Our sales factor excludes our foreign licensing royalties because they're under Illinois's 50%-of-gross-receipts threshold -- can we get alternative apportionment to include them anyway since they're a big, high-margin chunk of our income?

Plain-English summary

A U.S. subsidiary ("Taxpayer") of a large multinational branded-consumer-goods parent company filed an amended Illinois corporate return, petitioning for alternative apportionment for a tax year (and prospectively). The parent and its U.S. affiliates own valuable brand intangibles and earn substantial royalty income from foreign affiliates that license those intangibles to sell branded consumer products abroad. Under Illinois's single-sales-factor rule, IITA Section 304(a)(3)(B-2) excludes gross receipts from licensing intangible property (like these royalties) from the sales factor unless such receipts exceed 50% of the taxpayer's total gross receipts in the current year and each of the two preceding years -- and the Taxpayer's royalty receipts fell below that 50% threshold. The Taxpayer argued this exclusion was distortive: the royalties made up a sizeable share of its total combined business income and carried a much higher profit margin than its other (tangible-goods) sales, yet had zero representation in the sales factor's numerator or denominator, producing a result "out of all proportion" to its real economic activity. It proposed three fallback fixes: (1) include the royalties directly in the sales factor's "everywhere sales" figure, (2) use separate accounting for the royalties, or (3) fold in the foreign affiliates paying the royalties (otherwise excluded 80/20 companies) as members of the Illinois combined group. It marshaled an extensive body of case law -- Illinois's own Miami Corp., plus out-of-state decisions like Colgate-Palmolive, Crocker Equipment Leasing, Twentieth Century-Fox, Atlantic Richfield, Crisa Corp., and Microsoft Corp. -- to argue that large, unrepresented, high-margin income streams like this can require an alternative method.

The Department denied the petition. Under 86 Ill. Adm. Code 100.3390(c), a taxpayer must prove, by clear and convincing evidence, that the standard formula results in taxation of extraterritorial values or an out-of-proportion result -- and separately prove that its own specific proposed alternative would fairly and accurately apportion income instead. The Department found the Taxpayer's showing amounted only to pointing out that the statutory 50% test excludes its royalties from the sales factor and that an alternative approach would reach a different (larger) apportionment percentage -- which the regulation expressly says isn't enough on its own. The Department further reasoned there is "nothing inherently distortive or unfair" about excluding royalties that fall below the 50% threshold, since that very threshold exists specifically to prevent sales-factor distortion. It distinguished Miami Corp. (which involved intangible rights tied to out-of-state real estate under the old three-factor formula, not licensing royalties under today's single-sales-factor rule) and instead applied the reasoning of Colgate-Palmolive and Michigan's Vectren decision against the Taxpayer -- a complaint that a different factor combination would produce a different (and lower) result is not, by itself, proof of unconstitutional distortion. The Department also faulted the separate-accounting and combined-group proposals for lacking any explanation of why they would be more accurate than formulary apportionment, and noted that pulling entities out of a unitary group often creates its own distortions through intercompany pricing.

What this means for you

Multinational or brand-licensing companies with foreign royalty income

Illinois excludes intangible-licensing royalties from the sales factor unless they exceed 50% of your total gross receipts (measured over three years). If your royalties fall short of that threshold, don't assume their size or high profit margin alone will win you alternative apportionment -- you need affirmative proof that the exclusion itself produces a grossly distorted, out-of-proportion Illinois tax result, not just that including them would produce a smaller number.

Anyone petitioning to add income or factors to the sales factor

Showing that an item is large, unrepresented, and high-margin is not, by itself, evidence of unconstitutional distortion. The Department will ask whether the statutory exclusion was itself designed to prevent distortion (as the 50% royalty test was) and will weigh case-by-case whether your facts resemble situations (like Miami Corp.'s out-of-state real estate intangibles under the old three-factor formula) where courts actually found gross distortion.

Companies proposing separate accounting or combined-group changes as a fallback

A bare assertion that separate accounting or combined-group changes "would fairly represent" your Illinois activity, without explaining why that method is more accurate than the standard formula, will not meet Illinois's burden of proof. Be prepared to also address how removing entities from a unitary group could itself introduce intercompany-pricing distortions.

Common questions

Q: Why did the Department deny the petition to include the foreign royalties in the sales factor?
A: Because the Taxpayer only showed that the statutory 50%-of-gross-receipts test excludes its royalties and that including them would produce a different apportionment percentage -- which the regulation says isn't enough on its own. The Taxpayer never separately proved the exclusion produced an actually grossly distorted, out-of-proportion result.

Q: Isn't it distortive to exclude a large, high-margin income stream from the sales factor entirely?
A: Not automatically, according to the Department. It found nothing inherently distortive about excluding royalties below the 50% threshold, since that threshold was itself designed to prevent sales-factor distortion from license-and-similar receipts.

Q: How did the Department distinguish the taxpayer's key case, Miami Corp.?
A: Miami Corp. involved intangible property rights tied to out-of-state real estate under Illinois's old three-factor (property/payroll/sales) formula. The Department found this different from foreign licensing royalties under today's single-sales-factor formula, so Miami Corp.'s finding of distortion didn't carry over.

Q: Why did the Department also reject the separate-accounting and combined-group fallback proposals?
A: The Taxpayer asserted these methods would "fairly represent" its activity without explaining why they were more accurate than formulary apportionment. The Department also noted that removing entities from a unitary combined group often creates its own distortions through intercompany pricing.

