86 Ill. Adm. Code 100.3380 — Special Rules (IITA Section 304)

# Special Rules (IITA Section 304)

TITLE 86: REVENUE CHAPTER I: DEPARTMENT OF REVENUE PART 100 INCOME TAX SECTION 100.3380 SPECIAL RULES (IITA SECTION 304)

Section 100.3380 Special Rules (IITA Section 304)

a) Determining Business Activity or Market Within Illinois 1) Petition IITA Section 304(f) provides that, if the allocation and apportionment provisions of Section 304(a) through (e) and (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 do not, 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 require, in respect of all or any part of the person's business activity, if reasonable:

A) Separate accounting;

B) The exclusion of any one or more factors;

C) The inclusion of one or more additional factors that will fairly represent the person's business activities or market in this State; or D) The employment of any other method to effectuate an equitable allocation and apportionment of the person's business income. 2) Director's Determination 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 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.

b) Property Factor. The following special rules are established in respect to the property factor in IITA Section 304(a)(1): 1) If the subrents taken into account in determining the net annual rental rate under Section 100.3350(c) produce a negative or clearly inaccurate value for any item of property, another method that will properly reflect the value of rented property may be required by the Director or requested by the person. In no case, however, shall the value be less than an amount that bears the same ratio to the annual rental rate paid by the person for the property as the fair market value of that portion of the property used by the person bears to the total fair market value of the rented property. EXAMPLE: A corporation rents a 10-story building at an annual rental rate of $1,000,000. The corporation occupies two stories and sublets eight stories for $1,000,000 a year. The net annual rental rate of the taxpayer is at least two-tenths of the corporation annual rental rate for the entire year, or $200,000. 2) If property owned by others is used by the person at no charge or rented by the person for a nominal rate, the net annual rental rate for the property shall be determined on the basis of a reasonable market rental rate for that property.

c) Sales Factor. The following special rules are established in respect to the sales factor in IITA Section 304(a)(3):

1) For taxable years ending before December 31, 2008, in the case of sales in which neither the origin nor the destination of the sale is within this State, and the person is taxable in neither the state of origin nor the state of destination, the sale shall be attributed to this State (and included in the numerator of the sales factor) if the person's activities in this State in connection with the sales are not protected by the provisions of P.L. 86-272, 15 U.S.C. 381-385. Although P.L. 86-272, by its terms covers only sales of tangible personal property, its rules regarding a state's power to impose a net income tax, for purposes of this special rule, will be applied whether or not the sale is of tangible or intangible property. This subsection (c)(1) does not apply in taxable years ending on or after December 31, 2008, because attributing the sale to this State is not required by IITA Section 304(a)(3) and does not fairly represent the market for the person's goods, services, or other sources of business income in this State. Notwithstanding the provisions of subsection (a)(2), taxpayers are not required to file a petition under Section 100.3390 requesting permission to file an original or amended return for any tax year ending on or after December 31, 2008 that does not apply the special rule in this subsection (c)(1). EXAMPLE: A corporation's salesman operates out of an office in Illinois. He regularly calls on customers both within and without Illinois. Orders are approved by him and transmitted to the corporation's headquarters in State A. For taxable years ending before December 31, 2008, if the property sold by the salesman is shipped from a state in which the corporation is not taxable to a purchaser in a state in which the corporation is not taxable, the sale is attributable to Illinois.

2) 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 shall be excluded. Gross receipts from an incidental or occasional sale of stock in a subsidiary shall 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 shall 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.

3) When the income producing activity relevant to the sourcing of business income from intangible personal property can be readily identified, that income shall be included in the denominator of the sales factor and, if the income producing activity occurs in this State, in the numerator of the sales factor as well. For example, with respect to taxable years ending before December 31, 2008, usually the income producing activity can be readily identified in respect to interest income received on deferred payments on sales of tangible property (see Section 100.3370(a)(1)(A)).

4) When business income from intangible property is sourced according to the income producing activity, and the income cannot readily be attributed to any income producing activity of the person, the income shall not be assigned to the numerator of the sales factor for any state and shall be excluded from the denominator of the sales factor. The following provisions illustrate this concept:

A) Subpart F (IRC sections 951 through 964) income is passive income generated by the mere holding of an intangible. For taxable years ending on or after December 31, 1995, subpart F income is excluded from the sales factor under IITA Section 304(a)(3)(D). For prior taxable years, there is a rebuttable presumption that subpart F income is not includable in either the numerator or the denominator of the sales factor. If a taxpayer wishes to include subpart F income in either the numerator or the denominator of the sales factor, the burden of proof is on the taxpayer to identify the income producing activities and to situs those activities within a particular state; or B) When business income in the form of dividends received on stock during taxable years ending before December 31, 1995, or interest received on bonds, debentures or government securities results from the mere holding of intangible personal property by the person, those dividends and interest shall be excluded from the denominator of the sales factor.

5) In the case of sales in the regular course of business of intangibles (including, by means of example, without limitation, patents, copyrights, bonds, stocks and other securities), gross receipts shall be disregarded and only the net gain (loss) shall be included in the sales factor, provided that, for taxable years ending on or after December 31, 2008, only net gains shall be included in the sales factor for sales sourced under IITA Section 304(a)(3)(C-5)(iii). EXAMPLE: In 1990, Corporation A, a calendar year taxpayer, sells stock with an adjusted basis of $98,000,000 for $100,000,000, realizing a federal net capital gain of $2,000,000. Only the net capital gain of $2,000,000 shall be reflected in A's sales factor for the taxable year ending December 31, 1990.

