Can a taxpayer get permission to use an alternative apportionment method (based on trading volume by exchange location) instead of the statutory sales-factor sourcing rules?

Subject

Alternative Apportionment

Plain-English summary

A Chicago-based proprietary trading firm ("COMPANY"), organized as an LLC taxed as a corporation and registered as a market maker on various exchanges, petitioned the Illinois Department of Revenue for permission to use an alternative apportionment method for its tax year ended December 31, 2014. The petition was filed as an attachment to an amended return, as allowed by 86 Ill. Adm. Code 100.3390(e)(2), after the Department had already audited the original 2014 return without adjusting the apportionment factor.

On its original return, COMPANY had sourced 100% of its trading receipts to Illinois, based on the fact that its trading activities were controlled from Chicago. COMPANY argued this overstated its actual Illinois market and asked instead to use a trading-volume method: sourcing receipts based on the location of the electronic exchanges where its trades were executed. Using 2014 trading-volume data (broken out by exchange in an attached exhibit), COMPANY calculated that only 50.19% of its trading revenue should be apportioned to Illinois under that alternative method, and it offered to apply the same method to open years 2015-2017 as well.

The Department declined to grant the petition. It explained that before a taxpayer can show that the statutory apportionment provisions don't "fairly represent the market" for its income (the standard for alternative apportionment under 35 ILCS 5/304(f)), the taxpayer must first actually determine its apportionment under the standard statutory rules. Here, the applicable statutory rule for a dealer in intangible personal property (COMPANY qualified as a dealer under IRC Section 475) sources income to the location of the customer, per 35 ILCS 5/304(a)(3)(C-5)(iii)(a) — not to where trades are controlled or executed. Because COMPANY had never determined its apportionment using that customer-location rule (it instead used a "trades controlled in Illinois" theory), the Department found it could not evaluate whether the statutory method failed to fairly reflect COMPANY's market, and so "your petition for an alternative method of apportionment cannot be granted at this time."

As the letter itself notes, this is a GIL, not a binding statement of Department policy.

What this means for you

Businesses or trading firms considering an alternative apportionment petition

This letter is a cautionary example, not a roadmap. The Department did not evaluate whether a trading-volume method would be an acceptable alternative apportionment method on the merits — it denied the petition on a threshold, procedural ground: the taxpayer had not first computed its apportionment using the statutorily prescribed method (customer-location sourcing for dealers under 35 ILCS 5/304(a)(3)(C-5)(iii)(a)). If you intend to petition for alternative apportionment under 35 ILCS 5/304(f), this letter indicates you should first calculate your apportionment the standard statutory way, so you can actually demonstrate that the standard method does not fairly reflect your market before proposing an alternative.

Dealers in intangible property (including trading firms)

The ruling reiterates that for a taxpayer who is a "dealer" in intangible personal property within the meaning of IRC Section 475, Illinois sources the related income or gain to the location of the customer (or, if the customer's location isn't known, to the customer's billing address on file), not to where the trading decisions are made or where trades are executed. This is the baseline rule a dealer must apply before any alternative apportionment argument can be considered.

Common questions

Q: Did the Department approve or deny the alternative apportionment method the taxpayer proposed?
A: The Department denied the petition. It did not rule on whether the proposed trading-volume method would fairly reflect the taxpayer's market — it denied the petition because the taxpayer had never first determined its apportionment under the standard statutory sourcing rule.

Q: Why did the Department say the petition could not be granted "at this time"?
A: Because the taxpayer's letter showed it had sourced 100% of its trading receipts to Illinois based on where its trades were controlled, rather than applying the statutory rule for dealers in intangible property, which sources income to the customer's location under 35 ILCS 5/304(a)(3)(C-5)(iii)(a). Without first applying that statutory method, the Department found there was no basis to determine whether it failed to fairly represent the taxpayer's market.

Q: What method did the taxpayer want to use instead?
A: The taxpayer wanted to source its trading revenue based on the volume of trades executed on each electronic exchange, arguing this better reflected the market for its trading activity than treating 100% of receipts as Illinois-sourced. Under this method, the taxpayer calculated that 50.19% of its 2014 trading revenue would be apportioned to Illinois.

Q: Does this letter set a precedent that trading-volume-based apportionment is (or isn't) acceptable in Illinois?
A: No. The Department's ruling did not address the merits of a trading-volume method at all. It resolved the petition solely on the threshold issue that the taxpayer hadn't first applied the statutory customer-location sourcing rule. Also, as a GIL, this letter is not a statement of Department policy and is not binding on the Department (2 Ill. Adm. Code 100.1200(b) and (c)).

