In Hartney Fuel Oil Co. v. Illinois Dept. of Revenue, the Illinois Circuit Court recently upheld a taxpayer's plan to source sales to a low rate city instead of a higher rate city.

Illinois Sales Tax Scheme: The State of Illinois imposes sales tax at a statewide rate of 6.5% 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 the 6.5% statewide tax, a number of local taxing bodies, including municipalities, counties, and mass transit authorities, impose local sales taxes at varying rates on sales within their boundaries. Sales tax regulations adopted by the Illinois Department of Revenue provide that the place of sales order acceptance determines the location where a sale is sourced for local sales tax purposes. 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 of choosing where to locate a sales office is that some local taxing jurisdictions are empowered by state law to share a portion of their sales tax revenues as an incentive for businesses to locate their operations within these jurisdictions.  

Court's Decision: In its 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 founded in 1916. Hartney's headquarters are located 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 6.5% statewide rate, plus 2.5% 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, with total annual sales of approximately $200 million. The sales tax rate imposed on Hartney's sales directly affects the profitability of its business. The court found that Hartney was under significant business pressure to sell its oil at the lowest possible price. Hartney relocated its sales office a number of times over the years, seeking the lowest marginal sales tax rate on its sales. It moved its sales office from Forest View in 1985 to Elmhurst, then to Burr Ridge, then to Peru and most recently to Mark, Illinois, where sales tax is limited to the 6.5% statewide tax. Hartney entered into an agreement with Mark in which Hartney shared a portion of local sales tax revenues, generated from Hartney's sales, as an incentive for Hartney choosing 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 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. Hartney entered an agreement with a third party independent contractor under which the third party provided a sales representative to man Hartney's Mark sales office. The independent contractor received $1000 per month as compensation for its services.

The court ruled that the determinative fact in sourcing Hartney's sales to Mark was that each sale was completed upon the sales representative's acceptance of customer purchase order at Hartney's Mark, Illinois sales office. The court ruled that because purchase order acceptance created a contractually binding agreement by Hartney to sell fuel oil to customers, under Illinois law the sales must be sourced to Mark, Illinois. The Illinois Department of Revenue has appealed the Circuit Court's decision to the Illinois Appellate Court.

Analysis of Circuit Court's Decision. The Circuit Court's decision was based on the Department's regulations, which direct that generally the place of sales order acceptance governs where a sales 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 the sales to Hartney's Forest View headquarters. The court's decision was also 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. 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.