1999 Practitioners' Questions and Answers

The provisions of Section 2-45 of the Retailers' Occupation Tax Act (35 ILCS 120/2-45), as well as regulations found at 86 Ill. Adm. Code 130.330 (g)(1), authorize purchasers to document the manufacturing machinery and equipment exemption by either an active registration or resale number, or by a certificate of exemption (the ST-587).

Purchasers who document the exemption by providing suppliers with an active registration or resale number are authorized to utilize blanket certificates.

However, Section 2-45 of the Retailers' Occupation Tax Act, as well as the provisions of 86 Ill. Adm. Code 130.330 (g)(1), require purchasers who do not have active registration or resale numbers to document each purchase with a certificate of exemption ( the ST-587).

A seller who has obtained either a valid registration or resale number or ST-587 certification documenting the manufacturing exemption need not prove the exemption on audit. We believe that the holding in Rock Island Tobacco and Specialty Co. v. DOR, 87 Ill.App.3d 487 (1980), is applicable.

Regardless of the manner in which the exemption is documented, we recommend as a matter of common sense that the documentation be as explicit as possible to reflect that the manufacturing exemption is being claimed. Receipt of a registration or resale number, without more information, might appear to document a resale exemption.

After June 30, 1999, a manufacturer requests a refund of sales (or use) tax from a vendor for the purchase of production related tangible personal property made during 1998. The reason stated for obtaining this refund is that the purchaser forgot to use MPC to offset the tax on the purchase. Must the manufacturer have reported the purchase on its 1998 ST-17 filed on or before June 30, 1999?

Can the manufacturer "retroactively" utilize the credit on the 1998 purchase?

If not, could the manufacturer have used the credit on the purchase if the purchase was reported on a timely filed 1998 ST-17? If the manufacturer can use the credit on the 1998 purchase, and this use of the credit was not reported on its 1998 ST-17, must it amend the 1998 ST-17 for this item?

If the credit can be used on this purchase, is the vendor under any obligation upon receiving such a tax refund request to verify that the use of MPC was reported on a ST-17 or amended ST-17 by the manufacturer?

Retailers and servicemen are not required to accept Manufacturer's Purchase Credit certifications (ST-16-Cs) after the sales have taken place and the appropriate tax has been paid. Likewise, retailers and servicemen are not required to give refunds of tax properly paid by a customer in exchange for such certifications. The Department believes that it does not have the statutory authority to prohibit retailers and servicemen from accepting such certifications after the qualifying sales have taken place.

In order for the manufacturer in the above question to use MPC with a vendor on a prior purchase in 1998, all of the following must occur:

a) the vendor must agree to accept the MPC and refund the Use Tax (6.25% State rate only) previously paid by the manufacturer;

b) the MPC being used must have been earned prior to the purchase of the production related tangible personal property;

c) the manufacturer must have filed, on or before June 30, 1999, an ST-17 (Annual Report of Manufacturer's Purchase Credit) for 1998; and

d) the manufacturer must have reported that MPC usage on the ST-17 for 1998, or the manufacturer must file, before that MPC expires, an amended report (ST-17-X) for 1998 showing the use of that MPC.

The vendor is not under any obligation to verify that the use of the credit was properly reported by the manufacturer on an ST-17 or ST-17-X. However, the vendor must retain in its books and records an ST-16-C (Manufacturer's Purchase Credit Certificate) provided by the manufacturer regarding that qualifying purchase.

Yes, the certificate will be accepted as valid and will be accepted on audit without requiring the seller to prove that the purchaser actually resold the property

The authority for this situation is found at section 2c of the Retailers' Occupation Tax Act. See, 35 ILCS 120/2c. This provision is also dealt with in the regulations at 86 Ill. Adm. Code 130.1405(b)(5)(c). In effect, this is a legislative realization that an out-of-state retailer who takes delivery of inventory in Illinois will not have an Illinois registration number or an Illinois resale number. To that extent, this certification from the out-of-state retailer is in lieu of an Illinois registration number or Illinois resale number. Sometimes Illinois sellers making these sales ask the out-of-state purchaser/reseller to include a registration number from the state in which he is registered as a retailer. However, neither the statute nor the regulation require that an out-of-state registration number be provided.

