As a result of two rulings, each effective July 1, 2015, the city of Chicago will attempt to tax the “Cloud” more directly and comprehensibly than any other U.S. jurisdiction. On June 9, 2015, the Chicago Department of Finance (the “Department”) issued rulings regarding (1) the application of the city’s Personal Property Lease Transaction Tax (the “Lease Transaction Tax”) to nonpossessory computer leases¹ and (2) the application of the city’s Amusement Tax (the “Amusement Tax”) to electronically delivered amusements.² (The Lease Transaction Tax and the Amusement Tax are each imposed at a 9% rate.)

Both rulings are staggering in their breadth. For example, the Amusement Tax ruling will extend the tax to streaming services for music, movies, games, and the like, as well as satellite TV delivered to a customer located in Chicago. However, the ruling does not impose the Amusement Tax on the same content when it is permanently downloaded by a consumer. The Lease Transaction Tax ruling extends the tax to the online procurement of real estate listings, car prices, stock prices, economic statistics, and “similar information or data that has been compiled, entered and stored on the provider’s computer.”³ In addition, under the ruling, the Lease Transaction Tax will apply to the online procurement of “word processing, calculations, data processing, tax preparation” and “other applications available to a customer through access to a provider’s computer and its software.”⁴ In the ruling, the Department expressly notes that these “examples are sometimes referred to as cloud computing, cloud services, hosted environment, software as a service, platform as a service, or infrastructure as a service.”⁵

City of Chicago Tax Enforcement It is important to note that both the Amusement Tax and the Lease Transaction Tax are, technically, imposed on the consumer. Both rulings explicitly avoid the issue of whether a provider of electronically delivered amusements, or the “lessor” of the computer in a non-possessory computer lease, has sufficient nexus with the city to require them to collect either tax. However, once the Department begins to audit and assess customers located within the city, many of those customers are likely to demand that providers collect the tax going forward. As a result, many providers will likely feel the need to register to collect the taxes, despite lacking nexus, and despite having strong arguments against the Department’s expansive interpretation of its taxing ordinances.

Notwithstanding the fact that each ruling has a July 1, 2015, effective date, the Department states in each ruling that it will limit the effect of the ruling to periods on or after September 1, 2015, to “allow affected businesses to make the required system changes.”⁶ However, the Department views each month in which a payment is made to be a separate rental or amusement period or transaction and, despite the September deferral, each ruling also states that the deferral “does not release or otherwise affect the liability of any business that failed to comply with existing law before the date of this ruling.” Consequently, it is unclear what protection the city’s September deferral actually offers, except perhaps a moratorium on active enforcement by the city.

Electronically Delivered Amusements (Amusement Tax Ruling No. 5) The Amusement Tax is imposed on patrons of every amusement within the city. “Amusement” is broadly defined, and it includes “any entertainment or recreational activity offered for public participation or on a membership or other basis,” and “any paid television programming, whether transmitted by wire, cable, fiber optics, laser, microwave, radio, satellite or similar means.”⁷

The Amusement Tax ruling specifically taxes charges paid for the privilege of the following amusements delivered to a patron in the city: (1) “watching electronically delivered television shows, movies, or videos”; (2) “listening to electronically delivered music”; and (3) “participating in games, on-line or otherwise.”⁸ As a consequence, streaming a movie, listening to streaming music, or playing a game on a smartphone or tablet will now trigger a 9% tax on the subscription charge for those services if those activities are done at a location in Chicago. Furthermore, the ruling addresses “bundled” transactions, by providing that “unless it is clearly proven that at least 50% of the price” is not for the amusement, the entire charge, except for any separately stated non-amusement charges, is subject to the Amusement Tax.⁹ That suggests great care must be paid to invoicing services when including any item that might be construed to be an amusement. The ruling does not differentiate between news, current events, sports, movies, music or other types of television programming. As a consequence, an establishment that charges patrons for access to television programming of any sort, plus other goods and services (e.g., a bar that imposes an admission charge for a pay-per-view event that includes food and beverages) may have to navigate the bundling rules.

Nonpossessory Computer Leases (Lease Transaction Tax Ruling No.12) The Lease Transaction Tax applies to any lease or rental for the possession or use of personal property in Chicago. The Lease Transaction Tax ruling actually concerns an exemption from the Lease Transaction Tax, Exemption 11, which is for the “nonpossessory lease of a computer in which the customer’s use or control of the provider’s computer is de minimis and the related charge is predominantly for information transferred to the customer rather than for the customer’s use or control of the computer,”¹⁰ for instance “such as the nonpossessory computer lease of a computer to receive either current price quotations or other information having a fleeting or transitory character.”¹¹

