What does Illinois Private Letter Ruling IT 18-0003-PLR conclude about Sales Factor -Intangible Property?

Plain-English summary

The Illinois Department of Revenue ruled that a lender who originates loans directly to customers is a "dealer" for Illinois sales-factor sourcing purposes under 35 ILCS 5/304(a)(3)(C-5)(iii)(a), even though the same lender qualifies for a federal tax exemption that lets it avoid being treated as a dealer for mark-to-market accounting purposes.

The taxpayer was a Delaware limited partnership that makes senior secured loans directly to North American middle-market companies (generally those with less than $25 million in EBITDA) to fund buyouts, recapitalizations, ownership transfers, expansion, or refinancing. Because it regularly originates loans to customers in the ordinary course of its business, it met the federal "dealer in securities" definition in 26 U.S.C. § 475(c)(1). Normally that would require mark-to-market accounting under Section 475(a). However, because the taxpayer's sales of the loans it originated were no more than "negligible," it qualified for the exemption in Treas. Reg. § 1.475(c)-1(c)(1), which lets a taxpayer avoid dealer treatment (and mark-to-market accounting) unless it elects otherwise.

The taxpayer asked the Department whether, despite this federal exemption, it would still be considered a "dealer" for purposes of sourcing its Illinois sales factor under IITA Section 304(a)(3)(C-5)(iii)(a) -- the provision that sources interest and gains from intangible personal property to Illinois based on the customer's location when the taxpayer is a dealer, rather than based on where the income-producing activity occurred (the default rule under subparagraph (b)).

The Department concluded that the dealer-sourcing rule should not turn on whether a taxpayer elects out of the Treas. Reg. § 1.475(c)-1(c)(1) exemption, because in either case the taxpayer is earning interest by originating loans to customers in the ordinary course of its business. Accordingly, a taxpayer eligible for the negligible-sales exemption is still treated as a dealer for IITA Section 304(a)(3)(C-5)(iii) purposes. As a result, the taxpayer must source its loan interest income to Illinois when the customer is an Illinois resident or has an Illinois commercial domicile (or, absent actual knowledge, when the customer's billing address on the dealer's records is in Illinois).

What this means for you

Lenders, loan originators, and investment managers

If your business regularly originates loans to customers in the ordinary course of business -- even if you qualify for the federal "negligible sales" exemption from mark-to-market dealer accounting under Treas. Reg. § 1.475(c)-1(c)(1) -- this ruling indicates the Illinois Department of Revenue will still treat you as a "dealer" for Illinois sales-factor sourcing. That means your interest income and gains from those loans are sourced to Illinois based on your customer's residence or commercial domicile (or billing address, absent actual knowledge otherwise), not based on where you performed the income-producing activity.

Accountants and tax professionals

This ruling addresses a narrow but recurring apportionment question: whether electing (or not electing) out of the Treas. Reg. § 1.475(c)-1(c)(1) exemption changes a taxpayer's status as a "dealer" for IITA Section 304(a)(3)(C-5)(iii)(a) sourcing. The Department's answer is no -- dealer status for Illinois sourcing purposes follows from actually meeting (or being eligible to meet) the federal 26 U.S.C. § 475(c)(1) definition, regardless of the taxpayer's election. Practitioners advising similarly situated lending clients should confirm whether their client's facts (loan origination model, negligible-sales pattern, no election out) match this ruling before relying on its reasoning, since a PLR binds the Department only for the requesting taxpayer.

Business owners operating multi-state lending or credit funds

If your fund or partnership originates loans across multiple states, this ruling is a reminder that Illinois apportionment for interest income from that activity can hinge on customer location rather than where your lending or servicing operations are based. That can shift more or less income into the Illinois sales factor numerator depending on your customer base, so it is worth reviewing with a tax advisor before assuming the default "income-producing activity" sourcing rule applies.

Common questions

Q: Can I rely on this ruling for my own business?
A: No, not directly. This is a Private Letter Ruling issued under 2 Ill. Adm. Code 1200.110, and it binds the Department only as to the specific taxpayer who requested it, and only to the extent that taxpayer's facts were complete and accurate. Other taxpayers -- even those in a very similar loan-origination business -- cannot rely on it and would need to request their own ruling or consult a tax professional.

Q: Does qualifying for the federal negligible-sales exemption mean I'm not a dealer for Illinois purposes?
A: No. According to this ruling, a taxpayer that is eligible for the Treas. Reg. § 1.475(c)-1(c)(1) exemption from federal dealer status is nonetheless considered a dealer for purposes of IITA Section 304(a)(3)(C-5)(iii), whether or not it elects out of that federal exemption.