Q: What is Illinois's 50% test for intangible-licensing royalties?
A: Under IITA Section 304(a)(3)(B-2), gross receipts from licensing patents, copyrights, trademarks, and similar intangible property can only be included in the sales factor if such receipts exceed 50% of the taxpayer's total gross receipts included in gross income during the tax year and each of the two immediately preceding tax years (measured on a unitary-group basis for group members).

Citations and references

Statutes, regulations, and cases cited:

• 35 ILCS 5/304(a), (h) (business income apportionment; single sales factor)
• 35 ILCS 5/304(f) (alternative apportionment petition)
• 35 ILCS 5/304(a)(3)(B-1), (B-2) (sourcing and 50%-of-gross-receipts test for intangible licensing royalties in the sales factor)
• 35 ILCS 5/1501(a)(27)(A) (80/20 company exclusion from unitary combined group)
• 86 Ill. Adm. Code 100.3370(a)(2)(F), (c)(6) (sourcing of intangible personal property receipts)
• 86 Ill. Adm. Code 100.3380(a)(2), (c)(3) (fair representation standard; sales factor inclusion of readily identifiable income-producing activity)
• 86 Ill. Adm. Code 100.3390(a), (c), (e)(1)-(2) (alternative apportionment procedures, burden of proof, filing requirements)
• Miami Corp. v. Dep't of Rev., 212 Ill. App. 3d 702 (1st Dist. 1991) (cited by taxpayer; distinguished by Department)
• Colgate-Palmolive Co. v. Bower, No. 01 L 50195 (Cook Cty. Cir. Ct. 2002) (cited by taxpayer; Department applies its reasoning against taxpayer)
• Crocker Equipment Leasing, Inc. v. Dep't of Rev., No. 2973, 12 OTR 16 (Or. 1992) (cited by taxpayer)
• Twentieth Century-Fox Film Corp. v. Dep't of Rev., 299 Or. 220, 700 P.2d 1035 (1985) (cited by taxpayer)
• Atlantic Richfield Co. v. Alaska, 705 P.2d 418 (Alaska 1985) (cited by taxpayer; also relied on in Miami Corp.)
• Appeal of Crisa Corp., 2002-SBE-004 (Cal. State Bd. of Equalization 2002) (cited by taxpayer)
• Microsoft Corp. v. Franchise Tax Bd., 39 Cal. 4th 750 (2006) (cited by taxpayer)
• Vectren Infrastructure Services Corp. v. Dep't of Treasury, Mich. Sup. Ct. No. 163742 (July 31, 2023) (cited by Department against taxpayer)
• Lakehead Pipe Line Co. v. Dep't of Rev., 192 Ill. App. 3d 756 (1st Dist. 1989) (cited by Department)
• AT&T Teleholdings, Inc. v. Dep't of Rev., 978 N.E.2d 371 (Ill. App. Ct. 2012) (cited by Department)

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/income-tax/2023.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/income-tax/2023/it23-0018-gil.pdf

Original ruling text

IT 23-0018-GIL

9/21/2023

ALTERNATIVE APPORTIONMENT

Alternative apportionment not appropriate where royalties earned from
licensing the use of intangible personal property did not compromise more
than 50% of taxpayer’s total gross receipts included in gross income and
are excluded from sales factor pursuant to IITA Section 304(a)(3)(B-2).
(GIL)
September 21, 2023
NAME
ADDRESS
Re:

Petition for Alternative Apportionment
COMPANY
FEIN: ##-#######
Tax Year Ended: DATE

Dear NAME:
This is in response to your April 11, 2023, petition to use an alternative method of
allocation or apportionment.
The Department issues two types of letter rulings. Private Letter Rulings (“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 on the Department, but only as to the taxpayer who is the subject
of the request for ruling and only to the extent the facts recited in the PLR are
correct and complete. Persons seeking PLRs must comply with the procedures
for PLRs found in the Department’s regulations at 2 Ill. Adm. Code 1200.110.
The purpose of a General Information Letter (“GIL”) is to direct taxpayers to
Department regulations or other sources of information regarding the topic about
which they have inquired. A GIL is not a statement of Department policy that
apply, interpret, or prescribe the tax laws, and is not binding on the Department.
See 2 Ill. Adm. Code 1200.120(b) and (c). You may access our website at
tax.illinois.gov
to review regulations, letter rulings, and other types of information relevant to
your inquiry.
The nature of your request and the information you have provided require that we
respond with a GIL. For the reasons discussed below, your petition cannot be
granted based on the information provided.
Your petition states as follows:
Enclosed please find the amended Illinois Form 1120-X, Amended
Corporation Income and Replacement Tax Return, (“Amended Return”)
prepared on behalf of COMPANY1 (“Taxpayer”) for the tax year ended
DATE.