6) Hedging Transactions A) A "hedging transaction" is a transaction entered into by a taxpayer in the normal course of business primarily to manage interest rate risk or the risk of price or currency fluctuations. (See IRC sections 475(c)(3), 1221(b)(2)(A) and 1256(e)(2).) The purpose of the sales factor in IITA Section 304(a) is to apportion the business income of a taxpayer conducting an interstate business to this State based on this State's relative share of the marketplace for the goods and services sold by the taxpayer in the course of its business. Gains and losses on hedging transactions entered into to manage the risks associated with the acquisition of resources by a taxpayer (for example, price fluctuations in commodities consumed in the taxpayer's business) do not reflect the market for the taxpayer's goods and services and, therefore, shall be excluded from the sales factor. Gains and losses on hedging transactions entered into to manage risks associated with the gross income the taxpayer expects from its sales of goods and services (for example, the effect of foreign currency fluctuations on the dollar amount of gross income the taxpayer will receive from sales to a particular foreign country) are best accounted for in the sales factor as adjustments to the gross receipts from the transactions whose risks are being hedged. Gains and losses on hedging transactions that manage risks associated with both acquisitions and sales of the taxpayer (for example, electricity futures bought or sold by a taxpayer engaged in the business of buying and selling electrical power), or that otherwise cannot be associated with a particular transaction or class of transactions in the computation of the sales factor, should be excluded from the sales factor. Federal income tax law provides a framework for identifying gains and losses from hedging transactions to the transactions or class of transactions being hedged and for keeping records necessary to support the identifications. The federal practice should be followed for State purposes.

B) General Rule. Except as provided in subsection (c)(6)(C), any income, gain or loss from a transaction properly identified as a hedge under IRC section 1221(b)(2)(A), 475(c)(3) or 1256(e)(2) shall be excluded from the numerator and denominator of the sales factor.

C) Special Rule. With respect to any hedging transaction described in subsection (c)(6)(B) as to which identification requirements of subsection (c)(6)(D) are satisfied, any income, gain or loss from the hedging transaction shall be included in the denominator of the sales factor if the gross receipts from the hedged item are included in the denominator. That income, gain or loss shall be included in the numerator of the sales factor if the gross receipts from the hedged item are included in the numerator of the sales factor, and excluded from the numerator of the sales factor if the gross receipts from the hedged item are excluded from the numerator of the sales factor. If the hedging transaction relates to an identified group of hedged items, the income, gain or loss from the hedging transaction shall be included in the numerator of the sales factor in the same proportion that the gross receipts from the group of hedged items are included in the numerator of the sales factor.

D) Identification Required. The identification requirements of this subsection (c)(6)(D) are met if the taxpayer's books and records clearly identify a hedging transaction as managing risk relating to a particular item or items of gross receipts, including anticipated items of gross receipts, that must be included in the sales factor. The identification requirements are met only if identification is made at the time and in the manner required under IRC section 475(c)(3), 26 CFR 1.1221-2(f) and (g), or 26 CFR 1.1256(e)-1 and the taxpayer's books and records include the information necessary to apply subsection (c)(6)(C).

E) This subsection (c)(6) does not apply to any hedging transaction that, for federal income tax purposes, is integrated with the hedged item, such as under 26 CFR 1.988-5 or 1.1275-6. In addition, for purposes of this subsection (c)(6): i) a transaction entered into by one member of a federal consolidated group identified as a hedge against a risk of another member of the federal consolidated group under the "single-entity approach" in 26 CFR 1.1221-2(e)(1) is not a hedging transaction if the two members of the federal consolidated group are not members of the same unitary business group, because the transaction is not hedging against a risk faced by the taxpayer entering into the transaction; and ii) a transaction entered into by one member of a unitary business group with another member of the unitary business group is not a hedging transaction, because the risk remains within the group, except in the case of a transaction identified under 26 CFR 1.1221-2(f) or (g) as a hedging transaction between two member of a unitary business group who are also members of a federal consolidated group that has made the "separate entity election" in 26 CFR 1.1221-2(e)(2) with regard to hedging transactions.

F) The provisions of this subsection (c)(6) are illustrated by the following examples: EXAMPLE 1: Taxpayer expects that, during its next production cycle, it will need 10 tons of commodity Y for its interstate manufacturing business. Commodity Y is a raw material used by Taxpayer in the manufacture of its inventory. In order to hedge against exposure to changes in the price of commodity Y, Taxpayer enters into a forward contract to purchase 10 tons of commodity Y. The forward contract is identified as a hedging transaction under IRC section 1221(b)(2)(A). Under subsection (c)(6)(B), any income, gain or loss recognized with respect to the forward contract shall be excluded from the numerator and denominator of the sales factor. EXAMPLE 2: On January 1, 2008, Taxpayer owns 10 tons of commodity X, which it holds for sale in the ordinary course of business and expects to sell during its taxable year ending December 31, 2008. To hedge against price fluctuations in commodity X, on January 10, 2008, while Taxpayer still owns commodity X, it sells the equivalent of 10 tons of commodity X futures contracts on a futures exchange. Taxpayer expects to sell commodity X to customers in various states, including Illinois. The futures contract is identified as a hedging transaction under IRC section 1221(b)(2)(A), and Taxpayer properly identifies the futures contract as required under subsection (c)(6)(D) as hedging gross receipts from sales of commodity X. Under subsection (c)(6)(C), any gain or loss taken into account by Taxpayer during its taxable year with respect to the futures contract shall be included in the denominator of the sales factor, and included in the numerator of the sales factor in the same proportion that gross receipts from actual sales of commodity X during the taxable year are included in the numerator of the sales factor. If a loss is recognized on the futures contract, the loss is treated as a reduction (but not below zero) of the gross receipts from the sale of commodity X in computing the sales factor. EXAMPLE 3: Taxpayer is a corporation on the accrual method of accounting with the U.S. dollar as its functional currency. On January 1, 2008, Taxpayer acquires 1,500 British pounds (£) for $2,250 (£1 = $1.50). The acquisition of £1,500 is properly identified by Taxpayer as a hedging transaction under IRC section 1221(b)(2)(A). On February 5, 2008, when the spot rate is £1 = $1.55, Taxpayer purchases inventory from its supplier by paying £1,500. Accordingly, Taxpayer recognizes $75 exchange gain for federal income tax purposes upon disposition of the British pounds. The $75 exchange gain shall be excluded from both the numerator and denominator of the sales factor under subsection (c)(6)(B). EXAMPLE 4: Taxpayer is a calendar year corporation with the U.S. dollar as its functional currency. Based on past experience, Taxpayer anticipates making 2009 first quarter sales to customers in New Zealand of 100,000 New Zealand dollars (NZD). In order to hedge against currency fluctuations related to the anticipated first quarter sales, on December 31, 2008, Taxpayer enters into a forward contract to sell 100,000 NZD on March 31, 2009 for $48,000. The forward contract is identified as a hedging transaction under IRC section 1221(b)(2)(A), and the Taxpayer properly identifies the transaction as hedging its anticipated New Zealand sales in accordance with subsection (c)(6)(D). During the first quarter of its 2009 taxable year, Taxpayer makes sales to its New Zealand customers of 90,000 NZD. Under IITA Section 304(a), gross receipts from its New Zealand sales shall be included in the denominator of the Taxpayer's sales factor and excluded from the numerator of the sales factor. Under subsection (c)(6)(C), any gain or loss recognized on the forward contract shall be included in the denominator of the Taxpayer's sales factor and excluded from the numerator of the factor. This treatment is appropriate even though the Taxpayer's sales to New Zealand customers were less than anticipated. Any loss recognized on the forward contract shall be treated as a reduction (but not below zero) of the gross receipts from sales to New Zealand customers that are included in the denominator of the sales factor.

