United States: Illinois Local Sales Tax Sourcing Update: Tax Administration By Lawsuit Vanquished (For Now)

On October 16, the Circuit Court of Cook County (the "Court"), in an order authored by Judge Peter Flynn, dismissed a lawsuit by the City of Chicago (the "City") and the Village of Skokie (collectively the "Plaintiffs") seeking to recover tax revenue from other municipalities that the Plaintiffs claimed were the result of transactions that should have been sourced to Chicago. This dismissal represents a significant setback to the Plaintiffs' recovery of tax revenue attributable to transactions occurring prior to the Illinois Supreme Court's 2013 decision in Hartney Fuel Oil Co. v. Hamer.1 In Hartney, the Illinois Supreme Court struck down the prior local sales tax sourcing regulations issued by the Illinois Department of Revenue.

In a previous alert, we reported on Illinois local sales tax actions filed by the Regional Transportation Authority ("RTA"), Cook County, the City of Chicago and the Village of Skokie against Kankakee and Channahon, two municipalities that had entered into sales tax rebate agreements with so-called order-acceptance brokers; and against the brokers, too. Through these actions, the plaintiffs sought to change the sourcing of sales prospectively and to recover the tax collected by the defendant municipalities and the rebates issued by the defendant municipalities. These actions were consolidated before Judge Flynn, in the Circuit Court of Cook County, in the matter of The City of Chicago and The Village of Skokie v. The City of Kankakee, et al.2 The intervening decision in Hartney affected the pending proceedings and led to efforts by the RTA and the City to discover information directly from retailers who processed orders through use of the brokers, and indirectly received rebates of the local sales taxes on such orders.

Earlier, the Court determined that the non-party retailers were not proper "respondents in discovery" in the RTA matter for pre-Hartney periods, and since then, the RTA issued subpoenas to the retailers for post-Hartney periods. Most of the RTA's subpoenas are still outstanding, after objections were filed by the retailers.

The Plaintiffs took a different approach and filed a Motion for Leave to File a Fourth Amended Complaint (the "4AC") to add 11 groups of Internet Retailers as defendants and three groups of Operating and Procurement Companies as defendants. Reed Smith represented several of the so-called Internet Retailers and authored one of the joint motions to deny the motion to amend.

Judge Flynn's Order dismissed the Plaintiffs' suit with prejudice. Notably, the Court found that the Order constituted a partial final judgment, pursuant to Illinois Supreme Court Rule 304(a), which allows for immediate appeal of the Order. There has been no indication from the Plaintiffs of whether it will appeal. Further, the plaintiffs did not include the Illinois Department of Revenue ("IDOR" or "the Department") in the suit, despite the fact that the Department is the agency that collects and enforces the Retailers' Occupation Tax and Use Tax laws, and that also divvies up the collected revenues to the various levels of government.3

Background Illinois imposes a sales tax called the Retailers' Occupation Tax ("ROT"), and a complementary Use Tax. At the heart of this very complicated lawsuit is the contention by Chicago that a large volume of sales should have been subject to Illinois Use Tax collection but were instead subjected to Illinois and local ROT as in-state sales. The difference had no bearing for the retailers who collected the tax nor the retail customers that paid the tax, but it was very important to Chicago, because the revenues generated by ROT and Use Tax, respectively, are allocated among the state and municipalities via different methods.

Unlike state and local ROT collections that are partly or fully distributed to the county and municipality where the sale takes place, Illinois Use Tax collections are distributed to local governments through a statutory formula partially based on population, but with a fixed 20% allotment to Chicago, among other specified allotments. Thus, the 4AC sought to recharacterize the ROT and local sales tax revenues as Illinois Use Tax, and to hold the defendant governments, brokers and retailers liable to Chicago for that 20% allotment.

Through its order, the Court not only denied the Plaintiffs' Motion to file its 4AC, but it also dismissed the underlying complaint in its entirety. In brief, the Court concluded that the "Chicago Plaintiffs have not pleaded, and cannot plead, cognizable claims against the Internet Retailers or the Operating Procurement Companies."

The statewide ROT and Use Tax rates are both 6.25%.4 Any ROT receipts collected are allocated as follows: 5% to the state, 1% to the municipality where the sale was sitused, and 0.25% to the county where the sale was sitused. Use Tax receipts, however, are allocated 5% to the state, and 1.25% divided between the City, the RTA, the Build Illinois Fund, the Metro-East Transit District, and the remaining municipal and county governments. Thus, the City would receive no revenue from a sale that is sitused outside of Chicago and subject to the ROT. In contrast, if that same sale were subject to Use Tax, the City would receive a portion of the tax revenue collected.5 Therefore, it is favorable for the City if sales sitused outside of its limits are characterized as subject to Use Tax rather than ROT.

The Court denied the Plaintiffs' motion to amend the complaint, and also dismissed the case in its entirety, for three principal reasons: (1) the conduct at issue had ceased, meaning the Plaintiffs' only claims for damages related to past conduct, which is insufficient to merit a declaratory judgment (as was sought in the complaint); (2) the Internet Retailers, procurement companies, and brokers were not properly joined as primary defendants—in fact, the Court determined that if any claim was to be brought against these defendants, it should be brought as a third-party suit; and (3) the Plaintiffs failed to join the Department in its suit, despite the fact that its claims necessitated involvement of the Department, as the entity with primary jurisdiction over the redistribution of ROT and Use Tax proceeds.

Notably, Judge Flynn opined that allowing the Plaintiffs' case to go forward would "empower an unwieldy and potentially disruptive form of municipal vigilante tax litigation, and undermine (if not outright undo) the careful balance struck by the General Assembly." An important consideration in Flynn's order was the fact that only the Department can allocate Use Tax funds, because the allocation is based partly on distribution of population throughout the state, which is in determined by a formula proprietary to the Department. The Internet Retailers, brokers, and procurement companies collected and remitted the tax owed, and therefore, Chicago and other would-be municipal plaintiffs must seek redress from the Department. To hold otherwise would "undercut the legislative allocation of tax collection and distribution to IDOR and would create an expensive, unworkable free-for-all." Thus, the case was dismissed.


1. 2013 IL 115130 (Nov. 2013)

2. Docket No. 11 CH 29745.

3. See Order, Chicago, et al. v. Kankakee, et al., Cook County Cir. Ct. Case No. 11-CH-29745 (Oct. 9, 2015).

4. Illinois law also allows local sales taxes, such that sales in many parts of Illinois are subject to a rate higher than 6.25%. For example, Chicago imposes a 3% local sales tax on top of the 6.25% ROT, for a total tax rate of 9.25% on taxable sales. Local sales taxes per se were not at issue in this case, so they will generally be excluded from discussion in this Tax Alert.

5. Eighty percent of the Use Tax goes to the state. The other 20% is split among various sources, with Chicago receiving 20% of this amount. Therefore, 20% * 20% = 4% of total revenue. In other words, Chicago gets 4 cents of every dollar collected as Use Tax.

This article is presented for informational purposes only and is not intended to constitute legal advice.

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