COMPANY1
Page 2
September 21, 2023
Taxpayer is amending its return to request that the Illinois Department of
Revenue approve the utilization of alternative apportionment and accept
the Amended Return as filed and prospectively for tax years ending on or
after DATE. Please refer to Statement 1 in the amended returns for
additional details. As a result, Taxpayer is requesting a tax refund in the
amount of $$$,$$$ for the tax year ended DATE.
Please direct all correspondence regarding this matter to my attention. If
you need further information or have questions regarding this matter,
please contact me at (###) ###-####.
Your submission includes the following additional information pertinent to your
petition for alternative apportionment:
COMPANY1 (“COMPANY1” or “Taxpayer”) timely filed an original YEAR
Illinois Corporate Income and Replacement Tax Return (“Return”). The
Taxpayer is now amending its YEAR Return to revise the Taxpayer’s
apportionment. Taxpayer respectfully requests that the Illinois Department
of Revenue (“Department”) approve the utilization of alternative
apportionment and accept the Amended Return as filed and for
prospective tax years ending on or after DATE.
Background Information
COMPANY1 is a wholly owned subsidiary of COMPANY2
(“COMPANY2”). COMPANY2 was formed in YEAR, when the firm made
its initial public offering, and was later incorporated in STATE in YEAR.
COMPANY2 operates solely outside of Illinois in southwest STATE.
COMPANY2, along with its subsidiaries, is a global leader in the
consumer goods industry providing branded products of superior quality
and value.
The COMPANY2 business revolves around five major segments: Beauty;
Grooming; Health Care; Fabric and Home Care; and Baby, Feminine, and
Family Care. 1 COMPANY2 products are instantly recognizable when
browsing the aisles of most stores. Brands available around the globe
include: NAME, among many others. These products are sold in more
than ### countries and territories, primarily through mass merchandisers,
e-commerce, grocery stores, membership club stores, drug stores,
department stores, distributors and pharmacies.2 The United States
(“U.S.”) accounts for roughly %%% of the company’s worldwide net sales.3
1

COMPANY2, Annual Report (Form 10-K) (June 30, 2018).
Id.
3
Id.
2

COMPANY1
Page 3
September 21, 2023
Europe is responsible for %%% of sales, Asia contributes %%% and Latin
America %%.4 To facilitate such activities, the company has on-the-ground
manufacturing and commercial operations in approximately ## countries.5
COMPANY2, along with other U.S. subsidiaries that are included in the
Illinois combined filing group, own many valuable intangibles used in the
U.S. and globally. COMPANY2 and its U.S. subsidiaries are responsible
for all corporate governance and administrative duties, advertising, and
research and development for its global brands. As a result, in addition to
sales of consumer goods, COMPANY2 and certain U.S. subsidiaries
receive royalties from foreign affiliates through licensing arrangements for
the intangibles owned by COMPANY2 and its U.S. subsidiaries. These
foreign royalties are earned as a percentage of sales from foreign affiliates
and represent the primary source of royalties reported on the Federal
1120. The income producing activities related to the royalty income,
including research and development, monitoring, and supervision of the
intangible personal property, take place entirely outside of Illinois. These
royalties represent a significant amount of income and have a relative
profit margin much higher than other apportionable income as further
discussed below.
Pursuant to 35 ILCS 5/304(h) of the Illinois Income Tax Act (“IITA”, “35
ILCS 5/”, “the Act”, “ILCS Chapter 35 Section 5/”), Taxpayer filed its
original return following the standard apportionment method using a single
sale factor formula. Taxpayer’s sales factor consisted primarily of sales of
tangible personal property representing consumer goods sold by members
of the Illinois combined group. However, COMPANY2 and certain U.S.
subsidiaries were unable to include in the Taxpayer’s sales factor the
royalties earned from licensing the use of intangible personal property
because such income did not comprise more than 50% of Taxpayer’s total
gross receipts included in gross income as required under IITA 35 ILCS
5/304(a)(3)(B-2).
Alternative Apportionment
Law
ILCS Chapter 35 Section 5/304(f) provides that if the normal allocation
and apportionment methods do not fairly represent the market for the
person’s goods, services, or other sources of business income in Illinois,
the person can petition the Director of Revenue to permit separate
accounting or the use of any other method to create an equitable
allocation and apportionment of the taxpayer’s business income.
4
5

Id.
Id.

COMPANY1
Page 4
September 21, 2023
Ill. Admin. Code §100.3390(a)(c) (IITA Section 304(f)) reads as follows:
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).
The Appellate Court of Illinois held in Miami Corp v. Dept. Rev., 571
N.E.2nd 800 that use of the statutory method was inappropriate. It was
determined that the taxpayer was entitled to utilize separate accounting.
The statutory apportionment formula (the three-factor method) did not
fairly represent activities in Illinois with respect to Louisiana oil and gas
reserves which generated in excess of 80% of the taxpayer’s total income.
The court found that the distortion created by the use of the statutory
formula amounted to an unfair representation of the taxpayer’s activities
within Illinois. Part of the court’s reasoning was based on the fact that
intangibles (sourced to Louisiana) were not included in the property factor
and substantial out-of-state independent contractors were not considered
in the payroll factor.
The Department has granted alternative apportionment requests when the
statutory apportioned income attributable to business activity in Illinois

COMPANY1
Page 5
September 21, 2023
does not fairly reflect the activities of the taxpayer in Illinois. In Private
Letter Ruling IT 05-0002-PLR (3/29/2005), the Department granted the
use of separate accounting when the taxpayer demonstrated that the
statutory apportionment method attributed more income to Illinois than
was earned by the individual unitary group members who were conducting
business in Illinois. The Department further approved a separate
accounting method for the same taxpayer in Private Letter ruling IT 050007-PLR (10/17/2005).
The Illinois Administrative Code sets forth the rules and requirements for
alternative apportionment petitions.6 Subsection (e) of the Regulation
prescribes three options for requesting alternative apportionment. In
relevant part, the Regulation provides that a petition for alternative
apportionment may be filed as an attachment to a return amending an
original return which was filed using the statutory allocation and
apportionment rules.7
Subsection (a) of the Regulation identifies the types of alternative
apportionment that may be requested. If reasonable, a taxpayer may
petition for the following: (1) separate accounting; (2) the exclusion of any
one or more of the factors; (3) the inclusion of one or more additional
factors which will fairly represent the person’s business activity in the
state; or (4) the employment of any other method to effectuate an
equitable allocation and apportionment of the person’s income.8
Discussion
In Taxpayer’s case, the standard apportionment formula does not fairly
represent the market for its business income, which includes royalties
earned from the licensing of intangible personal property. Taxpayer is
petitioning for an equitable allocation and apportionment of its income
under 86 Ill. Admin. Code §100.3390(a)(4).
As stated above, Taxpayer was unable to include in its sales factor
royalties earned from licensing the use of intangible personal property
primarily consisting of royalties paid by foreign affiliates through licensing
arrangements for the intangibles owned by COMPANY2 and its U.S.
subsidiaries included in the Illinois combined group. Taxpayer asserts that
the application of the standard single sales factor which excludes the
royalties from the sales factor is distortive and does not fairly represent the
market for the taxpayer’s business income.