Q: Is this letter binding on the Illinois Department of Revenue?
A: No. It is a General Information Letter, which "do[es] not constitute statements of Department policy that apply, interpret or prescribe the tax laws and are not binding against the Department," per 2 Ill. Adm. Code 100.1200(b) and (c). A taxpayer wanting a binding answer on its own specific facts would need a Private Letter Ruling.

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/income-tax/2020.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/income-tax/2020/it20-0001-gil.pdf

Original ruling text

IT 20-0001-GIL 01/07/2020 ALTERNATIVE APPORTIONMENT
Alternative Apportionment Not Allowed unless Taxpayer Demonstrates Sales Factor does not
Fairly Reflect Market for Goods or Services. (This is a GIL.)

January 7, 2020
Re:

Petition for Alternative Apportionment

Dear Mr. Xxxx:
This is in response to your letter dated January 11, 2019 in which you request permission to use an
alternative method of allocation or apportionment. Department of Revenue (“Department”) regulations
require that the Department issue only two types of letter rulings, Private Letter Rulings (“PLRs”) and
General Information Letters (“GILs”). PLRs are issued by the Department in response to specific
taxpayer inquiries concerning the application of a tax statute or rule to a particular fact situation. A
PLR is binding against the Department, but only as to the taxpayer issued the ruling and only to the
extent the facts recited in the PLR are correct and complete. GILs do not constitute statements of
Department policy that apply, interpret or prescribe the tax laws and are not binding against the
Department. See 2 Ill. Adm. Code 100.1200(b) and (c).
For the reasons discussed below, your petition cannot be granted at this time.
Your petition states as follows:
REPRESENTATI VE, as authorized agent for COMPANY (“COMPANY” “Company” or
“taxpayer”), requests the use of an alternative apportionment by amending COMPANY’s
Corporate Income and Replacement Tax return for the period ending December 31, 2014 as
authorized by 86 Ill. Admin. Code Section 100.3390(e)(2). The original amended return was
filed with Department of Revenue’s (“Department”) Business Processing Unit and a copy of the
amended return is attached.
In accordance with 86 Ill. Admin. Code 100.3390(e)(2), the taxpayer has never filed a petition
for alternative apportionment as provided under 86 Ill. Admin Code Section 100.3390(e)(1), or
whose subsection (e)(1) petition has been rejected. The explanation section of the amended
return states that the amended return is being filed based on a petition for alternative
apportionment and the Department’s Processing Unit should refer the amended return to the
Legal Service Bureau/Income Tax.
The Petition for alternative apportionment is for tax years ended on or after December 31,
2014.
COMPANY is a limited liability company that has elected to be treated as a corporation for
federal and Illinois income tax purposes.
COMPANY is a Chicago based proprietary trading firm. As a proprietary trading firm,
COMPANY uses its own capital to fund its trading activities for the sole benefit of the company
(also referred to as trading for its own account). In addition, COMPANY is registered with
various exchanges as a market maker in several listed instruments. As a market maker it
quotes both a buy and sell price in a financial instrument or commodity that it holds; hoping to

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make a profit on the turn. Although COMPANY is based in Chicago, it trades on numerous
electronic exchanges located in and outside of Illinois.
For federal income tax purposes, COMPANY is a dealer as defined under Internal Revenue
Code Section 475.
For the tax year ending December 31, 2014, COMPANY apportioned 100% of its receipts to
Illinois. Back in April 2017, the Department audited this return and made no adjustments to the
apportionment factor, but did make a minor adjustment to the tax base which resulted in a
small tax increase.
COMPANY and the Department have executed a waiver to the statute of limitation until
January 15, 2019 for the tax year ending December 31, 2014. Attached is a copy of the
executed waiver.
COMPANY requests the Department grant the use of an alternative apportionment method as
more detailed below.
For tax years ending on or after December 31, 2008, Illinois Income Tax Act (“IITA”) Section
304(a)(3)(C-5)(iii) provides:
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
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;
On August 3, 2017, the Department updated its administrative regulation related to the sales
factor for changes related to the adoption of market based sourcing. In particular 86 Ill. Adm.
Code Section 100.3370(c)(6)(C)(i) was added to provide additional guidance to the provisions
of IITA Section 304(a)(3)(C-5)(iii). The new administrative provision provides:
(i) in the case of a taxpayer who:
is a dealer in the item of intangible property within the meaning of 26 USC 475, the
income or gain is received from a customer in this State. A taxpayer is a dealer with
respect to an item of intangible personal property if the taxpayer is a dealer with respect
to the item under 26 USC 475(c)(1), or would be a dealer with respect to the item under
26 USC 475(c)(1) if the item were a security as defined under 26 USC 475(c)(2). For
purposes of this subsection (c)(6)(C)(i), 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

