Can a company exclude the sale proceeds of its inventory from the Illinois sales-factor when it sells off an entire division, using Illinois's alternative apportionment petition process?

Subject

Alternative Apportionment

Plain-English summary

A group of four unitary, affiliated corporations sold its entire Illinois grain division -- including accounts receivable, inventory, and fixed assets -- during a tax year ending May 31. The taxpayer petitioned the Illinois Department of Revenue under 35 ILCS 5/304(f) and 86 Ill. Adm. Code 100.3390 for permission to use an alternative method of apportionment: specifically, to exclude the inventory portion of the sale proceeds from both the numerator and denominator of its Illinois sales factor, arguing that including those proceeds would distort its Illinois-source income.

The Department walked through the sale asset-by-asset. Under 86 Ill. Adm. Code 100.3380(c)(2), gross receipts from an "incidental or occasional sale of assets used in the regular course" of a business are excluded from the sales factor -- the regulation gives the sale of "a factory or plant" as an example. The Department agreed the fixed-asset component of the sale qualified for this exclusion, since the taxpayer was clearly not in the business of selling its own fixed assets.

But the inventory component was different. The Department reasoned that inventory sales are "the quintessential source of a taxpayer's business income," and that Illinois's sales factor statute (35 ILCS 5/304(a)(3)(B)) generally requires inventory-sale proceeds to be included in the sales factor. It found no Illinois guidance allowing a bulk inventory sale to be treated as an "occasional sale," and drew an analogy to the Retailers' Occupation Tax, where a retailer generally cannot make an "occasional sale" of the same type of property it regularly sells (35 ILCS 120/1; 86 Ill. Adm. Code 130.110(a)).

Even though the Department's own analysis suggested that including the inventory proceeds "would fail to fairly represent the market for Taxpayer's goods" given that the division was being fully exited, the taxpayer's alternative apportionment petition still failed on the numbers: the taxpayer's own submission showed the difference between the statutory method and its proposed alternative was only about 4% of Illinois market share. Under 86 Ill. Adm. Code 100.3390(c), a taxpayer seeking alternative apportionment must prove by clear and convincing evidence that the statutory formula produces a "grossly distorted result." A roughly 4% variance did not meet that bar, so the Department held the petition "cannot be granted at this time."

As the letter itself states, this is a GIL, not a Private Letter Ruling -- it does not constitute a statement of Department policy and is not binding on the Department.

What this means for you

Businesses selling off a division or asset group

If you sell an entire division and want to exclude the proceeds from your Illinois sales factor, this letter suggests the Department will separate the sale into its component asset classes. Fixed assets sold outside your ordinary course of business may qualify for the "occasional sale" exclusion under 86 Ill. Adm. Code 100.3380(c)(2), but inventory proceeds generally will not -- even in a one-time, bulk, division-exiting sale -- because inventory sales are treated as the core of your ordinary business income.

Taxpayers considering an alternative apportionment petition

This letter is a reminder that showing a different apportionment percentage is not enough to win an alternative apportionment petition under 35 ILCS 5/304(f). Per 86 Ill. Adm. Code 100.3390(c), you must prove by clear and convincing evidence that the statutory method leads to a "grossly distorted result." Here, even though the Department's own reasoning acknowledged the standard method might not perfectly reflect the taxpayer's market, a roughly 4% difference was not distorted enough to satisfy that burden.

Accountants and tax professionals

The letter leans on case law -- Lakehead Pipe Line Co. v. Dep't of Rev., Miami Corporation v. Dep't of Rev., and AT&T Teleholdings, Inc. v. Dep't of Rev. -- for the proposition that a modest percentage swing does not amount to the kind of gross distortion Section 304(f) requires. When advising a client on a similar division sale, expect the Department to bifurcate the sales-factor treatment by asset class (fixed assets vs. inventory vs. receivables) rather than treating the whole transaction uniformly.

Common questions

Q: Did the Department let the taxpayer exclude the inventory sale proceeds from its Illinois sales factor?
A: No. The Department concluded that gross receipts from the sale of inventory property, "whether or not a bulk sale," are not excluded from the sales factor under 86 Ill. Adm. Code 100.3380(c)(2), because inventory sales are the taxpayer's ordinary source of business income.

Q: Did the Department treat all the sold assets the same way?
A: No. The Department agreed the fixed-asset component of the sale qualified for the "occasional sale" exclusion because the taxpayer was not in the business of selling its own fixed assets. It reached a different conclusion for the inventory component.

Q: Why did the Department deny the alternative apportionment petition even though it saw some merit in the taxpayer's market argument?
A: The Department found the taxpayer's petition failed to meet its burden of proof under 86 Ill. Adm. Code 100.3390(c), because the difference between the statutory method and the taxpayer's proposed alternative was only about 4% -- not the "grossly distorted result" required for alternative apportionment.