See 86 Ill. Admin. Code §100.3390 (the “Regulation”).
86 Ill. Admin. Code §100.3390(e)(2).
8
86 Ill. Admin. Code §100.3390(a)(1)-(4).
6
7

COMPANY1
Page 6
September 21, 2023
For the fiscal years ending DATE - DATE, the royalties earned by
COMPANY2 and its subsidiaries included in the Illinois combined filing
group represents %%% of total gross income, while the net royalty income
represents %%% of Illinois combined unitary income. The royalties earned
by the Taxpayer are included in business income subject to formula
apportionment in Illinois. However, there is no representation of the
royalties in the sales factor because the royalties are excluded pursuant to
IITA 35 ILCS 5/304(a)(3)(B-2).
IITA 35 ILCS 5/304(a)(3)(B-2) provides as follows:
Gross receipts from the license, sale, or other disposition of patents,
copyrights, trademarks, and similar items of intangible personal
property, other than gross receipts governed by paragraph (B-7) of
this item (3), may be included in the numerator or denominator of the
sales factor only if gross receipts from licenses, sales, or other
disposition of such items comprise more than %%% of the taxpayer’s
total gross receipts included in gross income during the tax year and
during each of the 2 immediately preceding tax years; provided that,
when a taxpayer is a member of a unitary business group, such
determination shall be made on the basis of the gross receipts of the
entire unitary business group.
The standard apportionment formula allows gross receipts from the
licensing of intangible property (e.g., royalties) to be included in the sales
factor only if gross receipts from licensing of such items comprise more
than 50% of the taxpayer’s total gross receipts included in gross income
during the tax year and during each of the 2 immediately preceding tax
years. Because Taxpayer’s royalty income consists of only %%% of total
gross income, the royalty income is excluded from the sales factor. Note, if
Taxpayer’s royalty income was included in the sales factor, the gross
receipts would be sourced to Illinois if the income producing activity of
such income is performed in the state based on costs of performance.
Effective for tax years ending on or after December 31, 2008, gross
receipts from transactions involving intangible personal property when the
taxpayer is not a dealer with respect to the intangible personal property,
are attributed to Illinois if the income producing activity is performed in the
state, based on costs of performance.9 Such gross receipts are sourced in
Illinois when the income producing activities are performed both in and
outside the state and, based on costs of performance, a greater proportion
of the income producing activity is performed in Illinois than in any other
state.10
9

86 Ill. Admin. Code §100.3370(c)(6).
86 Ill. Admin. Code §100.3370(c)(6)(C)(ii).

10

COMPANY1
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September 21, 2023
However, the standard apportionment formula was not created with
Taxpayer’s facts in mind. It does not consider the significant impact the
earned royalties represent of total business income. The net royalty
income represents %%% of the total combined business income for the
tax years ended DATE - DATE. Yet there is no connection between Illinois
and the foreign royalties, including from where they were paid and
received, as well as the income producing activity which takes place
outside of Illinois. Furthermore, including the foreign royalties in the sales
factor results in relief from the disparate taxation of extraterritorial income
(i.e., the foreign royalties) earned from the Taxpayer’s unitary business
and paid by unitary foreign affiliates. Without such relief, the statutory
formula operates unreasonably and arbitrarily in attributing income to
Illinois when the royalties have no representation in the sales factor as
further discussed below.
Moreover, the profit margin on the royalty income, representing branded
consumer product sales outside of the United States, is significantly higher
than the profit margin earned on the other sales earned by the Taxpayer.
In aggregate for fiscal years ending DATE – DATE, the average profit
margin for royalty income was %%%. In contrast, the average profit
margin earned by the Taxpayer’s other income was %%% for fiscal years
ending DATE – DATE. This further supports that there is a grossly
distorted result when the royalties have no representation in the sales
factor, while the profit margin for the royalties is approximately %%%% to
%%%% higher than the profit margin earned by the Taxpayer’s other
income.
In Colgate-Palmolive Company, Inc. (“Colgate-Palmolive”) v. Bower, No.
01 L 50195 (10/15/2002) (“Colgate”), the Cook County Judicial Circuit
Court held that a Delaware corporation that had business operations in
Illinois was not allowed to modify the standard apportionment formula (the
three-factor formula method). Colgate-Palmolive filed for alternative
apportionment to add a fourth intangible property factor to the Illinois
three-factor formula to fairly represent foreign royalties and dividends from
foreign subsidiaries. The Administrative Law Judge ruled that ColgatePalmolive failed to meet its burden of establishing that the standard
formula failed to “fairly represent the extent” of Colgate-Palmolive’s
business in Illinois.11 The court found that “ ... each part of Illinois’ statutory
three factor formula takes into account the ordinary income producing
activities and expenses related to Colgate-Palmolive’s production of the

11

Colgate.