7) Section 988 Transactions A) Section 988 Transactions. For sales factor purposes, foreign currency gain or loss that shall be computed under IRC section 988, with respect to accrued interest income or expense, gain or loss on a debt instrument, a payable, a receivable or a forward contract payable in a foreign currency described in 26 CFR 1.988-1(a)(2) shall be treated as an adjustment to the income, expense, gain or loss. Accordingly, the foreign currency gain or loss shall be included in the numerator and denominator of the sales factor only to the extent that the income to which the foreign currency gain or loss relates is included in the numerator and denominator of the sales factor. Foreign currency gains and losses with respect to expense shall be excluded from the numerator and denominator of the sales factor. The provisions of this subsection (c)(7)(A) are illustrated by the following examples: EXAMPLE 1: Taxpayer is a corporation on the accrual method of accounting with the U.S. dollar as its functional currency. On January 1, 2008, Taxpayer converts $13,000 to 10,000 British pounds (₤) at the spot rate of ₤1 = $1.30 and loans the ₤10,000 to Y for 3 years. The terms of the loan provide that Y will make interest payments of ₤1,000 on December 31 of 2008, 2009 and 2010 and will repay Taxpayer's ₤10,000 principal on December 31, 2010. Based on average spot rates for 2008, 2009 and 2010 of ₤1 = $1.32, ₤1 = $1.37 and ₤1 = $1.42, respectively, Taxpayer accrues interest income of $1,320 for 2008, $1,370 for 2009, and $1,420 for 2010. Under IITA Section 304(a), the accrued interest income shall be included in the denominator of Taxpayer's sales factor, but excluded from the numerator of its sales factor. Based on spot rates on December 31, 2008, December 31, 2009 and December 31, 2010 of ₤1 = $1.35, ₤1 = $1.40 and ₤1 = $1.45, respectively, Taxpayer recognizes for federal income tax purposes exchange gain of $30 upon receipt of the interest on December 31 of 2008, 2009 and 2010. In addition, Taxpayer recognizes, for federal income tax purposes, exchange gain of $1,500 upon repayment of the loan principal on December 31, 2010. Under subsection (c)(7)(A), the $30 of exchange gain recognized with respect to the accrued interest for 2008, 2009 and 2010 shall be included in the denominator of Taxpayer's sales factor and excluded from the numerator of its sales factor. The $1,500 of exchange gain with respect to the repayment of principal on December 31, 2010 shall be excluded from both the numerator and denominator of Taxpayer's sales factor because repayment of principal on a loan is not included in the sales factor. EXAMPLE 2: Taxpayer is a corporation on the accrual method of accounting with the U.S. dollar as its functional currency. On January 15, 2008, Taxpayer sells inventory for 10,000 Canadian dollars (C$). The spot rate on January 15, 2008 is C$1 = U.S. $.55. Under IITA Section 304(a), $5,500 in gross receipts from this sale shall be included in the denominator of Taxpayer's sales factor and excluded from the numerator of the sales factor. On February 23, 2008, when Taxpayer receives payment of the C$10,000, the spot rate is C$1 = U.S. $.50. For federal income tax purposes, Taxpayer recognizes ($500) of exchange loss upon receipt of C$10,000 on February 23, 2008. Under subsection (c)(7)(A), the ($500) exchange loss with respect to the January 15, 2008 sale shall be included in the denominator of the Taxpayer's sales factor and excluded from the numerator of the sales factor. The exchange loss is reflected as a reduction of the denominator of the Taxpayer's sales factor. B) Section 986(c)(1) Foreign Exchange Gain or Loss on Distributions of Previously Taxed Income. Foreign currency gain or loss recognized pursuant to IRC section 986(c)(1) on distributions of amounts previously taxed to the recipient as subpart F income or as earnings of a qualified electing fund shall be excluded from both the numerator and denominator of the sales factor because those distributions are excluded from federal gross income and, therefore, from the sales factor.

