The list of potential side-effects of medication can often lend some validity to the aphorism that the remedy is worse than the disease. Tax regulations are not required to list the potential side-effects, but the remedy proposed by the Illinois Department of Revenue (the "Department") for Illinois' local sales tax sourcing ailments may indeed be worse than the disease. The Department issued a Second Notice, including a revised version of its proposed local retailers' occupation tax (sales tax) sourcing regulations May 29, 2014. This version substantially revises the Department's initial draft, and provides a "remedy" that is likely to make some taxpayers feel worse. The Joint Committee on Administrative Rules ("JCAR") will consider the Second Notice revisions at its June 17, 2014 meeting, a necessary step prior to formal adoption of the regulations, so there is still time and opportunity to seek revisions to the proposed sourcing rules included in the Second Notice.

The sourcing of sales for Illinois local sales tax purposes has been in chaos since the Illinois Supreme Court's late 2013 Hartney Fuel Oil1 decision. The Hartney decision invalidated the Department's longstanding regulations that treated the place of "order acceptance" as the location where the occupation of selling and the incidence of the local occupation (sales) tax occurred. Since the issuance of the Illinois Supreme Court's decision in Hartney, the Department has issued emergency regulations and proposed permanent regulations that identified, but did not weigh, the factors that comprise the occupation of selling that might occur in multiple locations.2 Also since that time, the city of Chicago, the village of Skokie, Cook County, and the Regional Transportation Authority have hauled more than 100 companies into a judicial discovery process to establish where the occupation of selling took place for such companies in the pre-Hartney periods.3 These developments have introduced a significant amount of uncertainty into the sourcing of sales for purposes of Illinois' local sales tax. If this was not bad enough, with the issuance of the Second Notice, the Department has now introduced uncertainty into the sourcing of sales for the state use tax as well.

The Department's Second Notice for its Proposed Regulations

The Second Notice that the Department filed with JCAR makes significant changes to the Department's original proposed permanent regulations. The proposed regulations originally identified primary factors, each equally weighted, which by their presence in a particular jurisdiction would indicate a possible situs for the occupation of selling, and identified a set of secondary factors, also equally weighted, for additional consideration if the primary factors failed to be conclusive. Under the Department's original proposal, the tie-breaker among multiple jurisdictions having both primary and secondary factors was to be a consideration of which jurisdiction provided the greater support of government services to the retailer.4 The Second Notice revises that analysis by providing a tiered sequence for its application.

The Second Notice provides that for multi-jurisdictional retailers, the place of the "predominant and most important Selling Activities" is determined by the location in which "three or more Primary Selling Activities" take place.5 The Second Notice also provides that "A retailer engaging in three or more Primary Selling Activities outside the State shall collect and remit the Illinois Use tax, except as provided in subsection (d).6 Nothing would be wrong with this rule, if the Primary Selling Activities did not include among them the act of "order acceptance" – meaning the place where authority is exercised to "bind the seller to a sale."

In 1955, Illinois enacted its Use Tax in reaction to the 1951 decision of the U.S. Supreme Court in Norton v. Department of Revenue.7 There, the U.S. Supreme Court held that, notwithstanding the existence of a retail operation in Chicago, not all of Norton's gross receipts from sales to Illinois could be subject to Illinois sales tax, and therefore, no Illinois sales tax would apply to the gross receipts from purchasers' orders accepted outside Illinois and shipped to Illinois from outside Illinois.

The new draft identifies six secondary selling activities. The secondary selling activities are intended to be used to determine the sourcing location when no individual jurisdiction has more than two primary selling activities. However, if applying the secondary selling activities review for vendors with multi-jurisdictional primary selling activities does not yield a sourcing location, then the sourcing defaults to either the jurisdiction where the inventory for the sale is located, or to the jurisdiction that is the location of the vendor's headquarters, depending on which jurisdiction is the location of more selling activities (whether primary or secondary).

