On August 28, 2015, the Illinois Department of Revenue’s (the “Department”) proposed regulations clarifying the Department’s position on the sales taxation of shipping charges were posted to the Illinois Register, commencing a 45-day public comment period. On that same day, Reed Smith LLP’s State Tax team involved in the defense of over 65 Illinois False Claims Act (“IFCA”) prosecutions, Michael Wynne and Adam Beckerink, received a copy of the proposed regulations from the attorney general’s office. On August 31, 2015, the attorney general appeared in court to stay proceedings in IFCA cases against the three wineries that are plaintiffs in the action Reed Smith filed on their behalf, and on behalf of the Wine Institute against the attorney general and the Department in an effort to put an end to hundreds of IFCA prosecutions (the “Wine Institute” case).1
The proposed regulations describe the Department’s position regarding the sales taxation of separately stated shipping charges associated with online sales shipped to Illinois customers, when the customer had the option to pick up the goods in lieu of having them shipped. Such shipping charges are not subject to sales tax2 under the proposed regulations. This is true even if the only pick-up option is located outside of Illinois, contrary to the plaintiff's contention in these IFCA cases. These proposed regulations are directly on-point with Private Letter Rulings that were requested and received by Reed Smith on behalf of some of their winery clients, and therefore are consistent with Reed Smith’s position, in all IFCA cases and in the Wine Institute case, that the attorney general had allowed IFCA prosecutions to proceed based on positions directly contrary to existing Department regulations. IFCA defendants that offered the option on their website for customer pick-up at the seller’s location were therefore not required to collect sales tax on shipping charges, and should never have had prosecutions authorized against them.
Why the proposed regulations are a turning point. The proposed regulations clarify the Department’s position on the sales taxation of shipping charges in light of Kean v. Wal-Mart Stores, Inc., 235 Ill. 2d 351 (2009), which held that shipping charges are subject to Illinois sales tax when there is an inseparable link between the sale of tangible personal property and the outgoing transportation and delivery of the property. The Department acknowledged shortly after Kean that it would need to clarify its regulations, but the hundreds of IFCA claims the attorney general authorized to be prosecuted on what are now crumbling allegations that wineries should have collected sales tax on shipping charges paralyzed policy-making by the Department. That policy log jam was broken when Reed Smith and the Department agreed that Reed Smith would defend the Department’s Private Letter Rulings issued to individual taxpayers prosecuted under the IFCA, despite having offered the seller-location pick-up option to the IFCA plaintiff. Reed Smith has also obtained abatement of penalties from the Department on taxes paid on the position asserted by the IFCA plaintiff and the attorney general’s office. In addition, Reed Smith has filed suit on behalf of the Wine Institute and its members to enjoin further IFCA prosecutions unless the attorney general first obtains the Department’s agreement that (i) sales tax is owing on the alleged IFCA violations, and (ii) the Department would not abate standard penalties and would assert a negligence or fraud penalty if it had found the same alleged violation as a result of an audit.3
The content of the proposed regulations. The proposed regulations clarify that, post-Kean, shipping charges are taxable when there is an inseparable link between the sale of tangible personal property and the outgoing transportation and delivery of the property.4 An “inseparable link” exists when the shipping charges are not separately stated or when the seller does not offer the option to pick up the property in lieu of shipping it.5 Shipping charges are considered to be for a service separate and distinct from the sale of (taxable) tangible personal property and, therefore, where no inseparable link exists, shipping charges are not subject to sales tax.6 As a clarification of existing law, the proposed regulations would apply retroactive to November 19, 2009, the day after Kean was decided, and would reflect the Department’s position over the entire post-Kean period.
Perhaps most importantly, the proposed regulations provide an unambiguous safe harbor for a seller of tangible personal property who offers the purchaser an option to pick up the property and charges the same price for the property, regardless of whether the buyer chooses shipping or pick-up. In this situation, the shipping charges are not subject to sales tax.7 A number of examples apply the proposed rules to various factual scenarios, including one example where an Internet retailer offered an Illinois customer the option to have the property shipped to Illinois for a separately stated shipping fee, or to pick up the goods free of charge from its San Diego location.8 In such a case, there is no inseparable link between the taxable property being sold and the delivery of that property, and, therefore, the shipping charges are not taxable.9 The proposed regulations directly contradict the position taken by the plaintiff in the IFCA cases and the Illinois attorney general, asserting that the pick-up option must be in Illinois for the shipping charges to avoid taxation.