8) Vendor allowances. Retailers often enter into agreements with their vendors regarding the payment of certain allowances to induce sales. These vendor allowances fall into two distinct categories: buying allowances and merchandising allowances. A) Buying allowances. Rebates and other buying allowances generally are considered reductions to the cost of goods sold and, therefore, are excluded from the sales factor numerator and denominator. These may include, for example, a cash discount for prompt payment, a trade discount for a specified volume of purchase, markdown participation allowances to cover shortfalls in the sales price received by the retailer, defective or damaged merchandise allowances, and sales-based allowances for short-term promotions. The provisions of this subsection (c)(8)(A) are illustrated by the following examples: EXAMPLE 1: Retailer purchases 1,000 moccasins from vendor, who provides a margin guarantee of $17. The moccasins retail for $25 each. At the end of the season, the 20 remaining moccasins are marked down to $9. Vendor remits $160 to retailer, computed as follows: 20 X ($17-$9). The $160 does not constitute gross receipts includable in the sales factor, as it is a reduction to the cost of the moccasins. EXAMPLE 2: Retailer runs a promotion offering buy-one-get-one-half-off for Minty Toothpaste. Retailer and Vendor have an arrangement for vendor to provide a $0.75 discount for each item sold at a reduced price. Retailer sells 1,000 tubes of Minty Toothpaste during the promotional period. Vendor provides a $375 discount to Retailer for the items sold at a reduced price, computed as follows: 500 X $0.75. The $375 does not constitute gross receipts includable in the sales factor, as it is a reduction to the cost of Minty Toothpaste. B) Merchandising allowances. i) Merchandising allowances are part of the product’s selling price and may be reportable as gross income. Accordingly, merchandising allowances shall be included in the numerator and denominator of the sales factor to the extent that the merchandising allowances promote sales included in the numerator and denominator of the sales factor. The following are types of merchandising allowances: · Cooperative advertising, which is a sharing arrangement for the costs of advertising depicting the vendor’s products, such as a weekly circular; · Salary or payroll allowances, which are an incentive to provide more space or staff; and · Up-front cash payments and long-term agreements that compensate the retailer for a commitment to purchase a targeted volume of goods over a period of time. These are recorded as a liability when received and recognized as income when purchases are made. ii) The amount includable in the numerator shall be determined in one of the following manners, at the taxpayer’s election, consistently applied: · The ratio of the number of retail locations in Illinois over the total number of retail locations, or · The ratio of the gross receipts from retail locations in Illinois over the total gross receipts. EXAMPLE: Retailer W sells greeting cards for all occasions. Retailer W and Vendor Q have entered into an agreement under which Vendor Q pays Retailer W an allowance of $5 per hour to remove damaged cards and maintain the seasonal greeting card inventory. Retailer W’s employee spends 300 hours monitoring the inventory during the year, and Vendor Q pays Retailer W $1,500 ($5 times 300 hours). This income is considered gross receipts and must be included in the sales factor denominator. Retailer W has 15 stores in Illinois and 5 stores in Wisconsin, so $1,125 ($1,500 times 15/20) would be included in the sales factor numerator.

9) Cost sharing agreements. A) Payments received pursuant to a cost sharing agreement under Treasury Regulation 1.482-7 in exchange for intercompany services provided to a foreign person who would be a member of the same unitary business group but for the fact the foreign person’s business activity outside the United States is 80% or more of the foreign person’s business activity shall be excluded from both the numerator and denominator of the sales factor because those receipts do not reflect the market for the taxpayer’s goods, services or other ordinary sources of business income and are merely a contra adjustment to the costs of providing those goods and services. In a cost sharing agreement, related parties share the costs and risks of development, e.g. of intangible property, and also share in the reasonably anticipated benefits. A cost sharing agreement may also include a markup over costs, which may be considered receipts from sales of services under IITA section 304(a)(3)(C-5)(iv). EXAMPLE: Company Software, headquartered in Illinois, has three foreign affiliates: Software France, Software Germany and Software Hungary. They enter into a contract to jointly develop a new tax preparation software package. Company Software will provide the programming and each foreign affiliate will contribute knowledge of the language and tax laws in their country. The total cost of developing the software is $5,000,000. Each affiliate reimburses Company Software for 20% of the costs ($3,000,000 total) plus each affiliate will pay Company Software 2% of the costs as an administrative fee ($60,000 total). When completed, Company Software will own a 60% interest in each country’s version of the software and the foreign affiliate will own a 40% interest. The foreign affiliates are 80/20 companies and are not included in Company Software’s Illinois income tax return. Because Company Software and the affiliates will share in the expected benefits of the agreement, this should be characterized as a cost-sharing agreement with a markup. The reimbursed expenses will be excluded from Company Software’s apportionment factor. The markup is an administrative fee. As such, the markup will be considered receipts from the sale of services and will be included in the apportionment factor. B) Under a cost-plus service contract, the service provider bears none of the economic costs and risks associated with development, nor does it share in the anticipated benefits. The service provider merely receives a payment for the services rendered, and that payment is considered receipts from the sale of services under IITA section 304(a)(3)(C-5)(iv). EXAMPLE: Company Pharma, headquartered in Illinois, has a foreign affiliate Pharma Ireland, which owns intellectual property for a drug that it wants to distribute in the United States. Pharma Ireland pays Company Pharma to conduct drug trials for obtaining FDA approval to distribute the drugs. The drug trials are conducted in Illinois. Pharma Ireland reimburses Company Pharma its costs of $100,000 for conducting the trials plus a 5% markup ($105,000 total). The ownership of the intellectual property remains entirely with Pharma Ireland after the drug is approved. Pharma Ireland is an 80/20 company and is not included in Company Pharma’s Illinois income tax return. The contract is a cost-plus service contract because ownership of the intellectual property remains with Pharma Ireland, and Company Pharma will not share in the profits from sales of the drug. Both the reimbursed costs ($100,000) and the markup ($5,000) may be included in the denominator of Company Pharma’s sales factor under 86 Ill. Adm. Code 100.3370(a)(1)(b). Continuing the analysis for determining whether the receipts will be included in the sales factor numerator, the services were received in Illinois where the drug trials were conducted, but Pharma Ireland does not have a place of business in Illinois, so the services will be sourced to the location where the services were ordered. Provided that Company Pharma is subject to tax in Ireland, the $105,000 will be sourced to that country. If Company Pharma is not subject to tax in Ireland, the $105,000 will be excluded from both the numerator and the denominator of the sales factor. d) Unitary Partners: Inclusion of Shares of Partnership Unitary Business Income and Factors in Combined Unitary Business Income and Factors of Partners 1) IITA Section 304(e) provides that whenever 2 or more persons are engaged in a unitary business as described in IITA Section 1501(a)(27), a part of which is conducted in this State by one or more members of the group, the business income attributable to this State by any member or members shall be apportioned by means of the combined apportionment method. Because partnerships may be members of a unitary business group within the meaning of IITA Section 1501(a)(27), this provision requires a partnership to use combined apportionment when it is engaged in a unitary business with one or more of its partners. However, partners who are not engaged in a unitary business with the partnership shall include their shares of the partnership's business income apportioned to Illinois in their Illinois net incomes under IITA Section 305(a), and those partners' business activities or share of the partnership's market in Illinois would not be represented fairly by their shares of partnership income computed by combining the business income and apportionment factors of the partnership with the business income and apportionment factors of its unitary partners.

