In late 2012, the Illinois Appellate Court, Third District, in its decision in Hartney Fuel Oil Co. v. Hamer, upheld a 2011 Illinois Circuit Court decision adopting a bright line test, based on place of sales order acceptance, for sourcing retail sales and the consequent state and local sales taxes to which they are subject. On January 30, 2013, the Illinois Supreme Court accepted the Illinois Department of Revenue’s petition for leave to appeal the Appellate Court’s decision. In the last two years, additional lawsuits addressing the proper legal test for sourcing sales for local sales tax purposes have been filed in Cook County Circuit Court by the City of Chicago and Regional Transportation Authority. It is expected that the Illinois Supreme Court’s upcoming decision in Hartney will bring legal clarity to this long-simmering Illinois sales tax controversy.
Background. The State of Illinois imposes sales tax at a statewide rate of 6.25% on sales at retail of tangible personal property. A portion of this revenue is remitted by the state to the local jurisdiction in which the sale takes place. In addition to a 6.25% statewide tax, a number of local jurisdictions, including municipalities, counties, and mass transit authorities, impose local sales taxes at varying rates on sales within their boundaries. For example, the combined state and local sales tax rate on sales in the City of Chicago is currently 9.25% (as of January 1, 2013 down from 9.5%). Sales tax regulations adopted by the Illinois Department of Revenue provide that the single most important factor in determining the local jurisdiction entitled to tax a sale is the seller’s place of sales order acceptance. A number of retailers have purposely located their sales office functions in low tax rate jurisdictions in order to take advantage of their lower marginal sales tax rates. An additional benefit to retailers in choosing where to locate a sales office is that certain local taxing jurisdictions are empowered by state law to share a portion of local sales tax revenues generated from their sales, encompassed within the statewide 6.25% tax rate, as an incentive for retail businesses to locate their operations within these jurisdictions.
Appellate Court. In its 2011 decision in Hartney, a Putnam County Circuit Court addressed the issue of where sales are sourced for local sales tax purposes. The taxpayer, Hartney Oil Company, is a family-owned oil distribution business, headquartered in Forest View, Illinois, a suburb of Chicago. The combined state and local sales tax rate on retail sales within Forest View is 9.0%, consisting of the 6.25% statewide rate, plus 2.75% of sales taxes imposed by local taxing jurisdictions, including the Village of Forest View, Cook County, and the Regional Transportation Authority.
Hartney’s oil distribution business is a high-volume, low-profit-margin business. Hartney relocated its sales office a number of times over the years, seeking the lowest marginal sales tax rate on its sales, an most recently moved this office to Mark, Illinois, where sales tax is limited to the 6.25% statewide tax. Hartney entered an agreement with Mark in which Hartney shared a portion of sales tax revenues, generated from Hartney’s sales, which served as an incentive for Hartney to locate its sales office in Mark.
The Illinois Department of Revenue audited Hartney’s sales tax returns. The Department sourced Hartney’s sales to Forest View, Illinois and issued a multi-million dollar assessment against Hartney for local sales taxes imposed on these sales in Forest View. Hartney filed suit in Putnam County Circuit Court protesting the Department’s assessment. The Circuit Court struck down the Department’s assessment, ruling that Hartney had proved by a preponderance of the evidence that fuel sales were completed at its dedicated sales office in Mark, Illinois, and that these sales must be sourced to Mark and not to Forest View, Illinois. The court found that customers, having been provided bid pricing information and the option of purchasing fuel from Hartney or elsewhere, could choose to purchase from Hartney. To do so, customers were directed to place their orders for Hartney oil products with the sales representative at Hartney’s Mark, Illinois sales office. Calls for fuel purchases made to Hartney’s Forest View headquarters were redirected to the Mark sales office. Purchase orders placed by customers, who did not pass a credit check, were rejected by the sales agent at the Mark sales office.
Long-term purchase orders were negotiated with customers by Peter Hartney. Customers mailed partially executed sales orders to the Mark sales office where they were then executed by Peter Hartney and returned to the customers. Hartney entered an agreement with a third party independent contractor under which the third party provided a sales representative to staff Hartney’s Mark sales office. The independent contractor received $1,000 per month as compensation for its services and for office space.
The Illinois Appellate Court upheld the Circuit Court’s ruling that the determinative fact in sourcing Hartney’s sales to Mark was that each sale was completed upon the sales representative’s acceptance of a customer purchase order at Hartney’s Mark, Illinois sales office. Because purchase order acceptance created a contractually binding agreement by Hartney to sell fuel oil to customers, the Appellate Court concluded under Illinois law that sales must be sourced to Mark, Illinois. The Illinois Department of Revenue filed petition for leave to appeal with the Illinois Supreme Court, which that court granted on January 30, 2013.