COMPANY1
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September 21, 2023
income at issue, as well as the fact the income producing activities related
to the particular income at issue were not performed within Illinois.”12
In reaching the decision that Colgate-Palmolive failed to meet its burden,
the court reasoned that all three factors had representation of the activities
associated with the foreign royalties and dividends from foreign
subsidiaries. Specifically, the sales factor included the dividends from
foreign corporations and royalty income earned from licensing intangible
personal property to foreign subsidiaries. Regarding the royalty income in
particular, the sales factor was specifically designed to take into account
where the costs of performance related to a taxpayer’s licensing or other
disposition of business intangibles occurred, in order to apportion the
receipts realized by such activities in the ordinary course of the taxpayer
business. 35 ILCS 5/304(a)(3), 5/1501(21); 86 Ill. Admin. Code
§100.3370(a), (b).13
It should be noted that the foreign royalties and dividends from foreign
subsidiaries earned by Colgate-Palmolive were included in the sales factor
despite the fact that they did not comprise more than 50% of the total
gross receipts of the taxpayer.14
The court’s reasoning in Colgate can be applied in the Taxpayer’s case. In
contrast to Colgate, the standard apportionment formula today fails to
represent the market for the royalty income in the Taxpayer’s case
because the royalties earned from licensing of intangible property are
excluded from the sales factor (i.e., the royalties do not comprise more
than 50% of Taxpayer’s gross income). The lack of inclusion in the factor
fails to take into account the ordinary income producing activities and
expenses related to Taxpayer’s royalty income (i.e., no factor
representation), as well as the fact the income producing activities related
to the particular income at issue were not performed in Illinois. Further,
Illinois administrative code specifies that income shall be included in the
denominator (and numerator) of the sales factor when the income
producing activity relative to the sourcing of business income from
intangible personal property can be readily identified, such as in the
Taxpayer’s case.15
Other State Alternative Apportionment Decisions
12

Id.
Id.
14
The facts of the Colgate decision detail that Colgate-Palmolive reported net sales of $2,085,271,427 on
Line 1 of its 1990 Federal return, while Colgate-Palmolive received $247,818,837 in royalty and dividend
income. Accordingly, the royalty and dividend income represented approximately 10.62% of the
summation of Line 1 of its 1990 Federal return and the royalty and dividend income earned in 1990.
15
86 Ill. Admin. Code §100.3380(c)(3).
13

COMPANY1
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September 21, 2023
In Crocker Equipment Leasing, Inc. (“Crocker”) v. Department of Revenue,
No. 2973, 12 OTR 16 (1992), the Court found that the taxpayer’s
alternative formula was a reasonable method of attributing income to the
state. The three-factor apportionment formula used by the Department of
Revenue to apportion the Oregon business income of the subsidiary of a
U.S. chartered national bank for corporate excise tax purposes did not
fairly represent the extent of the
corporation’s business activity in Oregon, because the calculation did not
include intangible property in the property factor. Crocker maintained that
98 percent of its earning assets were intangible, so the property must be
included in the factor to avoid distortion. The court found that the
taxpayer’s methodology was reasonable, as it established a “realistic
relationship to how the income is earned.”
The court’s reasons can be applied to the Taxpayer’s case. Including
royalties in the sales factor realistically represents the relationship
between licensing of intangible property and the income earned from sale
of those consumer goods. By not including the royalties, the
apportionment formula does not reasonably represent the Taxpayer’s
activities in Illinois. Stated differently, similar to Crocker, the inclusion of
the royalties in the sales factor establishes a realistic
relationship to how the Taxpayer earns its income, because the royalties
represent the income earned from branded consumer product sales
worldwide by unitary foreign affiliates as a result of the use of the same
intangible property for the sale of branded consumer goods in the United
States.
In Twentieth Century-Fox Film Corp. (“Twentieth Century Fox”) v.
Department of Revenue, 299 Or. 220, 700 P.2d 1035 (1985), Twentieth
Century Fox used the statutory three-factor formula for apportionment of
income to Oregon. The taxpayer included in the numerator of the property
factor only the cost of the positive prints of its films, which were the only
tangible personal property distributed in Oregon. Film negatives, which
were not included in the numerator, are valued at the cost of producing the
film, making them quite valuable. The court determined that it was unfair
to merely include the value of the positive prints and ignore the negatives,
because it ignored the economic reality of the film industry. The Oregon
Department of Revenue modified the property factor by including the value
of the film negatives in the value of the positive prints.
The court’s reasoning can also be applied to the Taxpayer’s case. In order
to convey the economic reality of the Taxpayer’s business, the sales factor
needs to include activity from both the sales of tangible property property
and royalties received from licensing of intangible property. The income
generated by the licensing of intangible property is effectively a portion of

