On January 14, 2016, the Illinois Department of Revenue (the “Department”) sent its Second Notice of Proposed Rulemaking to the Joint Committee on Administrative Rules (“JCAR”) regarding its proposed amendments to its regulations clarifying the taxability of shipping and handling charges (the “Proposed Amendments”). The Proposed Amendments to 86 Ill. Admin. Code sections 130.415 and 130.410 are intended to (i) provide greater guidance to the public regarding taxation of delivery charges; (ii) incorporate the Illinois Supreme Court’s holding in Kean v. Wal-Mart Stores, Inc., 235 Ill. 2d 351 (2009); and (iii) clarify when transportation and delivery charges are considered part of “gross receipts” subject to the Retailers’ Occupation Tax Act or the Use Tax Act. The Proposed Amendments are expressly stated to be retroactive to November 19, 2009, the date of the Kean decision.
During the First Notice Period, the Department received several comments from interested persons, including the Wine Institute, the Taxpayers’ Federation of Illinois (the “Taxpayers’ Federation”), the Wine and Spirits Distributors of Illinois, the Illinois Retail Merchants Association, the Illinois Petroleum Marketers Association and the Illinois Association of Convenience Stores. These comments included a submission from the Wine Institute that requested that the Department include a provision in the proposed regulations that would clarify that persons who had complied with the provisions of the regulation as it existed between the date of the Kean decision and the effective date of the proposed regulations would be considered to have correctly omitted or remitted tax on delivery charges. (During that period, the regulation treated shipping charges that were separately stated on an invoice as separately negotiated and, thus, a sale of service, rather than as an inseparable part of the sale of tangible personal property.) The comments from the Taxpayers’ Federation expressed similar concerns regarding the inclusion of a safe harbor provision to protect taxpayers for periods prior to the retroactive clarification by the Proposed Amendments.
In response to concerns expressed by the Wine Institute and the Taxpayers’ Federation, the Department, in its Second Notice of Proposed Rulemaking, has added a safe harbor provision to the Proposed Amendments for persons who have computed their tax liability in accordance with the provisions of the regulation as it existed between the date of the Kean decision and the effective date of the proposed regulation. As a result of this safe harbor, persons who computed their liability either under the regulations existing prior to the effective date of the Proposed Amendments by omitting tax on separately stated shipping charges, or by charting and remitting tax on such separately stated charges as directed under the Kean decision, will be held to have correctly omitted or remitted tax on delivery charges.
The Department also added provisions to the Proposed Amendments in response to other comments, including: (i) a provision specifying the persons who are governed by the new rules; (ii) provisions specifying that when a retailer offers a purchaser unqualified free shipping, or qualified free shipping for which a transaction is eligible (e.g., free shipping for purchases of more than $150), there is no inseparable link between the selling price of the tangible personal property and the delivery charge (therefore the delivery charge is not taxable); (iii) a provision permitting retailers to itemize the delivery charges on separately listed items in situations where delivery charges would be taxable for some items on an invoice and not taxable on others; and (iv) a provision permitting retailers to separately list each item and its corresponding delivery charge on the invoices in situations where delivery charges are taxable and the transaction involves mixed items (high/low rate items or taxable/exempt items).
The Proposed Amendments continue to clarify that if a purchaser either elects a separately identified shipping option when unqualified free shipping was available (e.g., elects to pay for expedited shipping), or elects to pay for shipping when a pick-up option was available, the delivery charge will remain nontaxable as long as the selling price of the tangible personal property neither increases nor decreases depending upon the delivery method chosen by the purchaser. The Proposed Amendments also clarify that if the selling price of the tangible personal property increases or decreases depending on the chosen delivery method, the delivery charges will be subject to tax to the extent that they exceed the actual cost of outgoing transportation and delivery, as that suggests that the retail price of the tangible personal property taxed is understated in the invoice, and to that extent is escaping taxation.
Effect on qui tam actions and possible consumer fraud actions Because of the retroactive safe harbor included in the Proposed Amendments, taxpayers that complied with the regulations as they existed prior to the effective date of the Proposed Amendments, or who otherwise complied with the Kean decision, should be safe from either a qui tam action (for collecting too little tax) or a consumer fraud action (for collecting too much tax), respectively.
Upon adoption of the Proposed Amendments, the attorney general should expect the following questions from taxpayers still facing qui tam actions relating to the shipping charge issue: (i) why is there still a qui tam action pending against me; (ii) how can you still have an offer outstanding for me to settle such an action at something other than full relief; and, (iii) if I previously settled a qui tam action, will Illinois refund my money?
However, until the Proposed Amendments are adopted, they are still not law. The Second Notice period commenced upon the Department filing the Second Notice with JCAR on January 14, 2016 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. During this period, JCAR will review the proposed rules and will consider, among other issues, statutory authority, propriety, standards for the exercise of discretion, economic effects, clarity, procedural requirements, and technical aspects.
After the JCAR review, assuming no objections or problems are raised, JCAR can file a Certificate of No Objection, which gives the Department the authority to adopt the rules by filing them with the secretary of state for publication in the Illinois Register, at which time they become final authority.
Although the Proposed Amendments improve the outlook for taxpayers defending against qui tam actions involving the delivery charge issue, experience thus far has shown that for some taxpayers, even with the Illinois attorney general’s help, it is more cost effective to enter into a settlement than to continue to contest the qui tam action, even though no liability is technically due. However, once the retroactive proposed amendments are adopted, the finality of such settlements will be subject to challenge.
Reed Smith plans to seek to recover prior settlement payments on behalf of its clients where cost effective to do so, and will report on the state’s response to an eminently fair proposition – that government not retain monies it knows with certainty were never due, and that were exacted under the duress of a False Claims Act prosecution authorized by the attorney general.
If you have questions regarding the Proposed Amendments and their impact on pending qui tam actions, please contact one of 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/.
Client Alert 2016-018