The saga over local sourcing of Illinois retailers’ occupation taxes is well known. The Illinois Department of Revenue has a dedicated webpage for the issue, and Inside SALT covered some of the litigation aspects last month (see Illinois Regional Transportation Authority Suffers A Setback In Its Sales Tax Sourcing Litigation).  A new chapter is unfolding now, with revised proposed local sourcing rules that would apply a multifactor sourcing analysis to both intrastate and interstate sales. The regulations may be made final as soon as next month, and retailers with complex retailing processes should consider how the rules could apply to their operations.

Background: The Illinois Department of Revenue Issued Emergency and Proposed Local Tax Sourcing Regulations after the Supreme Court of Illinois Invalidated Its Old Rules in Hartney

Illinois has perhaps the most complex sales and use tax system in the country. One driver of this complexity is the fact that the Retailers’ Occupation functions as a sales tax but is really an occupation tax measured by gross receipts – the tax imposed is on the privilege of engaging in the occupation of being a retailer. Illinois lets some local jurisdictions impose additional Retailers’ Occupation Taxes, and so the effective local rate can climb higher than the 6.25 percent statewide base rate, e.g., the 9.25 percent rate applicable in Chicago. As the tax is imposed on the business occupation rather than the sale itself, origin-based sourcing principles apply. And for out-of-state sales shipped into Illinois and not subject to Retailers’ Occupation Tax, retailers have only a use tax collection obligation at the 6.25 percent state rate.

For decades, the Department of Revenue’s regulations applied a bright-line test based on order acceptance to determine where the taxable retailing activity had occurred for local Retailers’ Occupation Tax sourcing purposes. Some taxpayers structured their operations in reliance on this approach. But the Supreme Court of Illinois struck down the bright-line order acceptance test in Hartney Fuel Oil Co. v. Hamer, 2013 IL 115130 (Nov. 21, 2013), holding that an evaluation of all the retailing activities was necessary to determine where the retailing occupation occurred and consequently to which local Retailers’ Occupation Taxes a transaction was subject. The old local tax sourcing regulations were invalidated.

After Hartney, the Department promulgated new emergency local tax sourcing rules, effective January 22, 2014 (see the Department of Revenue press release, letter to Joint Committee on Administrative Rules, sample rule text). The emergency rules also served as a framework for the initial proposed final rules. These emergency and initial proposed final rules applied to intrastate tax sourcing and did not affect the Department’s longstanding rule governing whether a transaction was subject to in-state Retailers’ Occupation Tax or merely an out-of-state use tax collection obligation, 86 Ill. Admin. Code 130.610.

The Newly Revised Proposed Regulations Generally Consider Five Primary Factors in Determining the Location of the Taxable Retailing Activity

After consulting stakeholders and receiving numerous comments, the Department substantially revised [...]

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