COMPANY1
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September 21, 2023
the sales of consumer goods, because the royalty income is based on a
percentage of the sales of branded consumer goods by certain unitary
foreign affiliates. It is unreasonable to exclude the royalties related to the
sale of branded consumer goods by the unitary foreign affiliates that is
earned as a percentage royalty, just as it was unreasonable to exclude the
negative prints from apportionment for Twentieth Century Fox.
While the Twentieth Century Fox case may be an industry related issue,
the Taxpayer has an economic reality that differs from most other
companies within its industry. The Taxpayer generates a significant
amount of revenue from foreign royalties as a result of their brand strategy
and recognition and generates substantial revenue from royalties which
have no representation in the sales factor. By subjecting the Taxpayer to
an apportionment formula excluding one of their major revenue producing
activities, there is gross distortion in the amount of income apportioned to
Illinois and it is not representative of the Illinois market.
In Atlantic Richfield Co. (“Atlantic Richfield”) v. Alaska, 705 P.2d 418
(Alaska 1985) (“Atlantic Richfield”), as addressed in the GIL, the Alaska
supreme court wrote that:
A unique characteristic of unitary oil and gas businesses is that the
major income-producing element is the value of the oil and gas
reserves in the ground. While this element can be readily identified,
it is not recognized under traditional formula apportionment
methods. *** [S]eparate accounting, not formula apportionment, is
the prevailing method throughout the United States for reporting
income for oil production.16
The case of Atlantic Richfield shows that failure to reflect income that is
prevalent and a major income producing element to a company is
distortive. Atlantic Richfield’s major income producing element was their
gas and oil reserves, which was not recognized using traditional
apportionment methods. In the instant case, Taxpayer’s major incomeproducing element is the use of the intangible property related to the
business’s branded consumer product sales. The intangible property is
used by the Taxpayer to earn revenue from the selling of branded
consumer goods inside and outside of the United States. The character of
the gross receipt from the consumer goods sold inside the United States
represents the sale of tangible personal property, while the character of
the gross receipts from the consumer goods sold outside the United
States is royalty income. Both gross receipt characters must be included
in the sales factor in order for the sales factor to fairly and accurately
16

Atlantic Richfield Co., 705 P.2d at 418, 426.

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reflect the Taxpayer’s major income-producing element (i.e., the sale of
consumer goods). Again, without their intangibles, COMPANY2 would not
have the ability to produce and sell its consumer branded products. The
intangible property related to their brands is a central part of their business
model, which relies on the success of existing brands as well as creation
of new products and brands. COMPANY2 attributes their financial success
directly with the success of their brands.17
In Appeal of Crisa Corporation, 2002-SBE-004 (6/20/02), California State
Board of Equalization (“SBE”) found the taxpayer’s numerical comparisons
standing alone are not sufficient to prove distortion and the taxpayer’s
request was ultimately denied. The SBE ruled that the central question
related to alternative apportionment is not whether there is a large enough
numerical distortive change, but rather whether there are unusual facts
that lead to unfair representation under the standard apportionment factor.
They provided five examples of “unusual transactions” that could trigger
application of alternative apportionment, one of which reading as follows:
A particular factor does not have material representation in either
the numerator or denominator, rendering that factor useless as a
means of reflecting business activity. For example, because a
company does not own or rent any tangible or real personal
property, the numerator and denominator of the property factor are
zero. (See Appeal of Oscar Enterprises, LTD, 87-SBE-069, Oct. 6,
1987.)
This example of an “unusual transaction” can be applied to Taxpayer’s
activity in Illinois. The royalty revenues represent a significant portion of
the profitability of the Taxpayer, but are not represented in the sales factor
numerator or denominator. When looking at profit margin, the margin
earned on royalty revenues is approximately %%% to %%% higher than
the profit margin earned on other gross income of the Taxpayer for fiscal
years ending YEAR - YEAR. However, only the other gross income
earned by the Taxpayer is represented in the statutory sales formula
resulting in a material misrepresentation. Furthermore, the exclusion of the
royalties from the sales factor leads to unfair representation under the
standard apportionment factor because the sales factor is not representing
all of the income earned from the Taxpayer’s intangible property in
connection with the sale of branded consumer products as described
above.
In Microsoft Corp. (“Microsoft”) v. Franchise Tax Board, 39 Ca. 4th 750,
771 (2006) (“Microsoft Corp.”), the court found that treasury receipts were
17

COMPANY2, Annual Report (Form 10-K) (June 30, 2021).

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distortive where the receipts generated less than 2 percent of Microsoft’s
income but 73 percent of its gross receipts.18 However, the court also
noted that the FTB’s approach of removing large receipts can result in an
exaggeration of California tax when the receipts account for a substantial
portion of the taxpayer’s income.19 Specifically, the court stated:
We caution, however, that in other cases the Board’s approach
may go too far in the opposite direction and fail the test of
reasonableness. By mixing net receipts for a particular set of out-ofstate transactions with gross receipts for all other transactions, it
minimizes the contribution of those out-of-state transactions to the
taxpayer’s income and exaggerates the resulting California tax. If,
unlike here, treasury operations provide a substantial portion of a
taxpayer’s income, this exaggeration may result in an
apportionment that does not fairly represent California business
activity.20
The situation that Microsoft Corp. warned of is present in this case. The
royalty income at issue “provide[s] a substantial portion of a taxpayer’s
income.” As discussed above, Taxpayer’s net royalty income represents
%%% of the Taxpayer’s combined business income for the tax years
ended DATE – DATE. Further, as stated above, the royalties have a much
higher profit margin than other gross income earned by the Taxpayer. The
royalty income gets no factor representation but contributes an aggregate
average %%% profit margin towards apportionable income. The
aggregate average profit margin for other gross income earned by the
Taxpayer is only %%%.
This is not a situation where including the royalty income defeats the
purpose of the sales factor to reflect the market for Taxpayer’s activities,
which is the intended purpose of the special apportionment rule to exclude
certain revenues earned from licensing of intangible property as required
under IITA 35 ILCS 5/304(a)(3)(B-2). In this case, including the royalty
income in the sales factor properly represents the “market” for Illinois.
Otherwise, the exclusion of the royalty income from the sales factor
exaggerates Illinois tax and does not fairly represent Taxpayer’s unitary
business income in Illinois.
Conclusion
Based on the above, Taxpayer requests a deviation from the Illinois’
statutory apportionment method as it relates to the royalty earned from
18

