State & Local Tax Alert

Transcription

1 State & Local Tax Alert Breaking state and local tax developments from Grant Thornton LLP Illinois Amends Apportionment Regulations to Clarify Market- Based Sourcing, Alternative Apportionment Provisions Effective August 3, 2017, Illinois has amended the apportionment regulations governing the calculation of the sales factor to provide guidance on several issues, including marketbased sourcing, that have been previously addressed by statute. The guidance clarifies the proper sourcing of income from: (i) a patent, copyright or trademark; (ii) electricity; (iii) the sale or lease of real property; (iv) the lease or rental of tangible personal property; (v) interest, net gains and other items of income from intangible personal property; and (vi) services. 1 In addition, the adopted regulations eliminate the double throwback rule and clarify the exclusion of incidental or occasional sales. 2 Finally, the alternative apportionment regulation has been modified to reflect market-based sourcing and the creation of the Illinois Independent Tax Tribunal. 3 Many of the regulatory changes are retroactively applicable to tax years in which the underlying statutes governing the sales factor calculation were amended. Because the legislation enacting market-based sourcing applies to taxable years ending on or after December 31, 2008, the amendments relating to market-based sourcing generally are retroactive to correspond with this statutory change. Sales Factor Patents, Copyrights and Trademarks For taxable years beginning on or after December 31, 1999, Illinois amended its sales factor apportionment statute that applies to all nonresident entities paying income tax to address the sourcing of receipts from patents, copyrights or trademarks. 4 Gross receipts from the licensing, sale or other disposition of a patent, copyright, trademark or similar item of intangible personal property are sourced to Illinois to the extent the item is utilized in the state during the year the gross receipts are included in gross income. 5 The statute includes provisions for determining where the intangible property is utilized and includes a throwout rule if the state of utilization cannot be determined. 6 Also, these gross receipts may be included in the sales factor only if they comprise more than 50 percent of Release date September 11, 2017 State Illinois Issue/Topic Corporate Income Tax Contact details Jeff Cook T E jeff.cook@us.gt.com Justyna Kubicki T E justyna.kubicki@us.gt.com Erin Tyrrell T E erin.tyrrell@us.gt.com Sarah Nelson T E sarah.nelson@us.gt.com Jamie C. Yesnowitz Washington, DC T E jamie.yesnowitz@us.gt.com Chuck Jones T E chuck.jones@us.gt.com Lori Stolly Cincinnati T E lori.stolly@us.gt.com Priya D. Nair Washington, DC T E priya.nair@us.gt.com 1 ILL. ADMIN. CODE tit ILL. ADMIN. CODE tit ILL. ADMIN. CODE tit ILL. COMP. STAT. 5/304(a)(3)(B-1), (B-2) ILL. COMP. STAT. 5/304(a)(3)(B-1)(i) ILL. COMP. STAT. 5/304(a)(3)(B-1)(ii)..

2 Grant Thornton LLP - 2 the taxpayer s total gross receipts during the tax year and each of the two immediately preceding tax years. 7 The sales factor regulation is amended to incorporate and clarify these statutory provisions. 8 Under the amended regulation, a similar item is defined as intellectual property that is registered or otherwise enforceable under a law equivalent to federal laws concerning patents, copyrights and trademarks or that is recognized in the country under whose law the sale or license agreement would be enforced or under which an infringement case would be brought. 9 The regulation clarifies that the definition of gross receipts for patents, copyrights and trademarks includes amounts received as damages or settlements from claims of infringement. 10 For copyrights, gross receipts include only amounts received from a person engaged in printing or other publication of the material. 11 Gross receipts from the licensing, sale or other disposition of a patent include only proceeds received for the use of the patent in production, fabrication, manufacturing or other processing of a product or for producing, fabricating or manufacturing a product subject to the patent. 12 The regulation clarifies the statute providing that a copyright is utilized in a state to the extent that printing or other publication originates in the state. 13 According to the regulation, this originates at the place in which the licensee of the copyright incorporates the copyrighted material into the physical medium by which it will be delivered to the purchaser of the material or, if the copyrighted material is delivered without using a physical medium, the place at which delivery of the copyrighted material to the person purchasing the material from the licensee originates. 14 For a taxpayer that has been in existence less than three taxable years, the gross receipts may be included in its sales factor if those gross receipts comprise more than 50 percent of its total gross receipts during each taxable year it has been in existence. 15 Electricity For taxable years ending after July 15, 2009, sales of electricity are considered sales of tangible personal property. 16 Prior to this change, the sale of electricity was treated as a sale other than the sale of tangible personal property or as the sale of a service ILL. COMP. STAT. 5/304(a)(3)(B-2). 8 ILL. ADMIN. CODE tit (a)(2)(F), (c)(3). These provisions apply to taxable years beginning on or after December 31, ILL. ADMIN. CODE tit (a)(2)(F)(viii). 10 ILL. ADMIN. CODE tit (a)(2)(F)(i). 11 ILL. ADMIN. CODE tit (a)(2)(F)(iii). 12 ILL. ADMIN. CODE tit (a)(2)(F)(ii) ILL. COMP. STAT. 5/304(a)(3)(B-1)(ii)(II). 14 ILL. ADMIN. CODE tit (c)(3)(B). 15 ILL. ADMIN. CODE tit (a)(2)(F)(iv). 16 ILL. ADMIN. CODE tit (a)(4). This change reflects Exelon Corp. v. Department of Revenue, 917 N.E.2d 899 (Ill. 2009). 17 Id.