So long as the certification is taken in good faith, the Department will not go behind it. In fact, we think that the rationale of Rock Island Tobacco and Specialty Co. v. Department of Revenue, 87 Ill. App. 3d 476 (Third Dist. 1980) seems applicable.

The only situation that we can think of in which the certification would be disallowed would be if the Department had information that the certification was not taken in good faith (e.g., if there was collusion involving the seller and an out-of-state purchaser).

Regarding the Illinois Retailers' Occupation Tax: A retailer receives a letter from its customer that the customer had a reverse use tax audit and asks that a refund claim be filed by the retailer on tax paid previously to the retailer. The retailer can not file a claim for credit or an amended return without unconditionally repaying the customer the amount of tax collected (Regulation 130.1501 a) 3).

What happens to the retailer who has refunded the tax, but learns that the IDOR has denied the claim and it can not locate its customer to obtain the tax back?

Also, what about if the retailer believes that the claim is unlikely to be granted. Does the retailer have to refund the tax before it files the claim and learns whether the claim is valid?

Section 6 (the claim section) of the Retailers' Occupation Tax Act provides in part that:

"No credit may be allowed or refund made for any amount paid by or collected from any claimant unless it appears that the claimant has unconditionally repaid, to the purchaser, any amount collected from the purchaser and retained by the claimant with respect to the same transaction under the Use Tax Act."

As far as the Department is concerned, a retailer who has unconditionally repaid tax to his customer in order to file a claim has no basis upon which to demand a return of that money if the claim is denied. And this is true whether the unsuccessful claimant can find the customer or not. Unconditional refunds can not be conditioned upon a successful claim.

The State of Illinois taxes leases differently for Retailers' Occupation Tax and Use Tax purposes than the majority of other states. For Illinois sales tax purposes, there are two types of leasing situations: conditional sales and true leases. Illinois does not differentiate based upon the capital and operating lease designations. However, a capital lease would generally be considered a conditional sale and an operating lease would generally be considered a true lease. The terms of the contract control the designation the Department gives to the lease or conditional sale agreement.

A conditional sale is usually characterized by a nominal or one dollar purchase option at the close of the lease term. Stated otherwise, if it is obvious from the terms of the agreement that the leased property will be sold, the transaction is considered to be a conditional sale at the outset of the transaction, thus making all receipts subject to Retailers' Occupation Tax. An installment sales contract is an example of a conditional sale.

A true lease generally has no buy out provision at the close of the lease. If a buy out provision does exist, it must be a fair market value buy out option in order to maintain the character of the true lease. Lessors of tangible personal property under true leases in Illinois are deemed end users of the property to be leased. See the enclosed copy of 86 Ill. Adm. Code 130.220. As end users of tangible personal property located in Illinois, lessors owe Use Tax on their cost price of such property. The State of Illinois imposes no tax on rental receipts. Consequently, lessees incur no tax liability.

As stated above, in the case of a true lease, the lessors of the property being used in Illinois would be the parties with Use Tax obligations. The lessors would either pay their suppliers, if their suppliers were registered to collect Use Tax, or would self-assess and remit the tax to the Department. If the lessors already paid taxes in another state with respect to the acquisition of the tangible personal property, they would get a credit for the tax properly due and paid in such other state. See 86 Ill. Adm. Code 150.310(a)(3) enclosed.

Under Illinois law, lessors may not "pass through" their tax obligation on to the lessees as taxes. However, lessors and lessees may make private contractual arrangements for a reimbursement of the tax to be paid by the lessees.

The above guidelines are applicable to all true leases of tangible personal property in Illinois except for automobiles leased under terms of one year or less, which are subject to the Automobile Renting Occupation and Use Tax found at 35 ILCS 155/1 et seq.

The Department remains dependent upon the appropriations process for funds for cash refunds. For fiscal year 2000 the General Assembly appropriated $35,000,000.00 and this compares to a total appropriation of $24,500,000.00 ($9,500,00.00 original and $15,000,000 supplemental) for fiscal year 1999 which ended June 30. 1999. This additional funding has allowed the Department to pay out an increased number of refunds. However, the Department does not have sufficient funding to pay out all requests for refund. Therefore, the Department must continue to use the "hardship" criteria set forth in its rules.