Q: How is interest income sourced to Illinois under the dealer rule?
A: Under 35 ILCS 5/304(a)(3)(C-5)(iii)(a), a dealer's interest and gains from intangible personal property are sourced to Illinois if the customer is an Illinois resident or has an Illinois commercial domicile. If the dealer lacks actual knowledge of the customer's residence or commercial domicile, the customer is deemed to be in Illinois if the customer's billing address, as shown in the dealer's records, is in Illinois.

Q: What happens if a taxpayer is not a dealer under Section 475?
A: The ruling explains that if the taxpayer is not a dealer, its interest income is instead sourced under IITA Section 304(a)(3)(C-5)(iii)(b), based on where the taxpayer's income-producing activity is performed (or, if performed both within and outside Illinois, based on where the greater proportion of performance costs are incurred).

Citations and references

• 35 ILCS 5/304(a)(3)(A) -- defines the sales factor generally.
• 35 ILCS 5/304(a)(3)(C-5)(iii)(a) -- sources interest/gains from intangible personal property to Illinois based on customer location when the taxpayer is a "dealer" under IRC Section 475.
• 35 ILCS 5/304(a)(3)(C-5)(iii)(b) -- default sourcing rule (income-producing activity location) for non-dealers.
• 26 U.S.C. § 475(a)-(c) -- federal mark-to-market accounting requirement and "dealer in securities" definition.
• Treas. Reg. § 1.475(c)-1(c)(1) -- exemption from dealer status for taxpayers with no more than negligible sales of originated loans/securities, absent an election otherwise.
• 2 Ill. Adm. Code 1200.110 -- governs issuance and binding effect of Illinois private letter rulings.

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/income-tax/2018.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/income-tax/2018/it-18-0003-plr.pdf

Original ruling text

IT 18-0003-PLR 11/29/2018 SALES FACTOR -INTANGIBLE PROPERTY
Taxpayer originating loans to customers in ordinary course of business is Dealer

November 29, 2018
Re:

Request for Private Letter Ruling
TAXPAYER
FEIN: ####

Dear Xxxxx:
This is in response to your letter dated June 12, 2018 in which you request a Private Letter Ruling
on behalf of TAXPAYER. Review of your request for a Private Letter Ruling indicates that all
information described in paragraphs 1 through 8 of subsection (b) of 2 Ill. Adm. Code 1200.110 is
contained in your request. This Private Letter Ruling will bind the Department only with respect to
TAXPAYER. Issuance of this ruling is conditioned upon the understanding that TAXPAYER and/or
any related taxpayer(s) is not currently under audit or involved in litigation concerning the issues that
are the subject of this ruling request.
The facts and analysis as you have presented states as follows:
On behalf of our client, TAXPAYER (FEIN: ####, hereinafter referred to as “Taxpayer”), we
respectfully request the issuance of a private letter ruling (“PLR”) by the Illinois Department
of Revenue (“Department”) pursuant to 2 Ill Adm. Code 1200.110.
General Information

1. This PLR is not requested for hypothetical or alternatively proposed transactions; but rather
   to determine the income tax consequences of an actual transaction engaged in by
   Taxpayer, as described below.
2. Taxpayer is not currently engaged in litigation with the Department with regard to this or
   any other tax matter.
3. The Department has not previously ruled regarding this matter for Taxpayer. Neither
   Taxpayer nor Grant Thornton LLP has submitted the same or similar issue to the
   Department on behalf of Taxpayer.
4. We are aware of no authority contrary to the authorities referred to and cited below.
   Statement of Facts
   Taxpayer is a Delaware limited partnership established to provide partners with current
   income and long-term capital appreciation. This is achieved primarily by originating senior
   secured loans directly to North American middle market companies. The taxpayer serves as
   a senior secured lender primarily to U.S. companies with less than $25 million EBITDA which
   require financing to fund corporate events such as a buyout, recapitalization, ownership
   transfer, sourcing of expansion and capital growth or refinancing.

