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Monday, October 23, 2017

Suburbs That Mischaracterize Location of Sales Can Be Sued

A few years ago, the state legislature adopted a statute intended to prohibit municipalities from attempting to “manipulate” the location where retail sales occur for the purpose of diverting sales tax revenue to the municipality.  Section 8-11-21 of the Illinois Municipal Code prohibits municipalities from entering into sales tax rebate agreements with retailers that would result in the payment of sales tax to the municipality if, all other things being equal, the sale tax should have been distributed to another municipality based on the application of the tax allocation rules.

This statute recently came into play in City of Chicago, et al. v. City of Kankakee, et al., 2017 IL App (1st)153531. In that case, Chicago claimed that two suburban communities executed sales tax rebate agreements with out-of-state retailers to falsely characterize transactions as occurring in the suburbs, and  that because of that mischaracterization, these sales were not subject to the state’s “use tax.” The use tax is imposed on the sale of tangible personal property sold by out-of-state retailers that do not have a presence in Illinois where the item is used within Illinois. The use tax is collected by the state and then distributed to Chicago and others based on population and other factors. 

Why does it matter whether a retailer pays a use tax or sales tax?  The tax rate for both sales tax and use tax is 6.25%, so the amount of tax remitted by retailers who are required or allowed to pay each tax is the same.  However, the distribution of the tax receipts by the Illinois Department of Revenue is different for these two taxes.  For the sales tax, the State retains 5% and the remaining 1.25% is distributed to the local county and municipality where the sale occurs.  By contrast, for the use tax, the State retains 5% and the remaining 1.25% is distributed according to the following statutory calculation:  20% goes to Chicago, 10% to the RTA, 0.06% to the Madison County Mass Transit District, $3.15M to the Build Illinois Fund, and the remainder is distributed to more than 200 municipalities according to their proportionate share of the State’s population. 

Once you understand the distinction described above, it is easy to see that Chicago would receive 0.25% of the value of all retail sales from out-of-state retailers if the use tax applies. But, if the sale occurred in one of these two suburbs, Chicago would not share in any of the sales tax because that tax would go directly to the suburb. 

While the ultimate merits of the case have not been decided, the case is important because the appellate court held that Chicago, and the other municipal plaintiffs, could sue these two suburbs directly to seek payment of the share of the use tax to which it (or they) allegedly should have been entitled. We will certainly watch this case as it proceeds and keep you posted.

Post authored by Adam Simon, Ancel Glink


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