IT 20-0001-GIL
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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. A dealer shall treat the person with
whom it engages in a transaction as the customer, even when that person is acting on
behalf of a third party, unless the dealer has actual knowledge of the party on whose
behalf the person is acting. If a taxpayer is a dealer with respect to an item of intangible
personal property and recognizes gain or loss with respect to that item other than in
connection with a transaction with a customer (for example, unrealized gain or loss from
marking the item to market under 26 USC 475), that gain or loss shall be excluded from
the numerator and denominator of the sales factor (IITA Section 304(a)(3)(C-5)(iii)(a)).
IITA Section 304(f) Alternative allocation provides:
If the allocation and apportionment provisions of subsections (a) through (e) and of
subsection (h) do not, for taxable years ending before December 31, 2008, fairly
represent the extent of a person’s business activity in this State, or, for taxable years
ending on or after December 31, 2008, fairly represent the market for the person’s
goods, service or other sources of business income, the person may petition for, or the
Director may, without a petition, permit or require, in respect of all or any part of the
person’s business activity, if reasonable: (1) separate accounting; (2) the exclusion of
any one or more factors; (3) the inclusion of one or more additional factors which will
fairly represent the person’s business activities or market in this State; or (4) the
employment of any other method to effectuate an equitable allocation and
apportionment of the person’s business income.
On August 3, 2017, the Department modified its regulations for petitioning alternative
apportionment 86 Ill. Admin. Code Section 100.3390. Under 86 Ill. Admin. Code Section
100.3390(e) Timely Filed Petitions.
A taxpayer petition for use of a separate accounting method or any other alternative
apportionment method will not be considered by the Director unless such petition has
been timely filed. A taxpayer who petitions the Director for an alternative apportionment
formula does so subject to the Department’s right to verify, by audit of the taxpayer’s
return and supporting books and records within the applicable statute of limitations, the
facts submitted as the basis of the petition. A petition for alternative allocation or
apportionment is timely filed if the petition is filed:
(e)(1) 120 days prior to the date of the tax return (including extensions) for which
permission to use such alternative method is sought. A taxpayer who does not petition
more than 120 days prior to the due date of the original return must file their return and
pay tax according to the statutorily approved allocation or apportionment method.
(e)(2) As an attachment to a return amending an original return which was filed using
the statutory allocation and apportionment rules. A taxpayer who has not filed a petition
for alternative apportionment under section (e)(1) above, or whose (e)(1) petition has
been rejected, may thereafter file such petition with an amended return and the
Department will consider the petition along with any other issues raised in the claim for
refund pursuant to the procedures set forth at Section 100.9110 of this Part.