2) Accordingly, except in a case in which substantially all of the interests in the partnership (other than a publicly-traded partnership under IRC section 7704) are owned or controlled by members of the same unitary business group, when the business activities of a partnership and any of its partners' business activities constitute a unitary business:

A) The partner's distributive share of the business income and apportionment factors of the partnership shall be included in that partner's business income and apportionment factors. Also, for taxable years ending on or after December 31, 2017, the partner's distributive share of the everywhere sales of the partnership shall be included in the partner's everywhere sales for purposes of applying Section 100.3600. In determining the business income of the partnership, transactions between the unitary partner (or members of its unitary business group) and the partnership shall not be eliminated. However, all transactions between the unitary business group and the partnership shall be eliminated for purposes of computing the apportionment factors of the partner and of any other member of the unitary business group. EXAMPLE: Partner and Partnership are engaged in a unitary business. Partner owns a 20% interest in Partnership. Partnership has $10,000,000 in sales everywhere, $3,000,000 of which are to Partner, and $4,000,000 in Illinois sales, $1,000,000 of which are to Partner. In computing its apportionment factor, Partner shall include $1,400,000 from Partnership in its everywhere sales (20% of Partnership's $10,000,000 in everywhere sales, after eliminating the $3,000,000 in sales to Partner) and $600,000 from Partnership in its Illinois sales (20% of Partnership's $4,000,000 in Illinois sales, after eliminating the $1,000,000 in sales to Partner). Also, Partner must eliminate any sales it made to Partnership.

B) If a partnership and one of its partners are engaged in a unitary business and the partnership is itself a partner in a second partnership: i) If the partner is not engaged in a unitary business with the second partnership, the partner's share of the first partnership's share of the business income and apportionment factors of the second partnership shall not be included in the partner's business income and apportionment factors. Instead, the partner's share of the first partnership's share of the base income apportioned to Illinois by the second partnership shall be included in the partner's Illinois net income. ii) If the partner is engaged in a unitary business with the second partnership, the partner's share of the first partnership's share of the business income and apportionment factors of the second partnership shall be included in the partner's business income and apportionment factors.

C) If, for taxable years ending on or after December 31, 2017, a partner and a partnership engaged in a unitary business apportion their business income using different apportionment formulas under IITA Section 304: i) The apportionment percentage of the partnership shall computed under Section 100.3600 by treating the partnership as a member of the unitary business group, but using only that partner's distributive share of the partnership's apportionment factors and sales. That partner's apportionment percentage is equal to that partner's apportionment percentage computed under Section 100.3600 plus the partnership's apportionment percentage computed under Section 100.3600. ii) If a partnership has more than one partner in the same unitary business group, and the partnership uses a different apportionment formula than one or more of the partners, each partner that uses the same apportionment formula as the partnership shall compute its apportionment factor as provided in subsection (d)(2)(A) and each partner that uses a different apportionment formula shall compute its apportionment factor as provided in subsection (d)(2)(C)(i).

3) This subsection (d) does not apply to a partner's shares of business income and apportionment factors from any partnership that cannot be included in a unitary business group with that partner. A) This subsection (d) does not apply because: i) for taxable years ending prior to December 31, 2017, the partner and the partnership are required to apportion their business income using different apportionment formulas under IITA Section 304, and therefore cannot be members of a unitary business group under IITA Section 1501(a)(27); or ii) the business activities of either the partner or the partnership outside the United States are equal to or greater than 80% of the total worldwide business activities of that partner or partnership, as determined under IITA Section 1502(a)(27). In applying this 80/20 test to a taxpayer, no apportionment factors of any partnership shall be included in the apportionment factors of that taxpayer pursuant to this subsection (d). B) For taxable years ending prior to December 31, 2017, if the partnership is itself a partner in a second partnership, and one of its partners is engaged in a unitary business with the second partnership and is not prohibited from being a member of a unitary business group that includes the second partnership under subsection (d)(3)(A)(i) or (ii), that partner shall include in its business income and apportionment factors its share of the partnership's share of the second partnership's business income and apportionment factors.

