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In late 2013, the Illinois Supreme Court issued its long awaited decision in the Hartney Oil local sales tax sourcing litigation. We had previously reported on the 2011 Illinois Circuit Court, and 2012 Illinois Appellate Court decisions in this litigation, ruling in favor of the taxpayer. The Illinois Supreme Court, in its decision in Hartney Fuel Oil Comp. v. Hamer, 2013 IL 115130 (Nov. 21, 2013), struck down Illinois Retailers Occupation Tax (generically “sales tax”) assessments issued to the taxpayer by the Illinois Department of Revenue (the “Department”). However, unlike the courts below, the State Supreme Court also invalidated Department regulations that source sales for local sales tax purposes based on the location of sales order acceptance. The Department is in the process of adopting new regulations, which, unlike its previous regulations, will consider the totality of the factual circumstances in sourcing sales. The Hartney decision has also spurred new litigation as local governments work to enforce the court’s decision.
The taxpayer, Hartney Fuel Oil Company, is a retailer of fuel oil products. At issue were the Department’s local sales tax regulations, which stated that the single most important factor to consider when sourcing sales was the place of sales order acceptance. Hartney, and other Illinois taxpayers, interpreted these regulations as adopting a bright-line test that sourced sales exclusively based on place the orders were accepted.
Hartney’s corporate offices were located in the Chicago area, where local sales taxes, when combined with the state-wide sales tax of 6.25%, were as high as 9.25%. Based on its interpretation of the Department’s regulations, Hartney moved its place of sales order acceptance to the town of Mark, Illinois, where no local sales taxes applied to sales – i.e. the total sales tax rate equaled just 6.25%. After audit, the Department issued Hartney a multi-million dollar tax assessment for local sales taxes, penalties and interest, which, considering all facts, sourced Hartney’s sales back to its Forestview, Illinois corporate headquarters.
Like the courts below, the Illinois Supreme Court determined that Hartney had correctly interpreted the Department’s regulations in determining that the place of sales order acceptance controlled the rate of local sales taxes due. Unlike the lower courts, however, the State Supreme Court also ruled that the regulations were invalid because they were inconsistent with the statutory provisions they purported to interpret, which imposed tax on the “business of selling.” The court held this statutory language required a fact-intensive examination by sellers to determine where their selling activities primarily took place.
Based on the totality of factual circumstances, the court held that the “bulk” of Hartney’s selling activities took place at its Forestview, Illinois headquarters where activities such as marketing, inventory maintenance, price setting, and sales relationship cultivation took place. The court also held that while a sales clerk in Mark, Illinois could accept a purchase order and bind Hartney to a sales contract, the clerk participated in no other aspect of the business of selling. Thus, the court ruled that Hartney’s sales should be sourced to its corporate headquarters in Forestview, and found Hartney liable for additional local sales taxes due there on its sales.
Nevertheless, the court ruled that, pursuant to the Illinois Taxpayers’ Bill of Rights Act, the Department has a duty to abate taxes and penalties based on its erroneous regulations. Because the court found that Hartney’s actions were consistent with the Department’s published (albeit erroneous) regulations, the court ruled that the Department must abate taxes and penalties imposed for the audit period against Hartney.
Based on the Hartney decision, taxpayers would generally appear protected, under the Illinois Taxpayers’ Bill of Rights Act, from historic liabilities due from previously sales sourcing based on the place of order acceptance. The Department has made clear, however, that such protection will not apply on a going forward basis. Shortly after the Illinois Supreme Court issued its decision in Hartney, the Department issued a press release advising taxpayers with selling activities in multiple jurisdictions to carefully review how they source sales in light of this decision. The Department warned that in determining whether enforcement action would be warranted against a retailer for failure to collect and pay the correct local sales taxes, the Department would consider whether the taxpayer had made a reasonable, prompt, good faith effort to comply with the Hartney decision.
On January 22, 2014, the Department filed Emergency Regulations and proposed permanent regulations with the General Assembly’s Joint Committee on Administrative Rules. The regulations, in interpreting Hartney, identify four primary indicia of selling activities that, as a general matter, will dictate where sales are sourced. These primary indicia are: i) offer; ii) acceptance; iii) inventory; and iv) sales personnel. To the extent examination of these factors fails to identify a selling location, the regulations specify that five secondary factors should then be considered, including the location: i) of the seller’s administrative functions; ii) of customer sales solicitation; iii) where contracts are received; iv) where title passes; and v) where goods are delivered. The emergency regulations were effective immediately for 150 days.
The proposed permanent regulations were published in the Illinois Register on February 7, 2014, which commenced a 45 day public comment period. And, as part of the public comment process, the Department held a public hearing on Friday, March 21, 2014, at which it collected comments on the proposed regulations.
Hartney also has spurred new litigation in Cook County Circuit Court by the Regional Transportation Association (“RTA”) as it attempts to enforce this decision. The RTA oversees the Chicago area mass transit system, and derives substantial revenues from sales tax imposed on sales in the Chicago area.
In April 2013, we reported on separate lawsuits the RTA and City of Chicago filed against the Kankakee and Channahon municipalities located just outside the Chicago area. The RTA and Chicago have recently issued new discovery requests in these suits to retailers locating purchase order acceptance offices in these municipalities. Once the retailers respond, it is very possible they may be added to the suits against the municipalities as defendants.
Additionally, on March 11, 2014 the RTA filed a complaint against American Airlines, its fuel sales retailer affiliate, and the City of Sycamore. And, on March 19, 2014, the RTA filed also complaints against Genoa, Savanna, and Morris, as well as several retailers locating purchase order acceptance offices in these municipalities. The complaints seek declaratory rulings, under Hartney, that sales can no longer be sourced to the municipalities based on mere purchase order acceptance, and seek recovery of tax revenues erroneously sourced to the municipalities, including revenues shared by the municipalities under Economic Development Agreements entered with the retailers.
Despite the totality of factual circumstances test adopted in Hartney, determination of where sales are sourced for local sales tax purposes will presumably remain straightforward for those retailers that conduct all selling activities at the same business location. However, for retailers that conduct sales solicitation, sales order acceptance, credit approval and/or other selling activities at different business locations, sourcing sales will be relatively complicated under the new test, and require an examination of all relevant facts in order to properly source each sale.
Despite the legal and factual complexity, and the lack of permanent regulations, taxpayers are now required to review their selling activities in conjunction with Hartney in order to make a good faith effort to source their sales and pay the appropriate local sales tax. In particular, taxpayers that previously moved their sales order acceptance function from their corporate headquarters to a low local sales tax jurisdiction, in order to minimize local sales tax burdens on their sales, would be well advised to carefully review whether, based on the totality of factual circumstances, their sales should continue to be sourced to the low tax jurisdiction.
In addition, taxpayers in their review of local sales tax sourcing may choose to expand this review to other states, such as California, that similarly examine the totality of factual circumstances in sourcing sales for local sales purposes. |
