Reed Smith Client Alert

Authors: Lee A. Zoeller

On August 6, 2013, the City of Chicago’s Department of Finance revised its June 1, 2004 Personal Property Lease Transaction Tax ("Lease Tax") Ruling #5. The revised ruling, effective September 1, 2013, expands the Lease Tax base to include perpetual software licenses.


The City of Chicago imposes an 8 percent Lease Tax upon personal property—including software—leased or used within the city limits. The Lease Tax does not apply to sales of software. However, the Lease Tax does apply to certain "software licenses."

Prior to September 1, 2013, the City’s Department of Finance followed its Lease Tax Ruling #5, which provided that the Lease Tax applied to nearly all software licenses that were not "perpetual licenses." As mentioned above, the Department has now revised Ruling #5 to conclude that the Lease Tax is also due on perpetual licenses of computer software.1 As a practical matter, as of September 1, 2013, the City’s position is that nearly all software licenses are now subject to the Lease Tax.

In our view, taxpayers should challenge the application of the Lease Tax to their sales or purchases of software licenses because the City’s broad application of the Lease Tax goes beyond the scope of its own ordinance.

The Lease Tax Rulings Exceed the Authority Provided for in the City’s Own Ordinance

The City’s ordinance specifically provides that only software licenses that are exempt from the Illinois Retailers’ Occupation Tax and Illinois Use Tax ("IL Tax"), are subject to the Lease Tax.2 The only exemption from the IL Tax applicable to software is for retail sales of software used to operate exempt machinery and equipment used primarily in the manufacturing or assembling of tangible personal property for wholesale or retail sale or lease, or software used in exempt farm machinery and equipment.3 All other software licenses, including perpetual licenses, are excluded (not exempt) from IL Tax.

The difference between an exclusion and an exemption from tax is very clear and significant.4 If something is excluded from tax, the legislature never intended to tax it. In contrast, something that is exempt from tax is actually "subject to tax," but the legislature decided not to tax it by way of that exemption.

Thus, in our view, because nearly all other software licenses, including perpetual licenses, are excluded from the IL Tax (not exempt from the IL Tax), those software licenses should not be subject to the Lease Tax.

A Change to Nine Years of Settled Law can only be made by a Change in Law, not by an Administrative Ruling

In addition, the City cannot change its interpretation of the Lease Tax ordinance to impose the Lease Tax on perpetual licenses, because for more than nine years, the City has consistently interpreted the ordinance as not taxing such licenses.5 The City cannot disturb the settled expectations produced by the prior interpretation without a change in law.6

Based on the above, the City can only impose Lease Tax on software used to operate manufacturing and farm machinery and equipment.

Taxpayers who have paid the Chicago Lease Tax on any software licenses—including licenses of software that were not perpetual licenses—should consider filing refund claims. Taxpayers should also consider not paying Lease Tax on any software licenses—including perpetual licenses—going forward.

If you are interested in more details on this issue, please contact one of the authors of this alert, or the Reed Smith attorney with whom you normally work. For more information on Reed Smith’s Illinois tax practice, visit

  1. 86 Ill. Admin. Code § 130.1935(a)(1) sets forth a five-part test to determine whether the transfer of software is not a "sale at retail" subject to the Illinois Retailers’ Occupation Tax law (35 ILCS 120/1 et seq.). A sale at retail is taxable unless otherwise exempted by law. Revised Ruling #5 uses the same five-part test to determine whether a software license is a perpetual license and, according to the revised ruling, subject to the Lease Tax.
  2. Municipal Code of Chicago § 3-32-020(I).
  3. 86 Ill. Adm. Code § 130.1935(d); 86 Ill. Adm. Code § 130.305(k); 86 Ill. Adm. Code § 130.330.
  4. As specifically noted by numerous state courts, "exemptions" from tax are distinct from "exclusions" from tax. See, e.g., Dearborn Wholesale Grocers, Inc. v. Whitler, 413 N.E.2d 370, 373 (Ill. 1980); Lancaster Laboratories, Inc. v. Commonwealth, 631 A.2d 739, 741 n.1 (Pa. Commw. Ct. 1993); Grace v. State Tax Commission, 332 N.E.2d 886, 889 (N.Y. 1975); Roark Amusement & Vending, L.P. v. Combs, 2011 Tex. App. LEXIS 632, *12 (Tex. Ct. App. 2011).
  5. American Oil Co. v. Mahin, 273 N.E.2d 818, 822-23 (Ill. 1971); Mississippi River Fuel Corp. v. Illinois Commerce Commission, 116 N.E.2d 394, 397 (Ill. 1953).
  6. American Oil Co., 273 N.E.2d at 822-23.



Client Alert 2013-284