4) If substantially all of the interests in a partnership (other than a publicly-traded partnership under IRC section 7704) are owned or controlled by members of the same unitary business group as the partnership, the partnership shall be treated as a member of the unitary business group for all purposes, and, for purposes of applying IITA Section 305(a) to any nonresident partner who is not a member of the same unitary business group, the business income of the partnership apportioned to this State shall be determined using the combined apportionment method prescribed by IITA Section 304(e). For purposes of this subsection (d), substantially all of the interests in a partnership are owned or controlled by members of the same unitary business group if more than 90% of the federal taxable income of the partnership is allocable to one or more of the following persons:

A) any member of the unitary business group;

B) any person who would be a member of the unitary business group if not for the fact that 80% or more of that person's business activities are conducted outside the United States;

C) any person who would be a member of the unitary business group except for the fact that the person and the partnership apportion their business incomes under different subsections of IITA Section 304 and, therefore, for taxable years ending prior to December 31, 2017, would be excluded from a unitary business group in which the partnership is a member; or D) any person who would be disallowed a deduction for losses by IRC section 267(b), (c) and (f)(1) by virtue of being related to any person described in subsection (d)(4)(A), (B) or (C), as well as any partnership in which a person described in subsection (d)(4)(A), (B) or (C) is a partner.

5) Examples EXAMPLE 1: Corporation A owns a 50% interest in P-1, a partnership. Corporation A and P-1 are engaged in a unitary business within the meaning of IITA Section 1501(a)(27). P-1 itself conducts no business activities in Illinois, and the Illinois numerator of its apportionment factor is zero. P-1 holds a 50% interest in P-2, a partnership doing business exclusively in Illinois. P-1 has $1.4 million of taxable business income, not including any income from P-2. P-2 has base income of $1 million, all of which is business income, and on a separate-entity basis, all of its business income would be apportioned to Illinois. EXAMPLE 2: If Corporation A and P-2 are not members of the same unitary business group, Corporation A would compute its business income apportioned to Illinois by including $700,000 (50% of $1.4 million) of P-1's business income in Corporation A's business income, and 50% of P-1's apportionment factors in its apportionment factors. Corporation A also would include in its Illinois net income its 50% share of P-1's 50% share of the base of P-2 apportionable to Illinois, or $250,000 (50% of 50% of $1 million). EXAMPLE 3: If Corporation A, P-1 and P-2 are members of the same unitary business group, P-1 shall include 50% of P-2's business income and 50% of P-2's apportionment factors in its own business income and apportionment factors. Accordingly, P-1's business income will be $1.9 million (the $1.4 million it earned directly plus its 50% share of P-2's $1 million in business income). Corporation A will then compute its business income apportioned to Illinois by including its 50% share of P-1's business income, or $950,000 (50% of $1.9 million) with its business income and its 50% share of P-1's apportionment factors (which will include P-1's share of P-2's apportionment factors) in its apportionment factors. EXAMPLE 4: If Corporation A, P-1 and P-2 are unitary, but P-1 is excluded from the unitary business group of Corporation A and P-2 because those entities apportion their business income under IITA Section 304(a) and P-1 is a financial organization that apportions its business income under IITA Section 304(c) and the taxable year ends prior to December 31, 2017, Corporation A shall include in its business income and apportionment factors its 50% share of P-1's 50% share of the business income and apportionment factors of P-2. Also, Corporation A's Illinois net income includes 50% of the business income of P-1 apportioned to Illinois by P-1 using its own apportionment factors. Because, in this example, P-1 is not doing business in Illinois, none of its business income is included in Corporation A's Illinois net income. EXAMPLE 5: In a taxable year ending December 31, 2017, a combined group is comprised of two corporations: Financial Organization (which apportions its business income using the financial organization formula under IITA Section 304(c)) and Insurance Company (which apportions its business income using the premiums factor under IITA Section 304(b)). Financial Organization is a 20% partner in Partnership, which apportions its business income using the sales factor formula under IITA Section 304(a). Partnership is engaged in a unitary business with the members of the combined group. The apportionment data for the members of the unitary business group are as follows: Everywhere Sales Respective Section 304 Formula Company Numerator Denominator Percentage Insurance Co. $200 $9 $150 6.000% Financial Org. $300 $75 $250 30.000% Partnership $500 $100 $500 Financial Org.'s Partnership Share $100 $20 $100 20.000% Grand Total $600 The apportionment percentages of each member of the group are computed as follows: A B C D E Company Section 304 Apportionment Percentage Subgroup Everywhere Sales A * B Group Everywhere Sales C ÷ D Insurance Co. 6.000% $200 $12.00 $600 2.000% Financial Org. 30.000% $300 $90.00 $600 15.000% Financial Org.'s Partnership Share 20.000% $100 $20.00 $600 3.333% Financial Organization's apportionment percentage is 18.333% (the 15.000% computed under Section 100.3600 and its 3.333% share of Partnership's apportionment percentage computed under Section 100.3600) and the apportionment percentage of the group is 20.333%. e) Apportionment of Business Income by Foreign Taxpayers. 1) Under IRC section 882, foreign corporations include only effectively-connected income in their federal taxable income. Foreign taxpayers may exclude other items of income from their federal taxable income if authorized under treaty, as provided in IRC section 894. Using a foreign taxpayer's worldwide apportionment factors to determine how much of its domestic business income shall be apportioned to Illinois would not fairly represent that taxpayer's business activities or market within Illinois. Accordingly, a foreign taxpayer shall use only the apportionment factors related to its domestic business income when apportioning its business income to Illinois. Similarly, in determining whether 80% or more of a foreign taxpayer's total business activity is conducted outside the United States for purposes of IITA Section 1501(a)(27), that taxpayer shall use only the apportionment factors related to the business income included in its federal taxable income (plus addition modifications), rather than use all of its worldwide factors. 2) Foreign Sales Corporations. Under IRC section 921, "exempt foreign trade income" of a foreign sales corporation is treated as foreign source income excluded from gross income. "Exempt foreign trade income" is defined in IRC section 923 to equal the sum of the amounts of income derived from various categories of transaction, with the income from each category multiplied by specific percentages. As a general rule, there is no systematic relationship between transactions qualifying for this treatment and any particular item of property or payroll of a foreign sales corporation. Accordingly, the provisions of subsection (e)(1) shall not apply to a foreign sales corporation and, in apportioning its business income and in determining whether 80% or more of its business activity is conducted outside the United States, a foreign sales corporation uses all of its apportionment factors. (Source: Amended at 47 Ill. Reg. 6030, effective April 12, 2023)