Regional Transportation Authority Suit. On January 14, 2013 the Regional Transportation Authority (“RTA”) filed a lawsuit in Cook County Circuit Court against United Airlines (“United”) and its subsidiary United Aviation Fuels Corporation (“Fuels Corp.”) which also involves the legal test for sourcing sales for local sales tax purposes. Fuels Corp. acquires fuel from suppliers exempt from Illinois sales/use taxes under purchases for resale exemptions. Fuels Corp. maintains a sales office in Sycamore, Illinois. Fuels Corp. resells the fuel it purchases to United and charges Illinois sales taxes totaling 8.0% on these sales, consisting of the 6.25% statewide tax and 1.75% Sycamore tax. Fuels Corp. also entered an agreement with Sycamore in which it shares a portion of Sycamore’s sales tax revenues as an incentive to locate Fuels Corp?s sales office in Sycamore.
The RTA lawsuit seeks a declaratory judgment by the court that Fuels Corps’ sales are properly sited to Chicago where the combined state and local sales tax rate currently equals 9.25%. The lawsuit asserts that the only reason Fuels Corp. has an office in Sycamore is “to attempt to create a sham tax situs for fuel sales in a lower tax jurisdiction.” The lawsuit further asserts that there is “no true acceptance of a [fuel] purchase order that takes place in Sycamore.” Instead, the lawsuit asserts that fuel purchases must be sourced to Chicago where United maintains its corporate headquarters.
This lawsuit is similar to separate lawsuits filed in Cook County Circuit Court by both the RTA and City of Chicago in 2011 against the City of Kankakee and Village of Chanahon seeking similar declaratory relief. Many Chicago-area businesses have chosen to locate sales offices in Kankakee and Channahon to take advantage of their low marginal combined state and local sales tax rates, and in connection with this have entered agreements in which the taxpayers are entitled to share a portion of local sales tax revenues sourced to these local jurisdictions. The Illinois Supreme Court’s decision in Hartney Fuel Oil Co. v. Hamer will greatly influence, if not determine, the ultimate success of these lawsuits.
Commentary. The Appellate Court’s decision in Hartney Fuel Oil Co. v. Hamer, was based on Department of Revenue local sales tax regulations, which direct that generally the place of sales order acceptance governs where a sale is sourced for local sales tax purposes. In the face of these regulations, the court was not persuaded by the Department’s attempts to demonstrate that other factors, such as determination of sales price and credit approval, sourced sales to Hartney’s Forest View headquarters. The court’s decision was unaffected by the relative ease with which Hartney had previously moved its sales office from one tax jurisdiction to another in seeking the lowest marginal sales tax rate on its sales, and also was not affected by Hartney’s decision to contract out its Mark, Illinois sales office functions to an independent service provider. Instead, the deciding factual consideration in the court’s decision was that sales orders were accepted and binding sales contracts were entered in Mark, Illinois. The court’s focus on this fact, to the exclusion of others, establishes a bright-line test for purposes of sourcing a retailer’s Illinois sales and therefore determining the local sales tax rate applicable to these retail sales.
A bright-line test is clearly advantageous from a tax administration standpoint. Based on this bright-line test, taxpayers can determine with relative certainty which of the myriad of combined state and local sales tax rates to which their sales will be subjected by assigning these receipts to the jurisdiction in which sales order acceptance takes place. On the other hand, the Department of Revenue, likely influenced by its conclusion that a bright-line test is subject to taxpayer manipulation, is arguing for a totality-of-circumstances test for sourcing sales receipts, which it further argues would require consideration of a “plethora” of factors such as where prices are set, where price sheets are sent to customers, where credit decisions are made, where customer decisions are made, and where timing of deliveries is determined. A significant problem with such a test is that it will render uncertain the determination of where a taxpayer’s sales receipts are sourced, subject to conflicting interpretations by retailers and the Department.
The Illinois Supreme Court’s decision in Hartney should resolve the issue of which legal test—“sales order acceptance” or “totality-of-circumstances”—applies to source sales for local sales tax purposes. However, given the intense recent scrutiny of this issue by the Department as well as local taxing jurisdictions such as the City of Chicago and the RTA, once the court issues its decision, it will be essential that retailers with business operations spread over multiple locations consult with their legal counsel to carefully plan their business operations and marshal the facts necessary to demonstrate where sales are sourced under whichever legal test is ultimately adopted by the court. If the court adopts the bright-line test, for which the taxpayer in Hartney argues, it will be essential that retailers be able to document where sales orders are accepted. Even if the court adopts the totality-of-circumstances test, for which the Department argues, a tax planning opportunity will still exist; however, retailers will need to fully understand and apply the court's ruling in order to document by the totality of circumstances where their sales occur for local sales tax purposes.