3 Grant Thornton LLP - 3 Lease and Rental Income Receipts from the sale or lease of real property are sourced to Illinois if the property is located in the state. 18 Similarly, sales from the lease or rental of tangible personal property are considered to be in Illinois if the property is located in the state during the rental period. 19 For tangible personal property that is transported from state to state, such as motor vehicles, rolling stock or aircraft, the gross receipts are considered to be in Illinois to the extent the property is used in the state. 20 Interest, Net Gains and Other Items of Income from Intangible Property The regulation addresses the sourcing of interest, net gains and other items of income from intangible personal property, changes to which were previously adopted by statute. 21 For a dealer of securities, the income or gain is considered to be in Illinois if it is received from a customer in the state. 22 Customers with Illinois residency or that have an Illinois commercial domicile are considered to be in the state. If a dealer does not have actual knowledge of the residence or commercial domicile location, the billing address may be used. 23 For non-dealers, gross receipts from interest, net gains or other income are considered to be in Illinois if the income-producing activity of the taxpayer is performed in the state. If the income-producing activity is performed both within and without Illinois, it is considered to be in Illinois if a greater proportion of the activity is performed in Illinois than in any other state based on performance costs. 24 The regulation provides examples including the sales factor treatment of tickets to attend a sporting event, canned computer software and a rewards program. Services In general, gross receipts from the sale of services are sourced to Illinois to the extent that the receipts may be attributed to services received in Illinois. 25 A contract in which the taxpayer provides both a service and property is considered a sale of a service unless the contract is properly treated as a lease of property. 26 The regulation provides a list of factors to consider in determining whether the contract should be treated as a lease. In addition, the regulation highlights that the location where services are rendered may depend upon the identity of the subject matter of the service through a series of sourcing rules: ILL. COMP. STAT. 5/304(a)(3)(C-5)(i); ILL. ADMIN. CODE tit (c)(6)(A) ILL. COMP. STAT. 5/304(a)(3)(C-5)(ii); ILL. ADMIN. CODE tit (c)(6)(B). 20 Id ILL. COMP. STAT. 5/304(a)(3)(C-5)(iii)(B); ILL. ADMIN. CODE tit (c)(6)(C). For purposes of this provision, intangible property includes only an item that can ordinarily be resold or otherwise reconveyed by the person acquiring the item from the taxpayer. The term does not include any obligation of the taxpayer to make any payment, perform any act, or otherwise provide anything of value to another person. 22 ILL. ADMIN. CODE tit (c)(6)(C)(i). 23 Id. 24 ILL. ADMIN. CODE tit (c)(6)(C)(ii) ILL. COMP. STAT. 5/304(a)(3)(C-5)(iv); ILL. ADMIN. CODE tit (c)(6)(D)(i). 26 ILL. ADMIN. CODE tit (c)(6)(D)(ii).