Q: What standard must a taxpayer meet to win an Illinois alternative apportionment petition?
A: Under 86 Ill. Adm. Code 100.3390(c), the party seeking the alternative method must prove by clear and convincing evidence that the statutory formula operates unreasonably and arbitrarily, attributing to Illinois a percentage of income "out of all proportion" to the market for the taxpayer's goods or services -- not merely that a different formula would reach a different percentage.

Q: Is this letter binding on the Illinois Department of Revenue?
A: No. It is a General Information Letter. 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) as cited in the letter (see also 86 Ill. Adm. Code 1200.120(b) and (c)).

Q: Could the same taxpayer get a binding answer instead?
A: The letter distinguishes GILs from Private Letter Rulings (PLRs), noting a PLR is binding on the Department, but only for the taxpayer who requested it and only to the extent the facts in the PLR are accurate and complete. This letter was issued as a GIL rather than a PLR.

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/it20-0004-gil.pdf

Original ruling text

IT 20-0004-GIL 01/21/2020 ALTERNATIVE APPORTIONMENT
Alternative Apportionment Not Allowed unless Taxpayer Shows Sales Factor does not Fairly
Reflect Market for Goods or Services
January 21, 2020
Re:

Petition for Alternative Apportionment

Dear Taxpayer:
This is in response to your request to use an alternative method of allocation or apportionment for your
taxable year ending May 31, 20XX. 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 letter states as follows:
As provided by 35 ILCS §5/304(f) and 86 ILAC 100.3390, TAXPAYER hereby petitions for an
alternative method of apportionment for its 20XX tax year for purposes of its Corporate Income
Tax liability in Illinois. Specifically, Taxpayer asks for permission to exclude, from the numerator
and denominator of its sales apportionment factor, the gross proceeds (and net gains) from the
inventory component of its 20XX sale of an entire division. This method would avoid distorting
the Taxpayer’s Illinois source income, which is generated from the day-to-day sale of inventory
to wholesalers, and would be consistent with how Illinois law treats the proceeds and gains from
all of the other components of this sale.
Facts
Taxpayer is a group of four unitary, affiliated corporations with a DATE fiscal year end and files
Form 1120 for federal income tax purposes on a consolidated basis. During its 20XX tax year
(fiscal year ending 5/31/17), Taxpayer sold % of the assets of its NAME Illinois grain division, all
of which were located in Illinois. The sale consisted of three different classes of assets: accounts
receivable, inventory, and fixed assets (collectively, the NAME Assets). During the 20XX tax
year, Taxpayer received $$$ in gross proceeds in exchange for these assets, allocated as
follows: $$$ to accounts receivable, $$$ to inventory, and $$$ to fixed assets.
Law and Application
The Illinois sales factor is a fraction that generally includes total sales in Illinois in the numerator,
and total sales everywhere in the denominator. 35 ILCS 5/304(a)(3)(A). Sales of tangible assets
are sourced to Illinois if they are delivered to a purchaser in the state. 35 ILCS 5/304(a)(3)(b)(i).
Because Taxpayer’s NAME Assets were all located in Illinois and were thus delivered to the
purchaser in Illinois immediately upon their sale, all gross receipts from this sale would be
included in the numerator and denominator of Taxpayer’s Illinois sales factor absent contrary
guidance.