Section 100.3380 Special Rules (IITA Section 304)

a) Determining Business Activity or Market Within Illinois

1) Petition

IITA Section 304(f) provides that, if the allocation and apportionment provisions of Section 304(a) through (e) and (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 do not, 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 require, in respect of all or any part of the person's business activity, if reasonable:

A) Separate accounting;

B) The exclusion of any one or more factors;

C) The inclusion of one or more additional factors that will fairly represent the person's business activities or market in this State; or

D) The employment of any other method to effectuate an equitable allocation and apportionment of the person's business income.

2) Director's Determination

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 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.

b) Property Factor. The following special rules are established in respect to the property factor in IITA Section 304(a)(1):

1) If the subrents taken into account in determining the net annual rental rate under Section 100.3350(c) produce a negative or clearly inaccurate value for any item of property, another method that will properly reflect the value of rented property may be required by the Director or requested by the person. In no case, however, shall the value be less than an amount that bears the same ratio to the annual rental rate paid by the person for the property as the fair market value of that portion of the property used by the person bears to the total fair market value of the rented property.

EXAMPLE: A corporation rents a 10-story building at an annual rental rate of $1,000,000. The corporation occupies two stories and sublets eight stories for $1,000,000 a year. The net annual rental rate of the taxpayer is at least two-tenths of the corporation annual rental rate for the entire year, or $200,000.

2) If property owned by others is used by the person at no charge or rented by the person for a nominal rate, the net annual rental rate for the property shall be determined on the basis of a reasonable market rental rate for that property.

c) Sales Factor. The following special rules are established in respect to the sales factor in IITA Section 304(a)(3):

1) For taxable years ending before December 31, 2008, in the case of sales in which neither the origin nor the destination of the sale is within this State, and the person is taxable in neither the state of origin nor the state of destination, the sale shall be attributed to this State (and included in the numerator of the sales factor) if the person's activities in this State in connection with the sales are not protected by the provisions of P.L. 86-272, 15 U.S.C. 381-385. Although P.L. 86-272, by its terms covers only sales of tangible personal property, its rules regarding a state's power to impose a net income tax, for purposes of this special rule, will be applied whether or not the sale is of tangible or intangible property. This subsection (c)(1) does not apply in taxable years ending on or after December 31, 2008, because attributing the sale to this State is not required by IITA Section 304(a)(3) and does not fairly represent the market for the person's goods, services, or other sources of business income in this State. Notwithstanding the provisions of subsection (a)(2), taxpayers are not required to file a petition under Section 100.3390 requesting permission to file an original or amended return for any tax year ending on or after December 31, 2008 that does not apply the special rule in this subsection (c)(1).

EXAMPLE: A corporation's salesman operates out of an office in Illinois. He regularly calls on customers both within and without Illinois. Orders are approved by him and transmitted to the corporation's headquarters in State A. For taxable years ending before December 31, 2008, if the property sold by the salesman is shipped from a state in which the corporation is not taxable to a purchaser in a state in which the corporation is not taxable, the sale is attributable to Illinois.

2) 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 shall be excluded. Gross receipts from an incidental or occasional sale of stock in a subsidiary shall 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 shall 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.

3) When the income producing activity relevant to the sourcing of business income from intangible personal property can be readily identified, that income shall be included in the denominator of the sales factor and, if the income producing activity occurs in this State, in the numerator of the sales factor as well. For example, with respect to taxable years ending before December 31, 2008, usually the income producing activity can be readily identified in respect to interest income received on deferred payments on sales of tangible property (see Section 100.3370(a)(1)(A)).

4) When business income from intangible property is sourced according to the income producing activity, and the income cannot readily be attributed to any income producing activity of the person, the income shall not be assigned to the numerator of the sales factor for any state and shall be excluded from the denominator of the sales factor. The following provisions illustrate this concept:

A) Subpart F (IRC sections 951 through 964) income is passive income generated by the mere holding of an intangible. For taxable years ending on or after December 31, 1995, subpart F income is excluded from the sales factor under IITA Section 304(a)(3)(D). For prior taxable years, there is a rebuttable presumption that subpart F income is not includable in either the numerator or the denominator of the sales factor. If a taxpayer wishes to include subpart F income in either the numerator or the denominator of the sales factor, the burden of proof is on the taxpayer to identify the income producing activities and to situs those activities within a particular state; or

B) When business income in the form of dividends received on stock during taxable years ending before December 31, 1995, or interest received on bonds, debentures or government securities results from the mere holding of intangible personal property by the person, those dividends and interest shall be excluded from the denominator of the sales factor.

5) In the case of sales in the regular course of business of intangibles (including, by means of example, without limitation, patents, copyrights, bonds, stocks and other securities), gross receipts shall be disregarded and only the net gain (loss) shall be included in the sales factor, provided that, for taxable years ending on or after December 31, 2008, only net gains shall be included in the sales factor for sales sourced under IITA Section 304(a)(3)(C-5)(iii).

