The Illinois Department of Revenue (Department) recently adopted amendments to its sales factor and alternative apportionment regulations. The sales factor regulation (86 Ill. Adm. Code 100.3370) was amended to reflect the 1999 and 2008 statutory enactment of market-based sourcing. The alternative apportionment rules (86 Ill. Adm. Code 100.3380 and .3390) were amended to reflect statutory changes and to reflect current Department policies. These rules became final on August 3, 2017.

Sales factor regulation

The final amended sales factor regulation contains technical corrections throughout and adds substantive interpretive guidance on:

— Rules governing receipts from patents, copyrights, trademarks and other similar items of intangible personal property (the underlying statute was enacted for tax years ending on or after December 31, 1999)

— Rules governing market-based sourcing (the underlying statute was enacted for tax years ending on or after December 31, 2008)

In addition, the final amended sales factor regulation recognizes the Illinois Supreme Court decision in Exelon Corp. v. Department of Revenue,¹ by clarifying that sales of electricity are not considered sales of tangible personal property for apportionment purposes until tax years ending on or after July 15, 2009.

The final, amended version of the sales factor regulation adopted by the Department is substantially similar² to the proposed version of the regulation, which is discussed in-depth in Tax Alert 2017-277.

Alternative apportionment regulation

The alternative apportionment regulation was amended to reflect statutory changes, namely the adoption of market-based sourcing, and to reflect current Department policies. Under the amended regulation, a person may petition for, or the Department may require, the use of an alternative apportionment formula if: (1) for tax years ending before December 31, 2008, the use of the standard apportionment formula does not fairly represent the extent of a person's business activity in Illinois; or (2) for tax years ending on or after December 31, 2008, the use of the standard apportionment formula does not fairly represent the market for the person's goods, services, or other sources of business income. Alternative apportionment formulae include the following:

— Separate accounting

— Exclusion of any one or more factors

— Inclusion of one or more additional factors that will fairly represent the person's business activities or market in Illinois or

— Employment of any other method to effectuate an equitable allocation and apportionment of the person's business income

Throughout the regulation, the phrase "a person's business activity" is expanded to "a person's business activity or market."

Other amendments to the alternative apportionment regulation (specifically the exclusion of gross receipts from incidental or occasional sales found in 86 Ill. Adm. Code 100.3380(c)(2)), make clear that gross receipts from the sale of stock in a subsidiary are also excluded from the sales factor. The regulation lists various reasons why exclusion of incidental or occasional gross receipts from the sales factor is appropriate, with a common theme being that such sales are not usually in the market for the taxpayer's goods or services and inclusion would not reflect the taxpayer's market.

Adopted amendments further state that sales of intangibles and gross receipts in the regular course of business are disregarded and only the net gain (loss) is included in the sales factor. For tax years ending on or after December 31, 2008, however, only net gains are included in the sales factor for sales sourced under 35 ILCS 5/304(a)(3)(C-5)(iii) (dealing with interest on net gains and other items from the sale of intangible personal property).

Implications

The final amended sales factor regulation provides much-needed guidance on the application of the statutory rules, especially regarding the Department's distinction between a service and a transaction involving the sale of intangible property. However, it still leaves many areas unaddressed and open to dispute.

Because this final amended regulation would interpret statutory provisions that have been in place since 1999, for patents, copyrights, trademarks and other similar items of intangible personal property, and since 2008, for the market-based sourcing rules, taxpayers that have taken positions inconsistent with the final amended sales factor regulation are encouraged to consider any tax accounting implications these changes may pose.

The Department has not made any official announcement regarding whether it will take a "reasonable taxpayer" approach for purposes of issuing a Notice of Deficiency or abating the underpayment of tax penalty if a taxpayer reasonably interpreted the statute in a manner inconsistent with the final amended sales factor regulation. Taxpayers may need to consider whether the Taxpayer Bill of Rights provides a defense against a possible deficiency or penalty.³

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ENDNOTES

¹ Exelon Corp. v. Department of Revenue, 234 Ill 2d 266 (2009).

² Changes from the proposed amendments include 86 Ill. Adm. Code 100.3370(a)(2)(F)(i) and 100.3370(c)(5)(C)(ii) (more robust definitions for both); 100.3370(c)(6)(D)(iii)(Example 5) (inclusion of the phase "or have their ordering or billing address"); 100.3370(c)(6)(D)(iv) (last bullet) (inclusion of "deemed to be received").

³ Taxpayers' Bill of Rights Act; 20 ILCS 2520/.