sale:
- The location where marketing and solicitation occur
- The location where the seller engages in activities necessary to procure goods for sale
- The location of the retailer's officers, executives or employees with authority to set prices or determine other terms of sale
- The 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
- The location where title passes
- The location where the retailer displays goods to prospective customers
If the appropriate jurisdiction to which a sale should be sourced is still uncertain, the sale must be sourced to the location where the seller keeps the bulk of its inventory or the location of its headquarters, depending on which location exhibits the most primary and secondary factors discussed above. If sourcing still remains uncertain, the sale must be sourced to the location of the seller’s headquarters, absent clear and convincing evidence to the contrary.
The new proposed regulations will now have to be approved by the JCAR to go into effect.
UPDATE: On Mar. 10, 2014, the Illinois Department of Revenue withdrew proposed permanent regulations that it had previously filed with the JCAR to address how a business should determine where to source its sales for local sales tax purposes and filed new proposed permanent regulations with the JCAR. The new proposed regulations are substantively similar to emergency rules that are currently in effect, except that the new proposed rules eliminate the subsection of the emergency rules titled “Long Term or Blanket Contracts. A copy of the new proposed rules can be viewed in the March 21, 2014, issue of the Illinois Register starting on page 6549. Please note that this does not affect the emergency regulations, which will continue until expiration of the 150-day period.
UPDATE: On Jan. 22, 2014, the Illinois Department of Revenue (Department) filed emergency regulations and proposed permanent regulations with the Joint Committee on Administrative Rules (JCAR) to address how a business should determine where to source its sales for local sales tax purposes in light of Hartney Fuel Oil Co. V. Hamer, in which the Illinois Supreme Court invalidated the Department's long-standing rules that required sales to be sourced to the locality where the orders were accepted.
Under the emergency regulations and mirrored in the proposed permanent regulations, a sale must be sourced to the location where the bulk of the business' activities in relation to the sale took place. In making this determination, a business must consider the following four primary factors:
- The location of officers, executives and employees with discretion to negotiate on behalf of, and bind, the seller
- The location where offers are prepared and made
- The location where purchase orders are accepted or other actions are completed to bind the seller, and
- The location of inventory if tangible personal property is in retailer's inventory at the time of sale or delivery.
No one primary factor is given any greater weight than the other primary factors, and any determination must be based upon the totality of the circumstances.
If, after consideration of the primary factors, the location of the bulk of the business' activities in relation to the sale cannot be determined, the business may consider a number of secondary factors. These secondary factors include:
- The location where marketing and solicitation occur
- The location where purchase orders or other contractual documents are received
- The location of the delivery of the property to the purchaser
- The location where title passes
- The location of retailer's ordering, billing and other administrative departments
The Department's emergency regulations are in effect for 150 days from the date of filing, unless the JCAR votes by a 3/5 majority to suspend them. The Department's proposed permanent regulations are subject to a 90-day notice period, during the first 45 days of which local governments, industry groups, and members of the public may submit comments or request a public hearing and during the second 45 days of which proposed permanent regulations will be subject to review by the JCAR. If the JCAR takes no action by the end of the 90-day notice period, the proposed permanent regulations will become permanent and replace the emergency regulations.
On Nov. 21, 2013, the Illinois Supreme Court issued its decision in Hartney Fuel Oil Co. v. Hamer, Ill., No. 2013 IL 115130. The court found that local sales and use tax sourcing regulations under which local tax could be applied only by the local jurisdiction where the order was accepted (1) exceeded the statutory authority granted to the Illinois Department of Revenue (Department), and (2) were therefore invalid. Furthermore, the court ruled that an assessment issued using a sourcing standard other than the one provided in the regulations was impermissible because the Department was bound by its written advice.
At issue was the sourcing of revenues for local sales and use tax purposes by Hartney Fuel Oil Company (Hartney), a retail seller of fuel oil that had its base of operations in Forest View (Cook County), Ill. All Hartney operations related to the sales solicitation and selling process took place at their Forest View headquarters except that all fuel orders were accepted by a contract sales office in the village of Mark (Putnam County), Ill. No Hartney employees worked at the Mark location, and the activities performed at that site were done by a clerk who was provided for a fixed fee by a local painting business.
Local sales and use taxes in Illinois are imposed under any of three different authorities: the Home Rule County Retailer's Occupation Tax Law (55 ILCS 5/5-1006), the Home Rule Municipal Retailers' Occupation Tax Act (65 ILCS 5/8-11-1), or the Regional Transportation Authority Act (70 ILCS 3615/4.03). Because the local sourcing methodology provided under each of these statutes is largely nonexistent, regulations (86 Ill. Adm. Code 220.115; 86 Ill. Adm. Code 270.115; and 86 Ill. Adm. Code 320.115) were promulgated to address the sourcing methodology. Under these regulations, local tax could be applied only by the local jurisdiction where the order was accepted. Hartney followed this guidance and charged and collected local tax based on the rate applicable to Mark, unsurprisingly a lower rate than would have been applicable had Hartney accepted the orders in question at its Forest View headquarters.
On audit, the Department determined that the correct sourcing of Hartney's sales for local tax purposes was to Forest View under the Regional Transportation Authority Act rather than to Mark. The Department issued an assessment of over $23 million. Hartney paid the assessment under the Illinois' Protest Monies Act and sued for a refund in Putnam County circuit court, which found in favor of Hartney and concluded that the local sales were correctly sourced to Mark based on the regulations. That conclusion was affirmed by an appeals court.
On further appeal, the Illinois Supreme Court analyzed the language of the regulations and determined that the regulations provided an impermissible interpretation of the statutes, in that the regulations' adoption of a single bright-line standard for the sourcing of transactions for local sales and use tax purposes (sourcing exclusively based on the location of where the sales order is accepted) was not consistent with the standards for the sourcing of sales developed and applied for Illinois sales tax in other circumstances (sourcing based on a "totality of the circumstances" analysis). Accordingly, the Illinois Supreme Court found that the regulations were inconsistent with statutory authority and were, therefore, invalid. However, rather than affirm the Department's assessment, the Illinois Supreme Court instead waived the entire assessment, citing the state's Taxpayer Bill of Rights (20 ILCS 2520/4) and the duty imposed by the statute upon the Department to "abate taxes and penalties assessed upon erroneous written information or advice given by the Department."
As a preliminary matter, retailers should cease to apply the regulations to source sales for local sales and use tax purposes to the local jurisdiction where the order was accepted and begin collecting and remitting local sales tax based upon the "totality of the circumstances" test. Additionally, this decision appears to open the possibility of requesting abatement under the Taxpayer Bill of Rights in cases where the Department issues an assessment that is in keeping with statutes or jurisprudence but is in contravention of the Department's regulatory guidance, including forms and instructions.
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