Pursuant to 86 Ill. Adm. Code 130.1510 a taxpayer that demonstrates to the Department that it made an overpayment of ROT (or UT/SOT/SUT) as a result of an error of law or mistake of fact can only receive a refund if there is a sufficient appropriation. If there is not a sufficient appropriation to make cash refunds for all foreseeable claims during the period covered by such appropriation, then cash refunds are limited to "hardship" cases. Hardship exists where the claimant would not readily be able to use a credit memorandum. The best examples would be a claimant who has discontinued business or a claimant with a small monthly liability who is to receive a very large credit memorandum. As the question indicates, the Department is limited by the amount of resources the General Assembly appropriates for this purpose.

No. There is no exemption available. Because the manufacturer/lessor is purchasing the parts for use and not for resale, Retailers' Occupation Tax and Use Tax are applicable. When tangible personal property is located in this State at the time of its sale (or is subsequently produced in this State) and then is delivered in this State to the purchaser, the gross receipts from the sale are subject to tax if the sale is at retail.

However, Retailers' Occupation Tax liability does not apply to the gross receipts from a sale in which the seller is obligated, under the terms of an agreement with the purchaser, to make delivery of the property from a point in this State to a point outside this State, not to be returned to this State, provided that such delivery is actually made. See 86 Ill. Adm. Code 130.605(b).

As we understand the question, the parts are being delivered by the supplier to the lessor/manufacturer in Illinois. So long as that is the case, the interstate commerce exemption is not available.

We do not have sufficient facts to give a definitive answer to this question. We assume this is a cafeteria that is making sales of meals to employees. Therefore the cafeteria's gross receipts are subject to ROT liability at the high rate pursuant to 86 Ill. Adm. Code 130.330 and 130.2145.

Regarding the situation stated in the question where the company issues a $5.00 voucher and then the voucher holder purchases food items totaling $5.50, there are different scenarios that would have different tax consequences and these would vary depending upon the circumstances that surround the giving of the voucher.

If the taxpayer were issuing the voucher in exchange for consideration of any kind such as employee or contractor services, taxpayer would owe ROT on the total $5.50 because the use of the $5 voucher to pay for the food would be consideration as that term is used in Section 1 of the ROT Act (35 ILCS 120/1) in the definition of selling price.

If the voucher were equivalent to a gift coupon within the conditions of 86 Ill. Adm. Code 130.2125(c), then ROT would only be due on the $0.50, and the retailer would incur a use tax liability at the low rate on its cost price of the food items "given away". This would entail the retailer using a percentage certificate of resale when purchasing food items, 86 Ill. Adm. Code 130.1405(c)(2).

Another possibility would be when an employer would furnish meals to employees free of any charge whatsoever. For example, when employees of a restaurant, hotel or cafeteria are furnished their meals free at the place of employment and are entitled to no additional compensation if they do not eat their meals at that place of business, the furnishing of such free meals is not a sale under the ROT Act. In these cases the employer does owe use tax on such meals pursuant to 86 Ill. Adm. Code 130.2050.

We are assuming that the taxpayer's mistakes are discovered during an open period still subject to audit, and that there is no fraud involved. In that case, the taxpayer could file an amended return, pay the tax and interest, and request that the Department abate the penalties due to "reasonable cause." See Section 3-8 of the Uniform Penalty and Interest Act (UPIA) (35 ILCS 735/3-8). The Department's regulations at 86 Ill. Adm. Code 700.400 provide guidelines for what is considered "reasonable cause." If the taxpayer does not have "reasonable cause" for failing to pay the tax at the required time, the only option would be to petition the Board of Appeals for abatement of the penalties.

The Department is involved in a review of the Uniform Penalty and Interest Act. As a portion of this review, we have scheduled a public hearing in Chicago on November 19, 1999. The issue that is raised in this question, the fact that Section 3-3 of the Uniform Penalty and Interest Act penalizes taxpayers who voluntarily report underpayment, while not penalizing taxpayers whose underpayment is discovered as a result of a Department audit is an issue that will be given serious consideration as we determine what recommendations to make with regard to the current Uniform Penalty and Interest Act.

The discrepancy in treatment under Section 3-3 was motivated by a desire to encourage taxpayers to settle audits. It was thought at the time that by providing taxpayers with the opportunity to pay an audit liability penalty-free, more audits would be settled. However, as the questioner points out correctly, the current statutory scheme also may have the unintended effect of discouraging taxpayers from voluntarily reporting tax underpayments and waiting to see if they are audited.