Microsoft Corp., 39 Cal. 4th at 771.
Id.
20
Id.
19

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licensing of intangible personal property because the application of
Illinois’s tax apportionment formula produces a tax that fails to represent
the activities or market in Illinois. As a result of this distortion, Taxpayer
requests the use of an
alternative method to fairly represent the market for Taxpayer’s business
income by including its royalty income on Schedule UB Step 4, Line 2 “net
sales everywhere” in the amount of $$,$$$,$$$,$$$.
Alternative Position
In the event that the Department challenges or denies the Taxpayer’s
alternative apportionment position and refund request, the Taxpayer also
requests the Department consider and apply another method to effectuate
an equitable allocation and apportionment of Taxpayer’s royalties.
Another method is the use of separate accounting to apportion the
Taxpayer’s royalties separate and apart from all other activity. Using
separate accounting, Taxpayer’s apportionment will fairly represent
Taxpayer’s activity in Illinois, as it will no longer be skewed by the
inclusion of the royalties which are not fairly reflected in the apportionment
formula.
Finally, yet another method to use is to include as members of the Illinois
combined group all of the 80/20 companies that are excluded from the
combined group under IITA 35 ILCS 5/1501(a)(27)(A) that are paying the
royalties to the Taxpayer. The inclusion of the 80/20 companies would
serve to include the business income of the foreign corporations, as well
as include the sales of such corporations into the apportionment formula.
This method will also
fairly represent Taxpayer’s activity in Illinois as it would have matching
representation between business income and sales in the sales factor.
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.

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For taxable years ending on or after December 31, 1999, IITA Section
304(a)(3)(B-2) provides that gross receipts from the license, sale, or other
disposition of patents, copyrights, trademarks, and similar items of intangible
personal property may be included in the sales factor only if gross receipts from
the license, sale, or other disposition of such items comprise more than 50% of
the taxpayer’s total gross receipts included in gross income during the tax year
and during each of the two immediately preceding tax years, and provided that
when a taxpayer is a member of a unitary business group, such determination
shall be made on the basis of the gross receipts of the entire unitary business
group. If not excluded from the sales factor under the 50% B-2 test, these
receipts are sourced to Illinois according to IITA Section 304(a)(3)(B-1).
Section 304(f) of the IITA 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, 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.
86 Ill. Adm. Code Section 100.3380(a)(2) provides:
The Director has determined that, in the instances described in this
Section, the apportionment provisions provided in IITA Section 304(a)
through (e) and (h) do not fairly represent the extent of a person’s
business activity or market within Illinois. For tax years beginning on or
after the effective date of a rulemaking amending this Section to prescribe
a specific method of apportioning business income, all nonresident
taxpayers shall apportion their business income employing that method in
order to properly apportion their business income to Illinois. Taxpayers
whose business activity or market within Illinois is not fairly represented by
a method prescribed in this Section and who want to use another method
for a tax year beginning after the effective date of the rulemaking adopting
that method may obtain permission to use that other method by filing a

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petition under Section 100.3390. For tax years beginning prior to the
effective date of the rulemaking adopting a method of apportioning
business income, the Department will not require a taxpayer to adopt that
method; provided, however, if any taxpayer has used that method for any
of those tax years, the taxpayer must continue to use that method for that
tax year. Moreover, a taxpayer may file a petition under Section 100.3390
to use a method of apportionment prescribed in this Section for any open
tax year beginning prior to the effective date of the rulemaking adopting
that method, and that petition shall be granted in the absence of facts
showing that that method will not fairly represent the extent of a person’s
business activity or market in Illinois.
Taxpayers who wish to use an alternative method of apportionment under these
provisions are required to file a petition complying with the requirements of 86 Ill.
Adm. Code Section 100.3390. Subsection (c) of that regulation provides:
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).
Your petition for alternative apportionment indicates that gross receipts from the
foreign royalties are not more than 50% of COMPANY1 total gross receipts for
the tax year ended YEAR, and are therefore excluded from the sales factor under

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IITA Section 304(a)(3)(B-2). Your petition asserts that the royalties earned by
COMPANY1 are included in business income subject to formula apportionment
in Illinois but the failure to include such receipts in the sales factor results in an
Illinois tax liability that is distortive and does not fairly represent the market for
COMPANY1 business income in the State. The primary basis for this assertion
is that for fiscal years ending DATE – DATE, the statutory apportionment formula
fails to take into account that the gross receipts from the foreign royalties earned
by COMPANY1 represents %%% of total gross income, while the net royalty
income represents %%% of Illinois combined unitary income. In addition, you
state there is a grossly distorted result when the royalties have no representation
in the sales factor but the profit margin for the royalties is approximately %%%%

