In a recent ruling by the Illinois Supreme Court (Court), the Court invalidated regulations providing that the place where sales orders are accepted determines the location of a sale for purposes of certain local Retailer’s Occupation Taxes (ROT). Many retailers had taken advantage of this regulation in order to reduce their ROT liability.
In Hartney Fuel Oil Company v. Hamer, the Court determined that the regulations impermissibly narrowed state statutes because such regulations failed to provide for a fact-intensive inquiry to source the sales for local ROT purposes to the jurisdiction where the predominate selling activities occurred and instead permitted a bright-line test sourcing the sales for local ROT purposes to the jurisdiction in which the sales orders were accepted. In response to Hartney, the Illinois Department of Revenue (Department) plans to issue new regulations to help taxpayers ascertain their ROT liabilities.
Prior to Hartney, in order to reduce the Illinois local sales taxes imposed on a retail transaction, retailers would often structure their transactions so that the final acceptance of an order occurred in a jurisdiction with low or no local sales tax. This sourcing method was in accordance with the regulations promulgated by the Department, which permitted sales for local ROT purposes to be sourced to the jurisdiction in which the sales order was accepted.
Hartney Fuel Oil Company (Company) is a retailer of fuel oil and has its home office located in Forest View, Illinois (Cook County). From its Forest View office, the Company would set fuel prices, cultivate customer relationships and handle administrative tasks. The Company also had a sales office in Mark, Illinois (Putnam County). As part of its local sales tax planning, the Company would contract with a business located in Mark for the lease of office space and the services of a clerk to accept the final sales orders. The clerk was employed by the Mark local business and worked only out of the Mark office. Customers would call the Mark office to place daily fuel orders. The clerk in the Mark office would check the list of customers with approval to order on credit and would accept such order if the customer was on the list. The Company also had long-term fuel oil contracts which were negotiated out of the Forest View office and signed by the president of the Company at the Mark office.
The Company interpreted regulations issued by the Department as establishing a bright-line test sourcing the sales for local ROT purposes at the location where the seller accepts the purchase order, provided that the sale is at retail and the purchaser receives physical possession of the property in Illinois. The Department argued that a totality of the circumstances test (Circumstances Test) should be applied. The Circumstances Test is discussed in a section of the regulations that is different from the section of the regulations relied on by the Company. Under the Circumstances Test, the Department asserted, the sales would be sourced to Forest View instead of Mark.
The Court determined that the language of the ROT statute required a fact-intensive inquiry to source the sales for local ROT purposes to the jurisdiction where the selling activities predominately occurred. Based on this analysis, the Court determined that the regulations issued by the Department (and relied on by the Company) impermissibly narrowed the scope of the state statutes, contrary to legislative intent, because it included a bright-line test sourcing the sales for local ROT purposes to the jurisdiction where the final sales orders were accepted. Therefore, the Court invalidated the regulations. As a result, the Company is liable for the additional sales tax due to the rate differential in Forest View versus Mark.
Fortunately for the Company and pursuant to the Illinois Taxpayers’ Bill of Rights Act, the Department has a duty to abate any taxes and penalties that are assessed based upon erroneous written information. The Court determined that the Company’s approach to the ROT was consistent with the regulations published by the Department at that time. Therefore, the Court determined that the Department had a duty to abate the taxes and penalties it imposed on the Company for the audit period.
Department’s response to Hartney
The Department has stated that it will promulgate regulations in the near future to provide guidance to taxpayers in determining their ROT liabilities. Such guidance will provide a fact-specific approach consistent with the ruling in Hartney, as well as other court interpretations of the statutory language.
The Department advised taxpayers who collect ROT only in no or low-tax rate jurisdictions where they arrange for final acceptance of purchase orders to re-evaluate this procedure in light of Hartney. The Department stated in its guidance that:
Businesses engaged in this practice should revise their procedures for reporting local retailer occupation taxes to comply with the court’s decision in Hartney. In determining whether enforcement action is warranted against a retailer for failure to collect and pay the correct local retailers’ occupation taxes going forward, the Department will consider whether the taxpayer has made a reasonable, prompt, good faith effort to comply with the Court’s decision.
The Multistate Tax Update will continue to follow developments in the wake of the Court’s decision in Hartney.