The Department is not averse to attempting to craft some type of solution to this discrepancy. However, at this juncture we are not certain of how to craft a solution that fixes the current discrepancy in treatment without providing taxpayers an incentive to intentionally underpay taxes. At this point, we are not convinced that the interest due on the tax at the federal underpayment rate is a sufficient deterrent to voluntarily and knowing underpayment of taxes. We hope that the hearing on November 19 will generate some creative suggestions in this regard.

The answer in both instances depends on whether the service was purchased from a serviceman above the statutory threshold or below the statutory threshold.

Purchases of service from servicemen above the statutory threshold (de maximus servicemen) result in service use tax liability for the service customer. This is true whether the serviceman is located in Illinois or outside Illinois.

Purchases of service from unregistered servicemen below the statutory threshold (de minimus servicemen) result in no service use tax liability for the service customer. This is true whether the serviceman is located in Illinois or outside Illinois.

We can't give a blanket authorization to assume that purchases from servicemen who do not charge tax are de minimus servicemen. However, the history of the Service Occupation Tax Act has seen the threshold increase so that more and more servicemen were de minimus. The first thresholds were proposed at 2% and then 10%. As more and more servicemen realized that they would have to function as de maximus servicemen (i.e., register with the department, charge tax to customers and pay tax to the department) unless they were under the threshold, the threshold was raised to 35% for most servicemen and to 75% for pharmacists and special order printers. As a practical matter, with the thresholds that high, just about every serviceman qualifies as de minimus. I think it is unlikely (not impossible, but unlikely) that a lump sum invoice to a service customer is from a de maximus serviceman. So long as that is the case, I don't think that auditors are going to spend a lot of time trying to find an untaxed lump sum invoice from a de maximus serviceman. The chances of finding such an invoice are remote. This is especially true for invoices from special order printers where the statutory threshold is 75%.

Nonetheless, if there were something about an invoice which would lead an auditor to believe that it came from a de maximus serviceman, there would be nothing to prohibit that auditor from making further inquiry---and this would be true whether the invoice was from an Illinois serviceman or an out-of-state serviceman.

Nexus is not established if an out-of-State retailer makes sales to Illinois customers via the Internet where the out-of-State retailer's only presence in Illinois is through advertising over the Internet even if the Internet provider maintains servers in Illinois. This situation is no different than one where a company advertises on national television or radio and the customer orders the product by telephone.

The out-of-State retailer must meet the definition of a "retailer maintaining a place of business in Illinois" as that term is defined in 86 Ill. Adm. Code 150.201(i) in order to have nexus with Illinois. The United States Supreme Court in Quill Corp. v. North Dakota, 112 S.Ct 1904 (1992), set forth the current guidelines for determining what nexus requirements must be met before a person is properly subject to a state's tax laws. The Supreme Court has set out a 2-prong test for nexus. The first prong is whether the Due Process Cause is satisfied. Due process will be satisfied if the person or entity purposely avails itself or himself of the benefits of an economic market in a forum state. Quill at 1910. The second prong of the Supreme Court's nexus test requires that, if due process requirements have been satisfied, the person or entity must have physical presence in the forum state to satisfy the Commerce Clause.

An out-of-state retailer that does not have sufficient nexus with Illinois to be required to submit to Illinois tax laws does not incur Retailers' Occupation Tax on sales into Illinois and is not required to collect Use Tax on behalf of its Illinois customers. However, the retailer's Illinois customers will still incur Use Tax on the purchase of the out-of-State goods and have a duty to self-assess their Use Tax liability and remit the amount directly to the State.

There are currently 7 companies that are actively participating in the direct pay program. The are an additional 7 companies that have applied to participate in the program and the will be participating on an "effective rate" basis. The Department is currently working with these 7 taxpayers to determine an "effective rate." Two taxpayers applied to participate in the program but have since withdrawn.

IDOR views the direct pay pilot program as a positive experience. It has allowed DOR to foster working relationships with participants in getting them set up as active participants and reviewing their procedures for implementing their programs and computer systems. We have been able to implement the pilot program into existing IDOR systems without significant changes.

