Executive Summary
In the Sept. 9, 2022 issue of the Illinois Register, the Illinois Department of Revenue adopted amendments to its apportionment throw-back/throw-out rules as it relates to foreign sales. The updated rules may provide substantial benefit for companies currently subject to Illinois throw-back/throw-out on sales to foreign jurisdictions where income tax treaty protection applies.
Background and updated rules
Illinois requires sales of tangible personal property that are shipped from within the state to a jurisdiction where the taxpayer is not subject to tax to be “thrown back” into the Illinois sales numerator for the purposes of computing the apportionment factor. With respect to sales of services, if the taxpayer is not subject to tax in the jurisdiction in which the services are received, Illinois requires the sale to be “thrown out” or excluded from both the numerator and the denominator of the sales factor. In general, when considering whether a taxpayer is “subject to tax” in a foreign jurisdiction, Illinois Administrative Code title 86, section 100.3200(a)(2) provides that the determination should be made in reference to what activities create taxable presence under the laws of the United States. Historically, Illinois has provided that a taxpayer who is not required to pay income tax on activity in a foreign jurisdiction as a result of an income tax treaty would not be considered subject to tax in the foreign jurisdiction. As a result, taxpayers shipping tangible personal property from within Illinois to a foreign country, or providing services to customers in a foreign country, where treaty protection applies have historically been required to throw back all of those sales into the Illinois apportionment numerator or to throw out the sales from both the numerator and denominator, regardless of the level of activity in the foreign jurisdiction.
The new amendments under section 100.3200(a)(2)(C) provide that, for taxable years ending on or after Dec. 31, 2022, income tax treaty protections in a foreign jurisdiction do not create a throw-back/throw-out requirement for Illinois sales apportionment purposes. To the extent a taxpayer’s activities in the foreign jurisdiction create taxable presence and are exempted from income taxation under treaty, the taxpayer will be considered to be subject to tax in the foreign jurisdiction, and no throw-back or throw-out will be required. The amendments add a third example to section 100.3200(b)(2) that describes a taxpayer making sales into a foreign jurisdiction and conducting business activities that exceed the protections of P.L. 86-272. The taxpayer is protected from income taxation by treaty in the foreign jurisdiction, but they are not required to throwback sales to the foreign jurisdiction into the Illinois numerator for tax years ending on or after Dec. 31, 2022, since the foreign activity is sufficient to create taxable presence without the treaty protections.
Takeaways
Illinois taxpayers who have previously been required to throw back or throw-out substantial amounts of sales to a foreign jurisdiction due to treaty protections may see a significant reduction in their Illinois apportionment factor and corresponding tax liability as a result of the recent rule change. Affected taxpayers should work closely with their tax adviser to consider whether their level of activity in foreign jurisdictions is sufficient to avoid the throwback/throw out requirement under the amended rules.
