What does Illinois Private Letter Ruling IT 18-0009-PLR conclude about Sales Factor -Intangible Property?

Plain-English summary

The Illinois Department of Revenue issued this private letter ruling to a Delaware limited partnership that makes its money by originating senior secured loans directly to North American middle-market companies (borrowers with less than $25 million in EBITDA). The taxpayer earns interest income on those loans and reports it as ordinary income on its federal Form 1065. The question was how that interest income should be sourced for purposes of the Illinois sales factor -- specifically, whether the taxpayer counts as a "dealer in securities" under 35 ILCS 5/304(a)(3)(C-5)(iii)(a).

The wrinkle: under federal tax law (26 U.S.C. § 475(c)(1)), the taxpayer technically meets the definition of a "dealer in securities" because it regularly originates loans to customers in the ordinary course of business. But the taxpayer also qualifies for a federal regulatory exemption -- Treas. Reg. § 1.475(c)-1(c)(1) -- because it makes only "negligible sales" of the loans it originates, which lets it avoid the mark-to-market method of accounting that Section 475 would otherwise require of dealers. The taxpayer asked the Department whether, having taken advantage of that federal exemption, it would still be treated as a "dealer" for Illinois sales-factor sourcing purposes.

The Department ruled that it would. The Department reasoned that the Illinois sourcing rule under 35 ILCS 5/304(a)(3)(C-5)(iii) should not turn on whether a taxpayer does or does not elect out of the federal negligible-sales exemption -- in either case, the taxpayer is earning interest by making loans to customers in the ordinary course of its trade or business. Accordingly, a taxpayer that is eligible for the Treas. Reg. § 1.475(c)-1(c)(1) exemption is still considered a dealer in securities with respect to loans it originates, whether or not it elects out of that exemption. That means the taxpayer must source its loan interest income to Illinois under the dealer rule (35 ILCS 5/304(a)(3)(C-5)(iii)(a)) -- i.e., based on whether the customer is an Illinois resident or has an Illinois commercial domicile -- rather than under the non-dealer rule (subsection (b)), which sources income based on where the taxpayer's income-producing activity takes place.

Practically, this means the taxpayer must include interest income from loans made to Illinois customers in the numerator of its Illinois sales factor if the customer is an Illinois resident (or, for non-individuals, has its commercial domicile in Illinois), including relying on the customer's billing address if the taxpayer lacks actual knowledge of residence or commercial domicile.

What this means for you

Loan originators, specialty lenders, and private credit funds

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 Department views you as a "dealer in securities" for Illinois sales-factor purposes. That means your interest income from those loans is sourced to Illinois based on the customer's residency or commercial domicile (or billing address, absent better knowledge), not based on where your loan-origination activities occur.

Accountants and tax professionals preparing Illinois apportionment

When advising a lending or loan-origination client on Illinois apportionment of interest income under 35 ILCS 5/304(a)(3)(C-5)(iii), don't assume that federal non-dealer status (via the Treas. Reg. § 1.475(c)-1(c)(1) exemption) carries over to the Illinois sourcing analysis. This ruling shows the Department treating "dealer" status for Illinois sourcing purposes as turning on whether the taxpayer would meet the Section 475(c)(1) definition absent the exemption -- not on whether the taxpayer actually uses mark-to-market accounting.

Business owners considering a private letter ruling on similar facts

This PLR only binds the Department as to the taxpayer who requested it, and only because the facts as described (a Delaware limited partnership originating senior secured loans, managed by a SEC-regulated investment adviser, making only negligible sales of the loans it originates) were represented to be complete and accurate. If your fact pattern differs -- for example, if you make more than negligible sales of originated loans, or don't otherwise meet the Section 475(c)(1) dealer definition -- this ruling's conclusion may not apply to you, and you may want to request your own ruling under 2 Ill. Adm. Code 1200.110.

Common questions

Q: Can I rely on this ruling for my own business?
A: No, not directly. This is a Private Letter Ruling under 2 Ill. Adm. Code 1200.110, and it explicitly states it "will bind the Department only with respect to TAXPAYER." It binds the Department only as to the specific taxpayer who requested it, and only to the extent the facts that taxpayer gave were correct and complete. Other taxpayers cannot rely on it as binding precedent, though it can illustrate how the Department analyzes similar facts.

Q: Why does it matter whether the taxpayer is a "dealer" under Section 475?
A: Because 35 ILCS 5/304(a)(3)(C-5)(iii) uses two different sourcing rules for interest and other income from intangible personal property. If the taxpayer is a dealer within the meaning of IRC Section 475, income is sourced to Illinois based on where the customer is (residence, or commercial domicile, or billing address). If the taxpayer is not a dealer, income is instead sourced based on where the taxpayer's income-producing activity takes place.

Q: Does taking the federal "negligible sales" exemption mean a loan originator is no longer a dealer for Illinois purposes?
A: According to this ruling, no. The Department concluded that a taxpayer eligible for the Treas. Reg. § 1.475(c)-1(c)(1) exemption is still considered a dealer in securities with respect to loans it originates to customers, whether or not it elects out of that exemption.

Q: What has to be true for the loans to count as sourced to Illinois under the dealer rule?
A: Under 35 ILCS 5/304(a)(3)(C-5)(iii)(a), the interest or gain must be received from a customer in Illinois -- meaning the customer is an Illinois-resident individual, trust, or estate, or (for other customers) has its commercial domicile in Illinois. 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 on the dealer's records is in Illinois.

Citations and references

Statutes and regulations:

• 35 ILCS 5/304(a)(3)(A) -- defines the Illinois sales factor (Illinois sales over total sales)
• 35 ILCS 5/304(a)(3)(C-5)(iii)(a)-(b) -- sourcing rules for interest, net gains, and other income from intangible personal property, distinguishing dealers from non-dealers
• 26 U.S.C. § 475(a), (b), (c)(1), (c)(2) -- federal mark-to-market accounting requirement and definition of "dealer in securities"
• Treas. Reg. § 1.475(c)-1(c)(1) -- exemption from dealer status for taxpayers with only negligible sales of originated loans
• 2 Ill. Adm. Code 1200.110 -- Private Letter Ruling procedure, including the scope of who may rely on a PLR

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-18-0009-plr.pdf

Original ruling text

IT 18-0009-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 TAX PRACTIONER 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

IT 18-0009-PLR
Page 2

which require financing to fund corporate events such as a buyout, recapitalization, ownership
transfer, sourcing of expansion and capital growth or refinancing.
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.”

IT 18-0009-PLR
Page 3
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:
(A)
(B)

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

IT 18-0009-PLR
Page 4
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.
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)
(B)

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

IT 18-0009-PLR
Page 5
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
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)