IT 18-0003-PLR
Page 2
Taxpayer is managed by COMPANY (hereinafter “COMPANY”). Through COMPANY’s
management, the taxpayer has access to an asset management and origination platform,
which includes a national transaction sourcing network. It is noteworthy that while the taxpayer
is not directly subject to regulation as an investment company, COMPANY is subject to
regulation by the United States Securities and Exchange Commission as a Registered
Investment Advisor.
Taxpayer is actively engaged in the business of originating and investing in senior secured
loans and is treated as such for federal income tax purposes. Accordingly, under the Internal
Revenue Code interest income earned by the taxpayer is treated as ordinary income and
included on its Form 1065. Taxpayer generates interest income in Illinois and other states
from loans secured by assets located across the United States.
By statute, Taxpayer would be considered a dealer in securities for federal income tax
purposes. However, the taxpayer qualifies for an exemption under Treas. Reg. 1.475(c)-1(c).
This regulation provides a taxpayer with an exception from using the mark-to-market method
of accounting. Taxpayer is trying to determine if it would still be considered a dealer for Illinois
Income Tax purposes, and thus, allowed to apportion its income under Illinois Income Tax
Act 304(a)(3)(C-5)(iii)(a).
Requested Rulings
Though Taxpayer is not a dealer for federal income tax purposes because of the regulatory
exemption under Treas. Reg. 1.475(c)-1(c), Taxpayer is otherwise a dealer as defined by 26
USC 475 and thus is considered a dealer for purposes of Illinois Income Tax Act 304(a)(3)(C5)(iii)(a)?
Analysis
Illinois has various methods of sourcing interest income; the sourcing depends upon whether
the taxpayer is classified as a dealer within the meaning of 26 USC 475. If the taxpayer is not
a dealer, interest income is sourced to Illinois if the taxpayer’s income-producing activity is
performed in Illinois. However, if the taxpayer is a dealer, 35 ILCS 5/304(a)(3)(C-5)(iii)(a)
states:
“in the case of a taxpayer who is a dealer in the item of intangible property within the
meaning of Section 475 of the Internal Revenue Code, the income or gain is received
from a customer in this State. For purposes of this subparagraph, a customer is in this
State if the customer is an individual, trust or estate who is a resident of this State and,
for all other customers, if the customer’s commercial domicile is in this State. Unless
the dealer has actual knowledge of the residence or commercial domicile of a customer
during the taxable year, the customer shall be deemed to be a customer in this State
if the billing address of the customer, as shown in the records of the dealer, is in this
State.”
In looking to federal tax law, Section 475(c)(1) of the Internal Revenue Code (“Code”) defines
a “dealer in securities” as a taxpayer who:

IT 18-0001-PLR
Page 3
(A)

regularly purchases securities from or sells securities to customers in the ordinary
course of a trade or business; or

(B)

regularly offers to enter into, assume, offset, assign, or otherwise terminate
positions in securities with customers in the ordinary course of a trade or business.

In the ordinary course of business, Taxpayer originates loans directly with customers, that is,
Taxpayer makes loans by advancing cash in exchange for debt obligations of its customers.
As Taxpayer regularly originates loans to customers, Taxpayer meets the definition of a
“dealer in securities” as defined in the Code.
In general, Section 475 of the Code requires a dealer in securities to use a merk-to-market
method of accounting. By regulatory grace, however, the IRS effectively provides a taxpayer
with an exception (by not viewing the taxpayer as a dealer) from this mark-to-market
accounting if the taxpayer does not engage in more than “negligible sales” of securities it has
originated to customers. (Treas. Reg. 1.475-1(c)(1)(i)).
A taxpayer with “negligible sales” nonetheless may elect out of this regulatory exemption by
filing its return using the mark-to-market method of accounting described in Section 475(a).
(Treas. Reg. 1.475(c)-1(c)(1)(ii))
In summary, Taxpayer meets the definition of a “dealer in securities” as defined by the Code.
Taxpayer, however, qualifies for a regulatory exemption not to use the mark-to-market method
of accounting. Since taxpayer would technically meet the dealer definition under 475(c) but
for the exemption, the rule allows them to elect dealer status if they want it. As a result, it
would appear Taxpayer could still be considered a dealer for Illinois income tax purposes.
Conclusion
If the Taxpayer is not a dealer because they qualify for the exemption under Treas. Reg.
1.475(c)-1(c), the taxpayer would still be considered a dealer for purposes of IITA 304(a)(3)(C5)(iii)(a).
We respectfully request a private letter ruling from the Department regarding this matter.
Should you disagree with this opinion, please contact me to discuss this opinion prior to
issuing a ruling. If you have any further questions or require any additional information, please
contact me.

RULING
Section 304(a)(3)(A) of the Illinois Income Tax Act (“IITA” ; 35 ILCS 5/304(a)(3)(A)) defines the sales
factor for taxpayers other than insurance companies, financial organizations, federally regulated
exchanges, and transportation companies, as follows:
The sales factor is a fraction, the numerator of which is the total sales of the person in this
State during the taxable year, and the denominator of which is the total sales of the person
everywhere during the taxable year.