4 Grant Thornton LLP - 4 If the subject matter of the service is an item of tangible personal property, the service is received in Illinois if possession of the property is restored to the recipient of the service; If the subject matter of the service is real property, the service is received in the state in which the real property is located; If a service such as a medical treatment service is performed on an individual, the service is received in the state in which the individual is located when the service is performed; and Services performed by a taxpayer that are directly connected to or in support of services received in Illinois constitute services received in the state. 27 The regulation includes examples to clarify these principles. To illustrate the final item listed above, the regulation provides an example concerning an investment fund. 28 In the example, services performed by an investment fund for an investor are received in Illinois if the investor is located in the state. 29 For services provided by the taxpayer to or on behalf of the investment fund that are directly connected with services provided separately to investors, such as the preparation of communications and statements to investors, the service is received in Illinois to the extent the investors are located in the state. 30 Services provided to an investment fund that are not directly connected to or in support of services provided separately to investors, such as brokerage services or investment advice, are not received by the customer at the location of its investors. If the state where the service is received is not readily determinable, the location used for ordering in the regular course of business should be used. 31 Similarly, if the services are provided to a corporation, partnership or trust and the services are received in a state in which the entity does not maintain a fixed place of business, the services are deemed to be received at the location of the office from which the services were ordered in the regular course of business. If the ordering location cannot be determined, then the billing location should be used. For taxpayers not subject to tax in the state where the services are received or deemed to be received, the associated gross receipts must be thrown out. 32 Special Apportionment Rules Business Activity References Expanded to Include Market For taxable years ending on or after December 31, 2008, the phrase business activity in a regulation governing alternative apportionment procedures has been replaced with the 27 ILL. ADMIN. CODE tit (c)(6)(D)(iii). 28 Id., Example For individual investors, the receipts are sourced to Illinois if the investor resides in the state. For other investors, the receipts are sourced to Illinois if the investor has an ordering or billing address in the state. 30 Receipts for these services are sourced to Illinois using the ratio of: the average of the outstanding shares in the fund owned by investors located in Illinois at the beginning and end of each tax year; and the average of the total number of outstanding shares in the fund at the beginning of each year. 31 ILL. ADMIN. CODE tit (c)(6)(D)(iv). 32 Id.

5 Grant Thornton LLP - 5 phrase market for the person s goods, services, or other sources of business income. 33 Similarly, other references to business activity are amended to include or market. 34 Double Throwback Eliminated For taxable years ending before December 31, 2008, sales are attributable to Illinois when neither the origin nor the destination of the sale is within Illinois, the person is not taxable in the state of origin or destination, and the activities associated with the sales are not protected by P.L This double throwback provision does not apply to taxable years ending on or after December 31, 2008 on the basis that attributing the sale to Illinois does not fairly represent the market for the person s goods, services or other sources of business income in the state. Incidental or Occasional Sales Under the existing regulation, the gross receipts from the incidental or occasional sale of assets used in the regular course of a taxpayer s trade or business are excluded from the sales factor. 36 The regulation is amended to clarify that gross receipts from the sale of stock in a subsidiary also are excluded. As amended, the regulation includes a list of reasons why the exclusion of incidental or occasional sales is appropriate. 37 For example, these sales are not made in the market for the person s goods, services or other ordinary sources of business income. Also, to the extent that gains realized on the sale of assets in a taxpayer s business are the recapture of depreciation deductions, the taxpayer s economic income was understated in the years when those deduction were taken. In this situation, the recapture gains should be allocated using a method approximating the factor used in apportioning the deductions. Furthermore, to the extent the gain on the sale is from goodwill or similar intangibles, including the gross receipts will not reflect the market for the taxpayer s ordinary sources of business income. Finally, for sales of assets that are made in connection with a partial or complete withdrawal from the market in the state where the assets are located, including the gross receipts from these sales would increase the business income apportioned to that state when the taxpayer s market in that state has decreased. Petitioning for Alternative Apportionment The alternative apportionment regulation has been amended to clarify that for taxable years ending on or after December 31, 2008, if the standard allocation and apportionment provisions do not fairly represent the market for the taxpayer s goods, services or other sources of business income (previously, the extent of the person s business activity in the state), the taxpayer may petition for separate accounting, the exclusion of any one or more factors, the inclusion of one or more factors or the employment of any other method to 33 ILL. ADMIN. CODE tit (a)(1). 34 ILL. ADMIN. CODE tit (a)(1), (2). 35 ILL. ADMIN. CODE tit (c)(1). Also see P.L , codified at 15 U.S.C This federal rule prohibits a state from taxing interstate commerce and subjecting an entity to income taxation based on solicitation activities alone. 36 ILL. ADMIN. CODE tit (c)(2). 37 Id.

