In Hertz Corporation v. City of Chicago, widely known as the Enterprise case,¹ the Supreme Court of Illinois (Court) determined that the City of Chicago's extraterritorial enforcement of its personal property lease transaction tax² (lease tax) on short-term car rental companies doing business in and outside of Chicago on rental agreements executed outside of Chicago at a location that is within three miles of the City's border violates the home rule article of the State's constitution. The ruling overturns the decision of the appellate court.

Background

The City of Chicago imposes a lease tax on leases of personal property used within the City's boundaries, or the privilege of using property in the City that was leased outside of the City. The obligation to pay the tax is on the lessee, though lessors are obligated to collect the tax on property they lease inside the City. The transaction is exempt from the lease tax if the property is leased outside the City and primarily (defined as more than 50%) used outside of the City.³ The lease of the property is deemed to occur at the point where the property is delivered to the lessee.

In May 2011, the City's Department of Finance promulgated amended Ruling 11, requiring lessors of short-term car rentals doing business in the City to collect the tax for rental agreements executed within three miles of the City's border if the lessee was a Chicago resident, unless the lessee provided evidence that he/she intended to use the vehicle more than 50% outside of the City. The ruling required such agencies to maintain written records to support any claim of exemption, and provided additional guidance in the form of a sample provision that lessors could insert into their rental agreements that would allow the lessee to state his or her intention to use the vehicle primarily inside or outside of the City's boundaries. In the absence of any proof to the contrary, the City created a presumption that short-term leases to a Chicago resident based on his or her billing address were for use within the City and subject to the tax, while non-resident lessees were presumed to have leased the vehicle for use outside of the City.

The ruling also created a safe harbor provision for affected rental agencies, allowing them to assume that 25% of the rental charges to customers who are Chicago residents are for use in the City, and agencies could remit tax to the City on that amount. Hertz Corporation and Enterprise Leasing Company (collectively, car rental companies) filed suit for injunctive relief.

Analysis

The car rental companies argued that Ruling 11 was an extra-territorial extension of Chicago's taxing authority in violation of the Illinois constitution's home rule provisions. The State constitution allows home rule jurisdictions to exercise any power pertaining to its government affairs concurrently with the State, including the authority to tax, provided that the power is not specifically limited by the State legislature. In City of Carbondale v. Van Natta, 61 Ill. 2d 483 (1975), the Court held that the framers of the State constitution's home rule article intended to circumscribe the extraterritorial exercise of a home rule city's authority in the absence of express authorization from the General Assembly.

The car rental companies contended the lease transactions took place entirely outside of Chicago's municipal boundaries, including the lease negotiation, execution, and delivery of the vehicle. As such, enforcement of the tax on lessors located outside of Chicago was an unconstitutional extraterritorial extension of Chicago's authority to tax. Chicago argued the tax was on the use of the vehicle, and the operation of facilities within the City by the car rental companies provided the City with the authority to impose an enforcement obligation on affected rental agencies.

The key issue in this case is whether the City improperly extended its home rule power to tax beyond its borders by requiring lessors to collect lease transaction tax from lessees intending to use their vehicles primarily in Chicago during the rental period. While the Court agreed that the City has the authority to collect tax from taxpayers outside of its jurisdiction, it may only do so when the City has a sufficient connection with the location of the transaction. The City cited a number of instances in which taxpayers outside the City were required to collect tax on transactions inside the City, but the Court distinguished those cases from the present case, finding that the significant fact in those instances was the transactions being taxed all either occurred within the City's borders, or pertained to property delivered within the City's borders as directed by the taxpayers.

The City contended the lessee's stated intent amounted to evidence of use inside the City and, therefore, is subject to tax so long as the lessor was aware of the stated intent. The Court found this unconvincing, noting a stated intention is merely evidence of intent, and not actual use. The City also argued the car rental companies were doing business in Chicago because, by opening locations close to Chicago, they were leasing vehicles the lessors knew would be used on a short-term basis in Chicago. The Court dismissed this argument on similar grounds.

The Court ultimately decided that neither the residence of the lessee, nor the lessee's stated intent was an indication of where the rented vehicle was ultimately put to use. As such, Ruling 11 amounts to an extraterritorial tax on transactions that took place entirely outside of Chicago's borders. That exercise of authority violated the Court's prior decision in Van Natta, which held that any extraterritorial exercise of home rule authority by a municipality must be expressly granted by the General Assembly.

Implications

The City has made no public announcements regarding the procedures and its policy for refunding lease tax collected and remitted by lessors for periods preceding the decision. Assuming there are no special rules or policies adopted, the refund opportunity will depend on the specifics of each situation. Lessors that adopted the "safe harbor" provision per Ruling 11 and remitted the lease tax based on 25% of its rental charges to Chicago residents but did not reimburse themselves for the tax would have an opportunity to seek refunds of the tax. In addition, if a lessor did not collect tax from the lessee but remitted tax as a result of an audit without charging customers in arrears, the lessor should be entitled to a refund as long as the claim is filed within the applicable statute of limitations. If, on the other hand, the lessor collected tax from lessees and remitted those amounts, the lessor may need to first the refund tax collected to affected lessees. Lessees that receive a refund need to realize if they used the vehicle more than 50% in Chicago, they are still obligated to remit the lease tax directly to the City.

The decision raises numerous questions regarding the City's authority to enforce collection of the lease tax or collection and/or remittance of other transactional taxes imposed by the City. For example:

— Is a SaaS, cloud computing, etc. company with no physical connection to the City required to collect the lease tax imposed on such transactions (Transaction Tax Ruling 12 clarified the City's view of such transactions, which may be considered a form of a taxable nonpossessory computer lease)?

— Is the transferor of taxable software (Amended Ruling 5) required to collect the lease tax when it has no physical connection with the City but the software is stored and accessed at a third-party's server located in the City?

— Does a wholesaler of store checkout bags and bottled water with no physical presence in the City have an obligation to collect the checkout bag and bottled water tax from its customers who are resellers simply because the ordinances require such?

— Will companies such as ticket brokers or marketers of entertainment events in Chicago have an obligation to collect the Amusement Tax on the full value of the ticket instead of the venue's operator, especially when the payment received from the patron may include a service fee?

In the Hertz case, the Court looked not at the taxpayer's nexus with the City, but rather the transaction's connection to the City, specifically with regard to the use of the vehicle. In the absence of express authorization from the General Assembly, it is possible the extension of these taxes to lessors or wholesalers located outside of Chicago may violate the Court's ruling in Hertz.

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ENDNOTES

¹ Fully named "Hertz Corporation, et al., Appellants v The City of Chicago et al., Appellees". This case combined two separate cases filed against the City by the Hertz Corporation and Enterprise Leasing Company of Chicago.

² Chicago Municipal Code chapter 3-32.

³ Chicago Municipal Code Section 3-32-050(A)(1).