The Impact on the State Use Tax

Because the Second Notice provides that "[f]or purposes of determining where a retailer is engaged in the business of selling it does not matter whether the retailer is engaged in Selling Activities in taxing jurisdictions in multiple States, or in multiple jurisdictions in the State" and thus, "[t]he legal standard is the same," it is now possible for a vendor to have order acceptance within Illinois and still not trigger an Illinois sales tax collection obligation on a sale shipped from outside Illinois if the requisite three primary and secondary selling activities take place outside Illinois. Likewise, it is possible for a vendor to have order acceptance outside Illinois and shipment from outside Illinois and be required to collect Illinois sales tax, rather than use tax, if the requisite three selling activities take place at a location within Illinois.

Aside from disregarding or tacitly overruling the Norton decision, the Second Notice is also directly contrary to existing Illinois sales tax regulations. The Department's state sales tax regulation section 130.610(d)(3) provides that "where the sale is made by or through an out-of-State place of business of the seller, Retailers' Occupation [sales] Tax liability will, nevertheless, be incurred . . . (A) where the seller or his authorized representative accepts an order in Illinois so as to create a contract, or (B) where the order is received in Illinois on behalf of the seller and someone in Illinois has authority to accepted [sic] such order so as to create a contract (whether such authority is exercised in the particular case or not.)"8 There is no way to reconcile this existing regulation with the contrary provisions of the Second Notice.

Whereas the status quo prior to the Second Notice was that of general uncertainty regarding the sourcing of sales for purposes of local taxes, the Second Notice has now created uncertainty regarding whether certain sales are subject to the state sales tax or the state use tax. Although the state sales and use taxes are imposed at identical rates (6.25 percent), vendors collecting the state sales tax (as opposed to the state use tax) are also responsible for collecting the additional local sales taxes. As a result of the Second Notice, it is unclear whether certain existing state use tax collectors are now subject to the state sales tax and whether existing retailers subject to the sales tax are now required to collect state use tax. This uncertainty has implications beyond the local rate differential, given the current proclivity of Illinois to add chaos to the sales and use tax regime by allowing individuals to pursue routine sales and use tax audit issues through the use of its False Claims Act.9

More to Come

On May 30, 2014, the General Assembly passed Senate Bill (S.B. 2612) and it now awaits the governor's signature. SB 2612 provides sourcing criteria for non-controversial, non-multi-jurisdictional transactions that are also covered by the Second Notice and set forth long-established standards for over-the-counter sales, remote sales with delivery at an in-state retail location for pickup, vending machine food sales, and sales of coal at the point of extraction.

The Hartney decision's broad holding was that determining the location of the business of selling could not be determined by a single or primary criterion; therefore, many agreed that established single-criterion standards in use without controversy were themselves at risk if not codified in statute. Although it is believed that the governor will sign SB 2612 into law, because the General Assembly passed an admittedly unbalanced budget (revenues do not match expenditures) that also awaits the governor's signature, there is reason to be cautious about even non-controversial legislation. Reed Smith will continue to monitor and provide updates regarding the developments in this area. .


1 Hartney Fuel Oil Co. v. Hamer, 998 N.E.2d 1227 (2013).

2 See RS Tax Alert "Illinois Issues Emergency Sales Tax Sourcing Regulations" (January 27, 2014).

3 See RS Tax Alert "WARNING: Illinois Courts Will Not Abide By Sales Tax Audit Result" (February 4, 2014).

4 See RS Tax Alert "Illinois Issues Emergency Sales Tax Sourcing Regulations" (January 27, 2014).

5 See, e.g., Second Notice, for 86 Ill. Admin. Code. § 220.115(c)(2).

6 Id.

7 Norton Co. v. Department of Revenue of State of Illinois, 340 U.S. 534 (1951).

8 86 Ill. Admin. Code Sec. 130.610(d)(3).

9 See RS Tax Alert "WARNING: Illinois Courts Will Not Abide By Sales Tax Audit Results" (February 4, 2014).

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