The ruling provides examples of when the tax applies, such as when performing legal research or similar on-line database searches, to obtain consumer credit reports, or “real estate listings and prices, car prices, stock prices, economic statistics, weather statistics, job listings, resumes, company profiles, consumer profiles, marketing data, and similar information or data that has been compiled, entered and stored on the provider’s computer.”¹² In the ruling, the Department specifically identifies taxable leases of personal property to include “cloud computing, cloud services, hosted environment, software as a service, platform as a service, or infrastructure as a service.”¹³ This is quite an expansion for a concept evolved from taxing agreements for time-sharing on mainframe computers, and that has only been judicially tested once, involving legal research in the city on terminals provided by the legal search provider, in days that preceded the creation of the World Wide Web, and the expansion of fiber-optic networks that made possible the Internet networks relied on to deliver many of the services the ruling now targets. See, Meites v. City of Chicago, 184 Ill. App. 3d 887 (1989). The rulings represent a further evolution of the city’s approach under the Lease Transaction Tax to disregard contract terms and recharacterize transactions to fit its tax code definitions; it is doubtful that any consumer or provider of subscription Internet streaming services thinks they are contracting to lease tangible personal property.

“[E]ntertainment materials such as copyrighted books, musical and other sound recordings, feature length and episodic films are not ‘data or information’ as those terms are used in the definition of a ‘nonpossessory computer lease.’”¹⁴ Also excluded are charges for “storage of information on the [provider’s] computer by the user,” which are held for later use and not for the immediate processing of information.¹⁵ However, when such information is later accessed from a location in Chicago and a charge is made for that access, the Department will view that access as a nonpossessory computer lease, and the charge will be subject to the 9% tax.

The Lease Transaction Tax does not apply when the customer’s use or control of the provider’s computer is de minimis. Examples of de minimis usage include “[p]assive access to information” such as a “one-way dissemination of a scrolling list of stock prices,” or access to materials that “are primarily proprietary,” as in both cases the charge is predominantly for information, so the value of the interactive use of the provider’s computer is “subordinate to the value of the information or data the customer wishes to download or otherwise access.”¹⁶ However, the de minimis exemption does not apply to a charge for access to a legal research database, because in the case of such access, the “customer’s use of the provider’s computer is extensive,” and the charge is “predominantly for the ability to perform the searches that are necessary to locate those documents.”¹⁷

Sourcing/Customer Location The Department will determine whether the customer is within the city of Chicago for purposes of the Amusement Tax and the Lease Transaction Tax rulings by using its rules under the Mobile Telecommunications Sourcing Conformity Act. These rules principally look to the service or credit card billing address. Thus, having a Chicago billing address and engaging in the activities covered by the two rulings will presumptively subject one to the Amusement Tax and the Lease Transaction Tax, even if the actual place of use or access was outside of Chicago.

Observations The city of Chicago is facing monumental fiscal pressures. As these two rulings demonstrate, bad times make for bad tax administration. With these two rulings, the Department has expanded the scope of its tax ordinances to their absolute limit, if not further. If any state or local governments were wondering how to tax transactions occurring in the Cloud when legislative authority for such taxation is absent, the Department has just sketched a roadmap.

Even in good times, Chicago’s taxes are bad – the city’s interest on delinquent taxes is 12% per year, and in unagreed audits a penalty of 25% is typically imposed. The city has its own administrative hearings office to hear tax assessment protests and its own staff of litigators, and both taxpayers and the city can appeal from an unfavorable ruling. Consequently, many taxpayers fighting audit liabilities wind up reaching settlements and negotiating ways to come into compliance rather than risk the cost of litigation with the city over positions that would face meritorious challenges in a more taxpayer-friendly appeal structure.

Nonetheless, there are strong arguments that both rulings run afoul of provisions in the Federal Telecommunications Act, the Internet Tax Freedom Act, and federal and Illinois constitutional limits on taxation. In addition, the rulings gloss over many details of applicable federal law and how telecommunications and computer networks operate, and assume the simplest factual scenarios that do not realistically comport with how many providers and their customers transact business. As a consequence, the time to look at the impact of these rulings is now, before mounting exposure and interest accrual makes challenging these positions economically infeasible.

1. City of Chicago, Department of Finance, Personal Property Tax Ruling #12 (June 9, 2015), (“Ruling # 12”).
2. City of Chicago, Department of Finance, Amusement Tax Ruling #5 (June 9, 2015), (“Ruling # 5”).
3. Ruling # 12, ¶ 6.c.
4. Id., ¶ 6.d.
5. Id.
6. Ruling # 5, ¶ 15; Ruling # 12, ¶ 21.
7. Ruling # 5, ¶ 2.
8. Id.
9. Id., ¶ 12.
10. Ruling # 12, ¶ 9.
11. Id., ¶ 13.
12. Id., ¶ 6.c.
13. Id., ¶ 6.d.
14. Id., ¶ 6.
15. Id., ¶ 8.
16. Id., ¶ 11
17. Id., ¶ 12.

Client Alert 2015-166