Do the proposed regulations go far enough? We have summarized the most important change in the Department’s proposed regulations. However, the proposed regulations span 10 pages and cannot be fully summarized here. Nonetheless, we can highlight some additional issues that should have been (but were not) addressed in the proposed regulations. For example, sellers who did not offer the seller-location pick-up option would have been justified in not collecting tax on shipping charges because the existing regulation provides that a separately stated delivery charge on the invoice could be “deemed” to be separately negotiated if it otherwise reflected actual shipping costs. Although under Kean a charge was taxable if it was an inseparable part of the transaction the regulation continued to deem the stated shipping charge separable, thus providing yet another basis why IFCA prosecutions should not have been allowed to proceed. In the Wine Institute case, Reed Smith is asking that the taxes assessed despite such a regulatory provision be abated as having been assessed based on erroneous written information issued by the Department – the unamended regulation. The proposed regulation does not go far enough to undo the harm of long-delayed guidance.
Procedural matters. The Illinois Administrative Procedure Act specifies the process for promulgating regulations.10 Administrative rules are drafted by state agencies. The involvement of the public in the initial drafting is at the discretion of the agency; however, early public involvement is encouraged. Once drafted, the proposed rules are released as a “First Notice,” which lasts a minimum of 45 days and terminates when the Department files with the Joint Committee on Administrative Rules (“JCAR”), commencing the Second Notice period.11 The general public can submit comment on the rulemaking proposal to the Department and a public hearing may or may not be held during this period. The Department can modify the rulemaking during First Notice by submitting a First Notice Changes document to JCAR when it gives Second Notice.
The Second Notice period commences upon the Department’s filing the Second Notice with JCAR, and lasts for a maximum of 45 days, unless extended for an additional 45 days by mutual agreement of JCAR and the Department. During the Second Notice Period, legislative review of the rules is conducted first by the JCAR staff and then at a meeting of the legislative members. JCAR reviews the proposed rules for statutory authority, propriety, standards for the exercise of discretion, economic effects, clarity, procedural requirements, technical aspects, etc.
After JCAR review, the Department can adopt the regulations as permanent, unless a three-fifths or greater majority of JCAR determines that the regulations constitute a threat to the public interest, safety, or welfare.
For more information on the proposed regulations or False Claims Act suits in Illinois, contact the authors of this Alert or another member of the Reed Smith State Tax Group. For more information on Reed Smith’s Illinois tax practice, visit http://www.reedsmith.com/iltax/.
- For more information on the Wine Institute suit and the IFCA cases against out-of-state wineries, see our prior alerts here and here.
- More precisely, the charges are not subject to Illinois Retailer’s Occupation Tax or Use Tax. For the sake of simplicity, in this Tax Alert we refer to the tax using the more familiar term “sales tax.”
- Chimney Rock Winery LLC, et al. v. Beard, et al., Case No. 15 L 50552. The case has further implications as well. See http://www.reedsmith.com/The-Wine-Institute-and-Reed-Smith-Team-Up-To-Fight-Illinois-False-Claims-Act-Overreach-07-28-2015/ for more information.
- Proposed 86 Ill. Admin. Code 130.415(b)(1)(B)(i).
- Proposed 86 Ill. Admin. Code 130.415(b)(1)(B)(ii).
- Proposed 86 Ill. Admin. Code 130.415(b)(1)(B)(iii).
- Proposed 86 Ill. Admin. Code 130.415(b)(1)(C).
- Proposed 86 Ill. Admin. Code 130.415(b)(1)(D)(iii).
- Proposed 86 Ill. Admin. Code 130.415(b)(1)(D)(iii).
- 5 ILCS 100 et seq. Please see the document titled “Illinois Rulemaking Process,” which can be found at http://www.ilga.gov/commission/Jcar/, for further details.
- Please note that the proposed regulations expire if not adopted within one year after commencement of First Notice.
Client Alert 2015-242