IT 20-0004-GIL
Page 2
However, under 86 ILAC 100.3380(c)(2), gross receipts from an “incidental or occasional sale
of assets used in the regular course” of a seller’s trade or business are excluded from the seller’s
sales factor, both numerator and denominator, and this regulation further provides that “For
example, gross receipts from the sale of a factory or plant will be excluded.” As a result,
Taxpayer’s receipts from the sale of the NAME Assets are excluded from its Illinois sales factor
to the extent they qualify as an occasional sale of assets used in the regular course of business.
Under Illinois’s general regulatory framework, Taxpayer’s $$$ gross receipts from the sale of the
fixed asset component of its NAME Asset sale are excluded from its Illinois sales factor because
Taxpayer is clearly not in the business of selling its fixed assets and because the sale of a
“factory or plant” is specifically provided as an example of the type of assets subject to Illinois’
exclusionary rule.
Illinois does not appear to have published any guidance interpreting whether the bulk sale of
inventory would be considered an “occasional sale” of assets “used” in the regular course of a
person’s trade or business assets under 86 ILAC 100.3390(c)(2). As a result, Illinois’ guidance
regarding other tax types may be instructive in interpreting these sales apportionment factor
concepts.
For Illinois Retailer’s Occupation Tax (ROT) purposes, it is generally not possible for a taxpayer
engaged in the business of selling tangible personal property at retail to make an occasional
sale of that same tangible personal property. Isolated or occasional sale treatment for the Illinois
ROT generally only applies to companies who do not habitually engage in selling tangible
personal property at retail. 35 ILCS § 120/1; 86 ILAC 130.110(a). Further, if a taxpayer takes an
item out of inventory to use in its trade or business, then that taxpayer is generally required to
pay Illinois Use tax on that item of inventory. Taxpayer has not used any of these inventory items
in its business and is thus not required to pay Illinois Use Tax on them. As a result, absent
guidance to the contrary, it seems likely that for Illinois sales apportionment purposes a company
could not have an “occasional” sale of its own inventory, and would not be considered to “use”
its own inventory in its business unless it paid Use Tax on it.
Because Illinois’s sales factor clearly requires corporations’ sales factors to generally include the
proceeds from their sale of inventory (35 ILCS §5/304(a)(3)(B)), Illinois’s statutes and regulations
do not generally appear to allow or require the receipts of bulk inventory sales to be excluded
from the sales factor using the occasional sale or isolated sale rule. As a result, even though the
regular/ordinary course of Taxpayer’s business is to sell inventory on a day-to-day basis to
wholesalers within and outside Illinois, unless the proceeds from the sale of this inventory are
excluded from the Taxpayer’s sales factor, the resulting apportionment would fail to fairly
represent the market for Taxpayer’s goods simply because the inventory happened to be located
in Illinois at the time that the buyer stepped into Taxpayer’s shoes and took over the operations
of its NAME.
Under 35 ILCS §5/304(f), however, Illinois provides alternative apportionment as a remedy for
situations like the one faced by Taxpayer; specifically, ones in which the application of Illinois’
general allocation and apportionment laws do not “fairly represent the market for [Taxpayer’s]
goods.” In fact, one of the statutory justifications specified in Illinois’s regulations for the exclusion
of gross receipts from an occasional or isolated sale from the sales factor under 86 ILAC
100.3390(c)(2)(D), is that, “in the case of asset sales that are made in connection with a partial
or complete withdrawal from the market in the state in which the assets are located, including

IT 20-0004-GIL
Page 3
the gross receipts from those sales in the sales factor would increase the business income
apportioned to that state when the taxpayer’s market in that state has decreased. This is the
exact situation Taxpayer is facing here: Taxpayer has exited its business market in NAME Illinois
by selling its entire NAME Illinois grain division.
86 ILAC 100.3390, which provides the procedural framework for making Illinois alternative
apportionment petitions, provides that “the party …seeking to utilize apportionment method has
the burden of going forward with the evidence and proving by clear and convincing evidence
that the statutory formula … operates unreasonably and arbitrarily in attributing to Illinois a
percentage of income that is out of all proportion to … the market for the taxpayer’s goods,
services, and other sources of business income in this State.” 86 ILAC 100.3390(c).
In this case, the Taxpayer’s situation clearly meets its burden or proof for being granted an
alternative method of apportionment. Because the Taxpayer is selling its entire line of business
in NAME Illinois, it is fully exiting that business market. This is expressly listed in 86 ILAC
100.3380 as a justification for using Illinois’s alternative apportionment power to require the sales
factor exclusion of receipts from occasional sales of assets used in a taxpayer’s business, such
as the accounts receivable and fixed asset components of the sale of its NAME Assets. Because
there does not appear to be any principled reason for not extending this same treatment to the
inventory component of that same sale, that same treatment should be extended to the inventory
in this case.
RULING
Section 304(a) of the Illinois Income Tax Act (“IITA”; 35 ILCS 5/304) provides that when a nonresident
derives business income from Illinois and one or more other states, such income shall be apportioned
to Illinois by multiplying the income by the taxpayer’s apportionment factor. For taxable years ending
on and after December 31, 1998, except in the case of an insurance company, financial organization,
transportation company, or federally regulated exchange, the apportionment factor is equal to the sales
factor. IITA Section 304(a)(3) defines the sale factor as a fraction, the numerator of which is the total
sales of the person in Illinois during the taxable year, and the denominator of which is the total sales of
the person everywhere during the taxable year.
Section 304(f) of the IITA 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.