6 Grant Thornton LLP - 6 fairly allocate and apportion the taxpayer s income. 38 Also, the burden of proof provisions are amended to reflect market-based sourcing. 39 Administrative provisions concerning the petitions are amended. If a petition is approved, the Department will grant permission to use an alternative apportionment method in the form of a private letter ruling. 40 In addition, if the petition is made through an attachment to an amended return, the explanations section should state that the amended return includes a petition for alternative apportionment that should be referred to the Legal Services Bureau/Income Tax. 41 A copy of the return should also be mailed to the Legal Services Bureau/Income Tax. Protesting a notice of deficiency issued as a result of an audit now also includes a petition to the Illinois Independent Tax Tribunal. 42 Alternative apportionment may not be raised in a protest or petition to the Illinois Independent Tax Tribunal unless (i) the taxpayer has requested in writing that the auditor allow the use of alternative apportionment and the request was denied or (ii) the audit disallows an alternative method of apportionment used by the taxpayer on its return. 43 Commentary The long-awaited sales factor sourcing rules for services contained in Ill. Admin. Code. tit. 86 Sec are now final. For many years, taxpayers were limited to draft regulations which would change from time to time, often without much notice. With the amended regulations being in draft form, it was challenging for both taxpayers and auditors to make sourcing determinations, especially in the already complicated arena of intangibles and service income. Many times, a position or methodology was agreed upon as reasonable under audit with the taxpayer and auditor. The proper sourcing of income is now more certain with the adoption of the final regulations. Taxpayers should review historic positions going back to years ending on and after December 31, 2008 to determine if these positions need to be reconsidered. The amendments to Sec are useful because they provide clarification and a variety of examples that should assist in sourcing income from services. For instance, the regulation provides examples of when to apply either the service sourcing rules or the intangible sourcing rules. As discussed above, a particularly interesting example concerns the sourcing of services performed by an investment fund. If the services are directly connected to the services provided separately to investors, a look-through approach must be used. The services that are directly connected must be bifurcated and sourced differently than the services that are not directly connected to investors. Also, note that the throwout provisions cover situations in which the location where the service is received is not readily determinable as well as situations in which the taxpayer does not have a fixed place of business in the state. 38 ILL. ADMIN. CODE tit (a). 39 ILL. ADMIN. CODE tit (b). 40 ILL. ADMIN. CODE tit (e)(1). 41 ILL. ADMIN. CODE tit (e)(2). 42 ILL. ADMIN. CODE tit (e)(3). 43 Id.

7 Grant Thornton LLP - 7 As amended, Sec provides an opportunity for taxpayers to pursue potential refunds related to the elimination of double throwback. Also helpful are the additional stated reasons outlining when receipts should be excluded from apportionment due to an incidental or occasional sale. While the list of scenarios is not all-inclusive, it does provide some additional guidance that often will come into play when businesses are sold. The alternative apportionment provisions in Sec have been amended to reflect market-based sourcing and the addition of the Illinois Independent Tax Tribunal. A petition for alternative apportionment may be filed if the standard apportionment provisions do not fairly represent the market for the person s goods, services or other sources of business income. Taxpayers seeking alternative apportionment should carefully consider the administrative procedures contained in this regulation. The information contained herein is general in nature and based on authorities that are subject to change. It is not intended and should not be construed as legal, accounting or tax advice or opinion provided by Grant Thornton LLP to the reader. This material may not be applicable to or suitable for specific circumstances or needs and may require consideration of nontax and other tax factors. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Grant Thornton LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. No part of this document may be reproduced, retransmitted or otherwise redistributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, re-keying or using any information storage and retrieval system without written permission from Grant Thornton LLP. This document supports the marketing of professional services by Grant Thornton LLP. It is not written tax advice directed at the particular facts and circumstances of any person. Persons interested in the subject of this document should contact Grant Thornton or their tax advisor to discuss the potential application of this subject matter to their particular facts and circumstances. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed.