The Illinois General Assembly passed a last-minute, 198-page amendment to a film production tax credit bill (S.B. 1544) yesterday that makes substantial changes to the way Illinois taxpayers must compute their Illinois income tax liability. For example, S.B. 1544 changes the so-called “lockbox” rule applicable to financial institutions, the ability to deduct dividends received by certain real estate investment trusts, and methods of apportionment. One significant provision in S.B. 1544 changes Illinois’s current method of sourcing sales factor receipts for sales, other than sales of tangible personal property and certain intangibles, from costs of performance (“COP”) sourcing to market-based sourcing. This Legal Alert discusses the portion of S.B. 1544 that adopts the market-based approach to sourcing receipts for sales factor purposes.
Illinois apportions income under a single-sales factor regime. 35 I.L.C.S. 5/304(h). For purposes of determining which sales occur in the state, Illinois presently sources sales “other than sales of [tangible personal property] and [patents, copyrights, trademarks, and similar items of intangible personal property]” to Illinois if: (1) the income-producing activity is performed in the state; or (2) “the income producing activity is performed both within and without this State and the greater proportion of the income-producing activity is performed within this State than without this State, based on performance costs.” 35 I.L.C.S. 5/304(a)(3)(C). This language closely resembles that of section 17 of the Uniform Division of Income for Tax Purposes Act (“UDITPA”). UDITPA, drafted in 1957 by the National Conference of Commissioners on Uniform State Laws (“NCCUSL”), is a model state income tax law that governs allocation and apportionment of a multistate taxpayer’s income. Section 17 of UDITPA sets forth a model COP sourcing rule for sales of services and intangibles, attributing these sales to the state where the service is performed or the intangibles are being managed/maintained. As discussed below, the last-minute changes to S.B. 1544 follow the Multistate Tax Commission’s (“MTC”) criticism of UDITPA section 17’s use of COP sourcing.
Shift to Market-Based Sourcing
The day before the General Assembly’s spring session adjournment date of May 31, the House Revenue Committee amended S.B. 1544, which originally dealt solely with the state’s film production tax credit, to change Illinois’s current method of sourcing based on COP to market-based sourcing. Both the Senate and the House have now passed S.B. 1544, as amended. For taxable years ending after December 31, 2008, S.B. 1544 would attribute receipts derived from sales (other than sales of tangible personal property and patents, copyrights, trademarks, and similar items of intangible personal property) to Illinois if “the purchaser is in this State or the sale is otherwise attributable to this State’s marketplace.” S.B. 1544, 95th Gen. Assem., Reg. Sess. (Ill. 2007). Thus, if S.B. 1544 is signed into law by the Governor, Illinois taxpayers will be required to attribute income from sales of services and intangibles (other than sales of listed intellectual property assets) to the state where the benefit of the service or intangible is received. This change from COP sourcing to market-based sourcing will likely lead to dramatic and unpredictable results for many service providers with Illinois income tax liability.
The proposed Illinois legislation comes at a time when the NCCUSL has set up a Study Committee to review whether, and to what degree, the NCCUSL should commence a revision process with respect to UDITPA, including section 17’s COP provisions. As discussed in a previous Sutherland Legal Alert, the MTC has asked the NCCUSL, among other things, to replace section 17’s COP sourcing with market-based sourcing. Although it has not provided concrete bases for rejecting COP, the MTC has merely stated broad, non-specific reasons for adopting market-based sourcing in lieu of COP sourcing. The MTC’s comments in favor of market-based sourcing may have influenced the House Revenue Committee’s amendment of S.B. 1544 in light of the tax reform efforts floating around the General Assembly this session.
The last-minute changes to S.B. 1544 are, at a minimum, disconcerting. The voluminous amendment to S.B. 1544 submitted by the House Revenue Committee and approved by both sides of the General Assembly gave Illinois taxpayers little time to review the tax law changes contained in the bill, much less provide appropriate comments on those changes. Nonetheless, Illinois taxpayers – particularly service providers – should review their Illinois tax liability in light of the likely changes made by S.B. 1544.