IT 20-0004-GIL
Page 4

In applying Section 304(f), Department Regulations Section 100.3380(c)(2) provides the following
special rule:
When gross receipts arise from an incidental or occasional sale of assets used in the regular
course of the person's trade or business, those gross receipts shall be excluded from the sales
factor. For example, gross receipts from the sale of a factory or plant will be excluded. Gross
receipts from an incidental or occasional sale of stock in a subsidiary will also be excluded.
Exclusion of these gross receipts from the sales factor is appropriate for several reasons, more
than one of which may apply to a particular sale, including:
A) incidental or occasional sales are not made in the market for the person's goods, services or
other ordinary sources of business income;
B) to the extent that gains realized on the sale of assets used in a taxpayer's business are
comprised of recapture of depreciation deductions, the economic income of the taxpayer was
understated in the years in which those deductions were taken. The recapture gains that reflect
a correction of that understatement should be allocated using a method approximating the
factors that were used in apportioning the deductions. If the business otherwise remains
unchanged, including the gross receipts from the sale in the sales factor numerator of the state
in which the assets were located would allocate a disproportionate amount of the recapture gains
to that state compared to how the deductions being recaptured were allocated;
C) to the extent the gain on the sale is attributable to goodwill or similar intangibles representing
the value of customer relationships, including the gross receipts from the sale in the sales factor
will not reflect the market for the taxpayer's goods, services or other ordinary sources of business
income to the extent the sourcing of the receipts from that sale differs from the sales factor
computed without regard to that sale; and
D) in the case of sales of assets that are made in connection with a partial or complete withdrawal
from the market in the state in which the assets are located, including the gross receipts from
those sales in the sales factor would increase the business income apportioned to that state
when the taxpayer's market in that state has decreased.
As indicated above, the special rule under Regulations Section 100.3380(c)(2) applies only in the case
of an incidental or occasional sale of assets used in the regular course of the person’s trade or business.
It does not apply to gross receipts from the sale of property that is properly included in the inventory of
the taxpayer. The sale of inventory is the quintessential source of a taxpayer’s business income, the
sale of which serves to primarily establish the market for the taxpayer’s sources of business income.
Gross receipts from the sale of inventory property, whether or not a bulk sale, are not excluded from
the sales factor under Regulations Section 100.3380(c)(2).
As indicated above, for taxable years ending or after December 31, 2008, alternative apportionment
under IITA Section 304(f) is appropriate in cases where the allocation and apportionment provisions
under IITA Sections 304(a) through (e) do not fairly represent the market for the taxpayer’s goods,
services, or other sources of business income. Department Regulations Section 100.3390 allows

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taxpayers to petition the Department for application of an alternative apportionment method. Section
100.3390(c) sets forth the taxpayer’s burden of proof, as follows:
Burden of Proof. A departure from the required apportionment method is allowed only when
those methods do not accurately and fairly reflect business activity in Illinois (for taxable years
ending before December 31, 2008) or market in Illinois (for taxable years ending on or after
December 31, 2008). An alternative apportionment method may not be invoked, either by the
Director or by a taxpayer, merely because it reaches a different apportionment percentage than
the required statutory formula. However, if the application of the statutory formula will lead to a
grossly distorted result in a particular case, a fair and accurate alternative method is appropriate.
The party (the Director or the taxpayer) seeking to utilize an alternative apportionment method
has the burden or going forward with the evidence and proving by clear and convincing evidence
that the statutory formula results in the taxation of extraterritorial values or operates
unreasonably and arbitrarily in attributing to Illinois a percentage of income that is out of all
proportion to the business transacted in this State (for taxable years ending before December
31, 2008) or the market for the taxpayer's goods, services or other sources of business income
in this State (for taxable years ending on or after December 31, 2008). In addition, the party
seeking to use an alternative apportionment formula must go forward with the evidence and
prove that the proposed alternative apportionment method fairly and accurately apportions
income to Illinois based upon business activity in this State (for taxable years ending before
December 31, 2008) or the market for the taxpayer's goods, services or other sources of
business income in this State (for taxable years ending on or after December 31, 2008).
In any event, your petition fails to meet this burden. Even assuming, arguendo, the sales at issue do
not reflect the market for the taxpayer’s business income, the difference between the taxpayer’s Illinois
market applying the statutory method and the Illinois market under your proposed method is
approximately 4%. Therefore, your petition would have nonetheless failed to demonstrate that the
statutory method would lead to a grossly distorted result in attributing to Illinois a percentage of income
that is out of all proportion to the market for the taxpayer's goods, services or other sources of business
income in this State. See Lakehead Pipe Line Co. v. Dep’t of Rev., 192 Ill. App. 3d 756 (1st Dist. 1989);
Miami Corporation v. Dep’t of Rev., 212 Ill. App. 3d 702 (1st Dist. 1991); AT&T Teleholdings, Inc. v.
Dep’t of Rev., 978 N.E.2d 371 (Ill. App. Ct. 2012).
As stated above, 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)