For Illinois sales-factor sourcing, is a taxpayer that originates loans to customers still a 'dealer' in intangible property even though it qualifies for the federal negligible-sales exemption from mark-to-market accounting?

Plain-English summary

This Illinois Private Letter Ruling addresses how a lender's interest income gets sourced into the state's sales factor for corporate income tax apportionment purposes. The taxpayer was a Delaware limited partnership that originates senior secured loans directly to North American middle-market companies (borrowers with less than $25 million EBITDA), generating interest income treated as ordinary income for federal tax purposes.

Under federal tax law, a taxpayer who regularly originates loans to customers in the ordinary course of business meets the definition of a "dealer in securities" under 26 U.S.C. § 475(c)(1). Normally, dealers must use mark-to-market accounting. But Treas. Reg. § 1.475(c)-1(c)(1) provides a regulatory exemption: a taxpayer that engages in no more than "negligible sales" of the securities (loans) it originates is treated as not a dealer for federal purposes, unless it elects otherwise. The taxpayer here qualified for that exemption and asked the Department to confirm it would still be treated as a "dealer" for Illinois sales-factor sourcing under 35 ILCS 5/304(a)(3)(C-5)(iii)(a) -- a favorable classification, because dealer-sourced interest income is assigned to Illinois only if the customer is an Illinois resident or has an Illinois commercial domicile, rather than being sourced under the alternative income-producing-activity test that applies to non-dealers.

The Department ruled that the taxpayer is still considered a dealer for Illinois purposes. It reasoned that the sourcing rule under IITA Section 304(a)(3)(C-5)(iii) should not turn on whether a taxpayer elects out of the federal 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 business. Accordingly, a taxpayer eligible for the negligible-sales exemption is treated as a dealer in securities with respect to loans it originates, whether or not it elects out of that exemption. As a result, the taxpayer must source its interest income from those loans to Illinois using the dealer/customer-based test in subparagraph (a) -- meaning the income goes in the Illinois sales-factor numerator if the customer is an Illinois resident or has commercial domicile in Illinois (or, absent actual knowledge, if the customer's billing address on file is in Illinois).

The ruling letter itself notes that this is one of several private letter rulings the Department issued around this same fact pattern -- the taxpayer's own submission stated that "the Department has not previously ruled regarding this matter for Taxpayer" -- and reflects the Department's general approach to loan-originator sourcing questions, but this specific document binds the Department only for the taxpayer who requested it.

What this means for you

Loan originators and specialty/private lenders

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 accounting under Treas. Reg. § 1.475(c)-1(c)(1) -- this ruling shows the Department's reasoning that you are still treated as a "dealer" for Illinois sales-factor sourcing. That means your interest income from those loans is sourced to Illinois based on where your customer resides or has commercial domicile (or their billing address on file, absent better information), not based on where your income-producing activities take place.

Business owners and in-house tax teams at partnerships/funds

If your entity is structured similarly (e.g., a fund or partnership originating loans to middle-market borrowers), this ruling illustrates that electing or not electing out of the federal dealer exemption does not change your Illinois dealer status for apportionment purposes. You will want to track customer residence/commercial domicile (or billing addresses) for all loan customers to correctly compute your Illinois sales factor.

Accountants and tax professionals

This PLR clarifies the Department's view that IITA Section 304(a)(3)(C-5)(iii)(a)'s dealer test looks to whether a taxpayer would meet the IRC Section 475 dealer definition (absent the negligible-sales exemption), not to whether the taxpayer actually applies mark-to-market accounting federally. When advising loan-originating clients on Illinois apportionment, confirm whether the client's facts match this ruling's fact pattern closely enough to be persuasive, since only the requesting taxpayer can rely on it directly.

Common questions

Q: Does qualifying for the federal negligible-sales exemption mean a loan originator is NOT a dealer for Illinois sales-factor purposes?
A: No. The Department ruled that a taxpayer who regularly originates loans to customers in the ordinary course of business is still considered a dealer under 35 ILCS 5/304(a)(3)(C-5)(iii)(a), regardless of whether it qualifies for (or elects out of) the Treas. Reg. § 1.475(c)-1(c)(1) negligible-sales exemption from federal mark-to-market treatment.

Q: How is the dealer's interest income sourced to Illinois under this ruling?
A: Under 35 ILCS 5/304(a)(3)(C-5)(iii)(a), interest income from a dealer's intangible property is sourced to Illinois if the customer is an Illinois resident (for individuals, trusts, or estates) or has commercial domicile in Illinois (for other customers). Absent actual knowledge of the customer's residence or commercial domicile, the customer is deemed to be in Illinois if the billing address in the dealer's records is in Illinois.

Q: Why does dealer-vs-non-dealer status matter for sourcing?
A: Non-dealers source interest income under subparagraph (b) based on where the income-producing activity occurs (or, if performed in multiple states, where the greatest proportion of costs of performance occurs). Dealers instead use the customer-location test in subparagraph (a). The classification can materially change how much interest income lands in the Illinois sales factor.

Q: Can another taxpayer with a similar loan-origination business rely on this ruling?
A: No. This is a Private Letter Ruling issued under 2 Ill. Adm. Code 1200.110, and it binds the Illinois Department of Revenue only as to the specific taxpayer who requested it, and only to the extent the facts that taxpayer presented were correct and complete. Other taxpayers -- even those with very similar loan-origination facts -- cannot rely on this letter and would need to request their own ruling or consult a tax professional about their specific situation.

Citations and references

Statutes and regulations:

• 35 ILCS 5/304(a)(3)(A) -- defines the Illinois sales factor as a fraction of in-state sales over total sales
• 35 ILCS 5/304(a)(3)(C-5)(iii)(a) -- sources a dealer's interest/intangible income to Illinois based on customer residence or commercial domicile
• 35 ILCS 5/304(a)(3)(C-5)(iii)(b) -- sources a non-dealer's interest/intangible income to Illinois based on where the income-producing activity occurs
• 26 U.S.C. § 475(a), (b), (c)(1) -- federal definition of "dealer in securities" and the mark-to-market accounting requirement
• Treas. Reg. § 1.475(c)-1(c)(1) -- exemption from dealer status for negligible sales of originated loans, absent an election out
• 2 Ill. Adm. Code 1200.110 -- Illinois Department of Revenue's Private Letter Ruling procedure

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-18-0010-plr.pdf

Original ruling text

IT 18-0010-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 PRACTITIONER 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.

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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)(C-5)(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 incomeproducing 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 18-0010-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 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-tomarket 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-tomarket 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)(C-5)(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 18-0010-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 incomeproducing 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:

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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)