In the past two weeks I’ve had two separate taxpayers reach out to me with questions regarding the City of Chicago’s Personal Property Lease Transaction Tax (“LTT”). Various City of Chicago taxes have gained headlines recently, particularly the 9% LTT, which could have significant impact on your business if it’s either neglected or doesn’t properly include all of your taxable leases.
The State of Illinois is somewhat unique with regard to its taxation of leases of personal property. Most states place the obligation on lessors of operating leases to collect the sales/use tax on the periodic payments for leases of tangible personal property, allowing the lessor to purchase the property exempt for resale or re-lease. Illinois, however, requires lessors to pay the tax to their vendors on the purchase of tangible personal property that it intends to lease to its customers, rather than collecting tax on the lease stream. With no state sales tax on lease payments, the City of Chicago stepped into the void by enacting its own tax on those lease payments, a tax that was recently increased from 8% to 9%. The tax is imposed on the lease or rental of personal property in Chicago, and/or on the lease of property outside of Chicago, but that is used primarily within the City.
Example A: Taxpayer #1, doing its due diligence, was curious about certain leases of tangible personal property on which its vendor was collecting the state sales tax, but not Chicago’s LTT. If the vendor was charging this tax in error, it would leave the taxpayer with a valid refund claim of taxes remitted the state, but would create a corresponding exposure with regard to the LTT. Fortunately, examining the lease agreements showed that they were capital leases. At the end of the lease term, the lessee has the option to purchase the property for a nominal amount (usually $1, though it should be noted that only the option to purchase at a nominal amount is required, regardless of whether the lessee actually purchases the property). Both Illinois and Chicago deem these leases conditional sales, and therefore subject to the state sales or use tax, and not the LTT.
Example B: Taxpayer #2 is reviewing old software license invoices for the application of the Chicago LTT. The issue stems from another oddity in Illinois sales and use tax law. Illinois does not impose the sales and use tax on licenses of software that meet a five-prong test, the theory being that such licenses are more akin to leases than purchases. If the license is evidenced by a written agreement signed by both parties, restricts duplication and use of the software, prohibits sublicensing to unrelated third parties, provides for a free replacement or archival copy in the case of damage to the software, and is either perpetual, or calls for the software to be returned or destroyed at the end of the term, the license is not subject to sales or use tax in Illinois. But like leases of tangible personal property, the characterization of the license as a form of lease brings it under the purview of the LTT.
It should be noted that perpetual licenses that met Illinois’ five-prong test were, until recently, also non-taxable under the LTT. Perpetual licenses were not taxed as leases for purposes of the LTT, so, in theory, a license agreement could be both a non-taxable lease in the state of Illinois, and a non-taxable transaction treated as a sale in the City of Chicago. On August 6, 2013, Chicago issued Department of Finance Lease Transaction Ruling #5, which purports to clarify the LTT effective September 1, 2013 to eliminate this loophole. Some observers have said that this constitutes a major departure from prior application of the LTT, and have questioned the legality of imposing such a change through an administrative ruling as opposed to amending the law. However, until the issue is litigated, the department’s position should be considered valid.
This ruling indicates that the City of Chicago is taking a more serious look at enforcement of the lease transaction tax, particularly with regard to software licenses. If your business operates within the city and either leases property from a lessor, or uses software subject to a license that meets Illinois’ five-prong test, you should review those lease payments for the proper application of tax, and file your LTT returns. If you find there is significant exposure, it may behoove you to pursue a voluntary disclosure agreement with the City of Chicago.
Other recent “Illinois (IL)” posts by William Seitz, ESQ:
- Business Use Tax in Illinois and Other States: Part 1 - The Basics
- IL Software Taxability Rules Complex - But Can Provide Refund Opportunities
- Chicago Lease Tax Amnesty Option: Deadline Approaches!
- Illinois Clarifies Tax on Shipping: You Can Save if Pick-up Option Offered
- The “411” on the “LTT”: Chicago’s Expanded Lease Transaction Tax