United States: Illinois Department Of Revenue Holds Gain From Sale Of Business Segment Excluded from Sales Factor As Occasional Sale

In a private letter ruling, the Illinois Department of Revenue determined that a taxpayer's gain from selling the assets of a business segment is excluded from the sales factor as an occasional sale.₁ Under Illinois law, the taxpayer may elect to treat the gain from the sale as business income. This gain is apportioned using the taxpayer's sales factor, but the gross receipts from the sale are excluded from the numerator and denominator of the sales factor because they arose from an incidental or occasional sale of assets used in the regular course of the taxpayer's trade or business.

Background

The taxpayer, a corporation that was subject to Illinois corporation income tax, was a leader in enterprise analytics that captured, analyzed and created insight from unstructured conversations, email, employee desktop activity and customer data. Beginning in 2008, the taxpayer operated in two business segments. The first business segment focused on solutions that improved the reliability of call recording and applied human behavioral modeling to analyze customer interaction and optimize the performance of call center agents. The second business segment primarily assisted clients realize the benefits of transitioning their contact centers to a single network infrastructure.

In 2011, the taxpayer entered into an acquisition agreement providing for the sale of all its assets used in the second business segment to an unrelated buyer. Under the terms of the acquisition agreement, the buyer acquired substantially all of the assets, and assumed certain liabilities, related to the second business segment and the registered trademark and trade name. The taxpayer requested a private letter ruling from the Department confirming that it could elect to treat the gains from the sale of the second business segment as business income. Also, the taxpayer inquired whether the gross receipts from the sale would be excluded from the numerator and denominator of the taxpayer's sales factor for apportionment purposes.

Apportionment Provisions

Illinois specifies the manner in which a taxpayer's income is allocated or apportioned.² Under Illinois law, nonbusiness income is allocated and business income of a multistate taxpayer is apportioned. "Business income" includes all income that may be treated as apportionable income under the U.S. Constitution, but excludes compensation.³ A taxpayer may elect to treat all income other than compensation as business income.⁴ "Nonbusiness income" means all income other than business income or compensation.⁵ In general, corporations that derive business income from Illinois and other states must apportion income to Illinois using a single sales factor.⁶ If the standard allocation and apportionment factors do not fairly represent the extent of the taxpayer's business activity in Illinois, the taxpayer may request, or the Department may require, the use of an alternate apportionment methodology.⁷ The Department has adopted regulations to address certain situations where the normal sales factor does not fairly represent the extent of the taxpayer's business activity in Illinois.⁸ Specifically, a regulation provides that "where gross receipts arise from an incidental or occasional sale of assets used in the regular course of the person's trade or business, such gross receipts shall be excluded from the sales factor."⁹

Gain Excluded from Sales Factor as Occasional Sale

In the private letter ruling, the Department considered the taxpayer's representation that the sale of the assets related to the second business segment was an incidental or occasional sale of the taxpayer's assets, and that no similar sale had occurred in the taxpayer's history. If the taxpayer made an election to treat all of its income for 2011 as business income, the gain on its sale of assets related to the second business segment would constitute business income. The gain would be apportioned using the taxpayer's sales factor and the gross receipts from the sale would be excluded from the numerator and denominator of the sales factor.

Commentary

This private letter ruling, which was obtained by Grant Thornton on behalf of a taxpayer, is consistent with prior rulings by the Department and is favorable to certain taxpayers that sell business segments. If a taxpayer can demonstrate that it possesses the requisite fact pattern, the taxpayer may exclude the gain from the Illinois sales factor as an occasional sale, resulting in a significant reduction in the sales factor in certain instances.

This treatment is particularly beneficial in light of Illinois law that provides if a taxpayer makes the election to treat all income other than compensation as business income, the gain from the sale of a business segment's assets are treated as business income, regardless of whether the gain otherwise meets the definition of business income. Illinois is one of a very small number of states that allow for such an election. If such election were not available, the sale potentially would constitute nonbusiness income allocable to Illinois, and depending upon the particular facts and circumstances of the transaction could substantially increase the taxpayer's overall Illinois corporation income tax liability. After the election is made, the gain is not included in the sales factor if it constitutes an occasional sale, which characterization depends upon looking at the nature of the transaction and whether the taxpayer has made a pattern or practice of engaging in that type of transaction. Note that the Department relied upon the taxpayer's representation that an occasional sale occurred and did not state the specific analysis that typically is required to determine whether an occasional sale has occurred. The answer may have been clear in this fact pattern, but other taxpayers may have to investigate their facts further, for example, in cases where multiple sales of the same type have been made over a long period of time. Ultimately, it may be appropriate for taxpayers with similar fact patterns to seek a private letter ruling from the Department before taking these types of positions on their Illinois corporation income tax returns.

Footnotes

1 Private Letter Ruling IT 13-0001-PLR, Illinois Department of Revenue, March 1, 2013 (released April 2013).

2 35 ILL. COMP. STAT. 5/301 et seq.

3 35 ILL. COMP. STAT. 5/1501(a)(1).

4 Id. The taxpayer must make the election on its original return for the taxable year to which the election applies, or on a corrected return filed prior to the return's due date (including extensions). 35 ILL. COMP. STAT. 5/1501(b).

5 35 ILL. COMP. STAT. 5/1501(a)(13).

6 35 ILL. COMP. STAT. 5/304(a), (h)(3).

7 35 ILL. COMP. STAT. 5/304(f).

8 ILL. ADMIN. CODE tit. 86 § 100.3380.

9 ILL. ADMIN. CODE tit. 86 § 100.3380(c)(2).

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