IT 20-0001-GIL
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COMPANY has historically sourced 100% of its trading receipts to Illinois. This sourcing
method was primarily based on where COMPANY’s trading activities were controlled from.
Upon closer analysis of the Illinois sourcing provisions, in particular IITA Section 304(a)(3)(C5)(iii)(a), the sourcing of income from a dealer in an intangible within the meaning of IRC
Section 475 is the location of the customer. This provision applies to all taxpayers that sell
intangibles to customers in their regular course of their trade or business. In COMPANY’s
case, they are a dealer as defined by IRC Section 475 and Illinois market based sourcing is
the location of the dealer’s customers.
The challenge in applying the sourcing provisions of IITA Section 304(a)(3)(C-5)(iii)(a) to
COMPANY is that COMPANY does not have knowledge of who the counterparties are to its
transactions. Arguably, the counterparties of COMPANY are located throughout the United
States or even other countries. However, due to the nature of the COMPANY’s trading
transactions, COMPANY is unable to identify the ultimate counterparty. While COMPANY is
unable to identify the ultimate counterparty, it does have knowledge of the nature of the
transactions, including the volume and the location of the execution of the transactions on
servers/matching engines.
Last year, the Department amended 86 Ill. Admin. Code Section 100.3370(c)(6)(i) to provide
additional guidance on how dealers in intangibles should source income or gain from
transactions with its customers. One of the areas that was addressed in the amended
regulation was to cover a situation where the dealer did not know who the customer was. In
particular the amended regulation provides “a dealer shall treat the person with whom it
engages in a transaction as a customer, even when that person is acting on behalf of a third
party, unless the dealer has actual knowledge of the person on whose behalf the person is
acting.” Although this provision is intended to cover agency relationships, it is a recognition by
the Department that a seller may not know who the ultimate customer is but does know who
they are engaged with to facilitate the transaction.
COMPANY primarily trades securities on electronic exchanges located in Chicago and New
Jersey. Since a single strategy is a series of trades; i.e. various options, puts, calls, outright
purchases and sales, tracking revenue on a single transaction is not appropriate. The most
appropriate indicator of the activities that COMPANY has on a particular electronic exchange is
the trading volume. COMPANY keeps detailed records of the volume of execution of trades on
servers/matching engines.
Attached Exhibit A summarizes COMPANY’s trading activities for 2014, listing the volume of
trades and the location of execution of the trades. Also listed is the full name of the exchanges.
Based on the volume of trading activities in 2014, 50.19% of COMPANY’s revenue from
trading activities would be apportioned to Illinois. One could argue that this percentage
overstates the actual location of COMPANY’s ultimate counterparties located in Illinois. It is
highly unlikely that the location of COMPANY’s ultimate counterparties in Illinois are anywhere
near this percentage. COMPANY views the market for its trading revenue as the location of the
exchanges. By applying the 50.19% factor to the 2014 trading revenue of $$$ results in $$$ of
COMPANY’s receipts sourced to Illinois. COMPANY’s trading activities on the various
exchanges are maintained and can easily be reviewed from an audit perspective.

IT 20-0001-GIL
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Attached Exhibit B reflects COMPANY’s trading activities for 2015, 2016, and 2017. Although
our current request for alternative apportionment is for the 2014 tax year, COMPANY is
prepared to use this trading volume methodology to determine the sourcing of its trading
revenue for all open periods and file appropriate amended returns.
COMPANY has filed an amended return with the Department’s Processing Unity that
references this Petition for alternative apportionment as required by 86 Ill. Admin. Code
Section 100.3390(e)(2). It is our understanding that the Processing Unit will not process the
amended return until it is so authorized by the Legal Services Bureau/Income Tax.
COMPANY maintains that the use of its volume trading activities on the various exchanges
during 2014 is a reflection of the market for the revenue they earn from trading activities and
should be used to source the revenue from these activities. All other revenue that COMPANY
earns should be properly sourced as provided for in IITA Section 304(a)(3).

RULING
Section 304(f) of the Illinois Income Tax Act (“IITA” 35 ILCS 5/304(f)) states:
If the allocation and apportionment provisions of subsections (a) through (e) and of subsection
(h) do not, for taxable years ending before December 31, 2008,
fairly represent the extent of a
person’s business activity in this State, or, for taxable years ending on or after December 31, 2008,
fairly represent the market for the person’s goods, services, or other sources of business income, the
person
may petition for, or the Director may, without a petition, permit or require, in
respect of all or any part of the person’s business activity, if reasonable:
(1) Separate Accounting;
(2) The exclusion of any one or more factors;
(3) The inclusion of one or more additional factors which will fairly represent the person’s
business activities or market in this State; or
(4) The employment of any other method to effectuate an equitable allocation and
apportionment of the person’s business income.

In order to make a determination under IITA Section 304(h) as to whether or not the apportionment
provisions of subsections (a) through (e) and of subsection (h) reflect the market for the person’s
goods, services, or other sources of business income, it is necessary that the taxpayer first determine
its apportionment under such sections. If the apportionment under such sections does not fairly reflect
the taxpayer’s market, then an alternative apportionment method may be permitted. In this case, your
letter represents that Taxpayer’s trading gross receipts are sourced for apportionment purposes
applying the provisions of IITA Section 304(a)(3)(C-5)(iii)(a). That section provides as follows:
(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:

IT 20-0001-GIL
Page 6

(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

Your letter indicates that the Taxpayer has not determined its apportionment under Section
304(a)(3)(C-5)(iii)(a), but rather included 100% of its trading gross receipts in its Illinois sales factor
on the basis that its trades are controlled in Illinois. Because the Taxpayer has failed to determine its
apportionment under IITA Sections 304(a) through (e) and subsection (h), your petition for an
alternative method of apportionment cannot be granted at this time.
This is a GIL. A GIL does not constitute a statement of policy that applies, interprets or prescribes the
tax laws, and it is not binding on the Department.

Sincerely,

Brian Stocker
Associate Counsel (Income Tax)