The Department has denied one more recent application for the program, due to the need to get a filing history that the audit division can review during the next year to make a report to the Illinois legislature by January 1, 2001. This report along with proposed legislation will be required at that time. The results of our review of the participants will need to be completed in sufficient time to compile the information and create a meaningful report.

Regarding the local tax issue, taxpayers now have two options available for reporting purposes. One is to use actual vendor locations to determine and account for the local taxes. This method is being used by the majority of the taxpayers in the direct pay program. The only issue that has caused some extra effort has been in jurisdictions where multiple local tax rates exist. In these instances, our Local Tax Allocation Division has offered participants assistance in identifying the correct rates to utilize.

The second method used by only a few taxpayers is use of an effective rate that is determined by the Department. For these few taxpayers the Department has done a statistical sample for purchases made by the taxpayer for the prior two or three years. This resulted in an effective rate where 15% of purchases may have been made from Chicago vendors, another 10% from Bolingbrook, etc.. The taxpayer will use this effective rate for six to eight months and then the Department will audit that taxpayer's direct pay filing to determine the accuracy of the application of the effective rate. The goal here is to determine if filing experience will support use of a method that is easier for taxpayers to use.

During the most recent session of the 91st General Assembly, Senate Bill 802 (Maitland/Moore) was amended in the Senate to exempt from the state's sales and use tax Acts tangible personal property temporarily stored in Illinois, before being transported out of state for use elsewhere.

Specifically, this is an initiative of the Illinois State Chamber on behalf of an insurance company. The proposed language would allow any multi-state business to buy items that will ultimately be used outside of Illinois, tax-free. Currently, whenever or any business purchases items in Illinois, regardless of their intended destination, they are subject to the 6.25% state sales tax, plus any local sales taxes imposed. When any business transports the goods for use in another state; they are then subject to the other state's use tax. However, as Illinois does for property coming into this state, the other state allows any business credit for taxes already paid to Illinois. Essentially, An insurance company wants the conveniences of an Illinois location, but does not want to pay sales tax to Illinois, because in some cases, Illinois' sales tax rate is higher than other states. However, to purchase the same products from an out-of-state vendor, in order to avoid paying sales tax on the initial purchase of products, the company obviously incurs additional transportation costs. Thus, the argument of having to pay higher tax to Illinois is soft when offset by the additional transportation costs incurred when buying out-of-state.

On two separate occasions, Director Bower met with representatives of the State Chamber and the company to discuss the tenets of their proposals. Upon conclusion of the first meeting, Director Bower asked the company to prepare an analysis of the (financial) benefits to Illinois, in granting such an exemption. The company and the State Chamber came back to meet again, with the financial analysis requested by Director Bower.

The Department has never been able to determine the impact of such a proposal. Only the companies themselves know the products they purchase for redistribution out of state and the taxes paid on these products. As the analysis from the company demonstrated, the known fiscal impact to Illinois would be in excess of $4.2 million. While they estimated the other taxes that might be garnered if the sales tax exemption is granted, the one single known factor is the state sales tax loss of $4.2 million. And, this is the estimate for only one multi-state company doing business in Illinois. All multi-state corporations will qualify for this exemption. It is not unreasonable to believe this exemption could be very expensive for the state.

In the conversations with the company and the State Chamber, they willingly admitted that the identified loss would be immediate, while the listed "benefits" would be eventual and slow, if realized at all. The advocates of this proposal openly admitted that they could not guarantee any of the "benefits" listed would actually be realized, but it was "reasonable to believe that some portion of these dollars will be realized by the state". Again, the only certainty in any of the scenarios developed, is the immediate loss of sales tax dollars to the state and its local governments. (Local governments in Illinois would also share in this loss as they receive at least 20% of the current sales tax dollars generated. More in certain locals which impose home rule taxes.)

Simply stated, while it is understandable that the company, and other similarly situated companies, would seek such an exemption, it must be known that it will be expensive to Illinois, and its local governments. For these reasons, the Department has not been supportive of exporting its tax revenues to the benefit of other states. Under the proposed legislation, Illinois would continue to grant credit for taxes paid to other states for property purchased outside Illinois, but used in Illinois, while exempting all property purchased in Illinois, but subsequently used outside the state. Thus, in effect, granting the state where the property is actually used a tax windfall at the expense of all Illinois taxpayers.