• %%%% higher than the profit margin earned by the Taxpayer’s other income.
  The facts stated in your petition are not sufficient to satisfy the burden set forth in
  Ill. Adm. Code Section 100.3390(c). As indicated above, for taxable years
  ending on 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.
  In this case, your petition does not meet the regulatory requirement and cannot
  be granted at this time. Your request merely states that due to the statutory
  exclusion of foreign royalty from the sales factor pursuant to IITA Section
  304(a)(3)(B-2), an alternative apportionment formula would more accurately
  represent COMPANY1 market in Illinois. An alternative apportionment method
  may not be invoked, either by the Department or a by a taxpayer, merely
  because it reaches a different apportionment percentage than the required
  statutory formula.
  In this case, IITA Section 304(a)(3)(B-2) and 86 Ill. Adm. Code Section
  100.3370(a)(2)(F) provide that for taxable years ending on or after December 31,
  1999, gross receipts from the licensing, sale, or other disposition of a patent,
  copyright, trademark, or similar item of intangible personal property may be
  included in the sales factor only if gross receipts from licenses, sales, or other
  dispositions of these items comprise more than 50% of the taxpayer’s total gross
  receipts included in gross income during the tax year and during each of the two
  immediately preceding tax years. Exclusion of such receipts from the sales factor
  thereby prevents distortion of the sales factor that would otherwise occur.
  Section 304(f) relief is proper where the income allocated to the State by the
  otherwise applicable statutory formula is unfairly disproportionate to the business
  activity conducted in the State. There is nothing inherently distortive or unfair in
  excluding from the sales factor those royalties that do not comprise more than
  50% of gross income gross receipts from royalties earned from the licensing of
  intangible property based on the activities of the taxpayer. See also Vectren
  Infrastructure Services Corp., successor in interest to Minnesota Limited, Inc., v.

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Department of Treasury, Mich. Sup. Ct., No. 163742 (July 31, 2023). In that
case, the Michigan Supreme Court held that the inclusion of income from an
asset sale in the tax base apportionment under the Michigan Business Tax Act
did not violate the Due Process Clause nor the Commerce Clause, and that the
taxpayer failed to prove the statutory apportionment formula, excluding the sale
of assets from the sales factor, created a grossly disproportionate result when
applied to this one-time asset sale.
“ML and Justice Zahra’s dissent further argue that removing the value of
the asset sale from the denominator of the sales factor leads to gross
distortion because, without it, the sales factor fails to adequately consider
how the income was generated. This is nothing more than a gripe about
which factors are or are not included in the formula, and it is unpersuasive.
Whether a one- or three-factor test is used (or any other number of
factors), litigants have consistently unsuccessfully argued exactly what ML
argues here—that a different combination is required. Just as the courts
in Moorman, Kraft, Container Corp, and Trinova II rejected these endless
propositions of different proportionality factor combinations, so too do we.
Michigan chose a single-factor modifier based upon sales generated
within the state. Courts have routinely upheld the use of both a salesfactor modifier and other single-factor modifiers. The same courts have
also upheld the end result even when the difference using an alternative
modifier would have resulted in a much lower tax bill.”
In addition, your proposed alternative methods fail to demonstrate that the
statutory method would lead to a 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 Corp. 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). Merely
indicating separate accounting would effectuate equitable allocation and
apportionment of COMPANY1royalties, without any explanation of why these
methods are more accurate than formulary apportionment, is insufficient to meet
the burden of proof imposed by 86 Ill. Adm. Code Section 100.3390(c) on
taxpayers requesting permission to use an alternative method of apportionment.
As a unitary business enterprise, there are intercompany transactions that are
not reflected in your calculations. Separating companies from their unitary group
often creates more distortions due to intercompany pricing issues.
This conclusion is also warranted by a review of Illinois cases involving a
taxpayer’s request to invoke an alternative apportionment method pursuant to
IITA Section 304(f). For example, in Miami Corp. v. Dep’t of Rev., which you cite
as an authority in support of your petition to use an alternative formula, the Illinois
appellate court affirmed the circuit court’s decision that the Illinois three-factor

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formula, as applied by the Department in that case, grossly distorted the amount
of income to be apportioned to Illinois. The facts of that case, however, are
distinguishable from the facts presented in your petition, and distinguishable in a
way that warrants a different result. The primary difference is the fact that the
intangible income at issue in Miami Corp. arose from the taxpayer’s ownership of
real estate situated in other states, and the fact that Miami Corp. had no such
intangible property rights regarding land owned in Illinois. Both the appellate and
the trial court in Miami Corp. relied to a great degree on the reasoning of the
Alaska supreme court in Atlantic Richfield Co. v. Alaska, 705 P.2d 418 (Alaska
1985) app. dism’d, 474 U.S. 1043, 106 S.Ct. 74, 88 L.ed.2d 754 (1985).
Specifically, the Alaska supreme court wrote that:
A unique characteristic of unitary oil and gas businesses is that the major
income-producing element is the value of the oil and gas reserves in the
ground. While this element can be readily identified, it is not recognized
under traditional formula apportionment methods. *** [S]eparate
accounting, not formula apportionment, is the prevailing method
throughout the United States for reporting income for oil production.
Atlantic Richfield Co., 705 P.2d at 418, 426.
Furthermore, the statutory apportionment formula has since changed from threefactor apportionment formula (property, payroll, and sales) to a one factor
formula (sales). The intangibles at issue here are not like the intangible rights
that ran with the land in Miami Corp.
Accordingly, your petition for alternative apportionment for tax year ended DATE,
and for prospective tax years ending on or after DATE, cannot be granted.
However, if you have additional information related to this request that was not
previously submitted, you may supplement your petition and we will reconsider
your request. Please note that 86 Ill. Adm. Code Section 100.3390(e)(1) requires
a petition to be filed at least 120 days prior to the due date (including extensions)
for the first return for which permission is sought to use the alternative
apportionment method.
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,

Jennifer Uhles
Associate Counsel (Income Tax)