IT 18-0001-PLR
Page 4
IITA Section 304(a)(3)(C-5) provides, in part, that, for taxable years ending on or after December 31,
2008, sales, other than sales governed by paragraphs (B), (B-1), (B-2), (B-5) and (B-7), are in this
State if any of the following criteria are met:
(iii) In the case of interest, net gains (but not less than zero) and other items of income from
intangible personal property, the sale is in this State if:
(a) in the case of a taxpayer who is a dealer in the item of intangible personal property
within the meaning of Section 475 of the Internal Revenue Code, the income or
gain is received from a customer in this State. For purposes of this subparagraph,
a customer is in this State if the customer is an individual, trust or estate who is a
resident of this State and, for all other customers, if the customer’s commercial
domicile is in this State. Unless the dealer has actual knowledge of the residence
or commercial domicile of a customer during a taxable year, the customer shall be
deemed to be a customer in this State if the billing address of the customer, as
shown in the records of the dealer, is in this State; or
(b) in all other cases, if the income-producing activity of the taxpayer is performed in
this State or, if the income-producing activity of the taxpayer is performed both
within and without this State, if a greater proportion of the income-producing activity
of the taxpayer is performed within this State than any other state, based on
performance costs.
Section 475 of the Internal Revenue Code (IRC) prescribes use of the mark-to-market accounting
method for dealers in securities. Section 475(c)(1) defines a “dealer in securities” to mean a taxpayer
who:
(A)

regularly purchases securities from or sells securities to customers in the ordinary
course of a trade or business; or

(B)

regularly offers to enter into, assume, offset, assign or otherwise terminate positions in
securities with customers in the ordinary course of a trade or business.

Section 475(a) requires that a dealer in securities apply the mark-to-market method of accounting.
Section 475(b) allows for exceptions to mark-to-market accounting for dealers, providing that
subsection (a) shall not apply to certain securities held by a dealer including:
(B)(i) any security described in subsection (c)(2)(C) which is acquired (including originated)
by the taxpayer in the ordinary course of a trade or business of the taxpayer and which is not
held for sale, and (ii) any obligation to acquire a security described in clause (i) if such
obligation is entered into in the ordinary course of such trade or business and is not held for
sale.
Pursuant to these provisions, Treas. Reg. § 1.475(c)-1(c)(1) provides for the following exemption
from dealer status:
A taxpayer that regularly purchases securities from customers in the ordinary course of a
trade or business (including regularly making loans to customers in the ordinary course of a
trade or business of making loans) but engages in no more than negligible sales of the

IT 18-0001-PLR
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securities so acquired is not a dealer in securities within the meaning of section 475(c)(1)
unless the taxpayer elects to be so treated or, for purposes of section 471, the taxpayer
accounts for any security (as defined in section 475(c)(2)) as inventory.
Under IITA Section 304(a)(3)(C-5)(iii), whether interest, net gains, and other items of income from
intangible personal property are assigned to Illinois for sales factor purposes depends on whether
the taxpayer “is a dealer in the item of intangible personal property within the meaning of Section
475 of the Internal Revenue Code.” If the taxpayer is a dealer within the meaning of IRC Section
475, the gross receipts are assigned to Illinois if the customer is in Illinois. If the taxpayer is not a
dealer within the meaning of IRC Section 475, the gross receipts are assigned to Illinois under
Section 304(a)(3)(C-5)(iii)(b) if the income-producing activity is in Illinois. For this purpose, a taxpayer
is a dealer with respect to an item of intangible personal property if the taxpayer is actually a dealer
with respect to the item under IRC Section 475, or would be a dealer with respect to the item under
IRC Section 475 if the item were a security as defined in IRC Section 475(c)(2).
Your letter represents that the Taxpayer derives interest income by making loans to customers in
the ordinary course of its trade or business. You represent that the Taxpayer is not a dealer in
securities within the meaning of IRC Section 475(c)(1) by virtue of the exemption allowed under
Treas. Reg. § 1.475(c)-1(c)(1) to taxpayers who make only negligible sales of loans that they
originate and who do not elect out of the exemption. The particular sourcing rule under IITA Section
304(a)(3)(C-5)(iii) to be applied should not depend on whether a taxpayer does or does not elect out
of the dealer exemption available under Treas. Reg. 1.475(c)-1(c)(1). In either case, the taxpayer
earns interest by making loans to customers in the ordinary course of its trade or business.
Accordingly, for purposes of IITA Section 304(a)(3)(C-5)(iii), a taxpayer who is eligible for the
exemption under Treas. Reg. 1.475(c)-1(c)(1) is considered a dealer in securities with respect to
loans it originates to customers whether or not the taxpayer elects out of the exemption. In this case,
then, Taxpayer must include the interest income from loans made to its customers in the numerator
of its Illinois sales factor under IITA Section 304(a)(3)(C-5(iii)(a) if the customer is a resident of Illinois
or its commercial domicile is in this State.
This ruling shall bind the Department as provided herein. The facts upon which this ruling is based
are subject to review by the Department during the course of any audit, investigation or hearing and
this ruling shall bind the Department only if the material facts as recited and incorporated in this
ruling are correct and complete. This ruling shall bind the Department for all taxable years, except
as limited pursuant to 2 Ill. Adm. Code 1200.110(d) and (e).This ruling will cease to bind the
Department if there is a pertinent change in statutory law, case law, rules or in the material facts
recited in this ruling.
Sincerely,

Brian L. Stocker
Chairman, PLR Committee (Income Tax)