EXAMPLE: In 1990, Corporation A, a calendar year taxpayer, sells stock with an adjusted basis of $98,000,000 for $100,000,000, realizing a federal net capital gain of $2,000,000. Only the net capital gain of $2,000,000 shall be reflected in A's sales factor for the taxable year ending December 31, 1990.

6) Hedging Transactions

A) A "hedging transaction" is a transaction entered into by a taxpayer in the normal course of business primarily to manage interest rate risk or the risk of price or currency fluctuations. (See IRC sections 475(c)(3), 1221(b)(2)(A) and 1256(e)(2).) The purpose of the sales factor in IITA Section 304(a) is to apportion the business income of a taxpayer conducting an interstate business to this State based on this State's relative share of the marketplace for the goods and services sold by the taxpayer in the course of its business. Gains and losses on hedging transactions entered into to manage the risks associated with the acquisition of resources by a taxpayer (for example, price fluctuations in commodities consumed in the taxpayer's business) do not reflect the market for the taxpayer's goods and services and, therefore, shall be excluded from the sales factor. Gains and losses on hedging transactions entered into to manage risks associated with the gross income the taxpayer expects from its sales of goods and services (for example, the effect of foreign currency fluctuations on the dollar amount of gross income the taxpayer will receive from sales to a particular foreign country) are best accounted for in the sales factor as adjustments to the gross receipts from the transactions whose risks are being hedged. Gains and losses on hedging transactions that manage risks associated with both acquisitions and sales of the taxpayer (for example, electricity futures bought or sold by a taxpayer engaged in the business of buying and selling electrical power), or that otherwise cannot be associated with a particular transaction or class of transactions in the computation of the sales factor, should be excluded from the sales factor. Federal income tax law provides a framework for identifying gains and losses from hedging transactions to the transactions or class of transactions being hedged and for keeping records necessary to support the identifications. The federal practice should be followed for State purposes.

B) General Rule. Except as provided in subsection (c)(6)(C), any income, gain or loss from a transaction properly identified as a hedge under IRC section 1221(b)(2)(A), 475(c)(3) or 1256(e)(2) shall be excluded from the numerator and denominator of the sales factor.

C) Special Rule. With respect to any hedging transaction described in subsection (c)(6)(B) as to which identification requirements of subsection (c)(6)(D) are satisfied, any income, gain or loss from the hedging transaction shall be included in the denominator of the sales factor if the gross receipts from the hedged item are included in the denominator. That income, gain or loss shall be included in the numerator of the sales factor if the gross receipts from the hedged item are included in the numerator of the sales factor, and excluded from the numerator of the sales factor if the gross receipts from the hedged item are excluded from the numerator of the sales factor. If the hedging transaction relates to an identified group of hedged items, the income, gain or loss from the hedging transaction shall be included in the numerator of the sales factor in the same proportion that the gross receipts from the group of hedged items are included in the numerator of the sales factor.

D) Identification Required. The identification requirements of this subsection (c)(6)(D) are met if the taxpayer's books and records clearly identify a hedging transaction as managing risk relating to a particular item or items of gross receipts, including anticipated items of gross receipts, that must be included in the sales factor. The identification requirements are met only if identification is made at the time and in the manner required under IRC section 475(c)(3), 26 CFR 1.1221-2(f) and (g), or 26 CFR 1.1256(e)-1 and the taxpayer's books and records include the information necessary to apply subsection (c)(6)(C).

E) This subsection (c)(6) does not apply to any hedging transaction that, for federal income tax purposes, is integrated with the hedged item, such as under 26 CFR 1.988-5 or 1.1275-6. In addition, for purposes of this subsection (c)(6):

i) a transaction entered into by one member of a federal consolidated group identified as a hedge against a risk of another member of the federal consolidated group under the "single-entity approach" in 26 CFR 1.1221-2(e)(1) is not a hedging transaction if the two members of the federal consolidated group are not members of the same unitary business group, because the transaction is not hedging against a risk faced by the taxpayer entering into the transaction; and

ii) a transaction entered into by one member of a unitary business group with another member of the unitary business group is not a hedging transaction, because the risk remains within the group, except in the case of a transaction identified under 26 CFR 1.1221-2(f) or (g) as a hedging transaction between two member of a unitary business group who are also members of a federal consolidated group that has made the "separate entity election" in 26 CFR 1.1221-2(e)(2) with regard to hedging transactions.

F) The provisions of this subsection (c)(6) are illustrated by the following examples:

EXAMPLE 1: Taxpayer expects that, during its next production cycle, it will need 10 tons of commodity Y for its interstate manufacturing business. Commodity Y is a raw material used by Taxpayer in the manufacture of its inventory. In order to hedge against exposure to changes in the price of commodity Y, Taxpayer enters into a forward contract to purchase 10 tons of commodity Y. The forward contract is identified as a hedging transaction under IRC section 1221(b)(2)(A). Under subsection (c)(6)(B), any income, gain or loss recognized with respect to the forward contract shall be excluded from the numerator and denominator of the sales factor.

EXAMPLE 2: On January 1, 2008, Taxpayer owns 10 tons of commodity X, which it holds for sale in the ordinary course of business and expects to sell during its taxable year ending December 31, 2008. To hedge against price fluctuations in commodity X, on January 10, 2008, while Taxpayer still owns commodity X, it sells the equivalent of 10 tons of commodity X futures contracts on a futures exchange. Taxpayer expects to sell commodity X to customers in various states, including Illinois. The futures contract is identified as a hedging transaction under IRC section 1221(b)(2)(A), and Taxpayer properly identifies the futures contract as required under subsection (c)(6)(D) as hedging gross receipts from sales of commodity X. Under subsection (c)(6)(C), any gain or loss taken into account by Taxpayer during its taxable year with respect to the futures contract shall be included in the denominator of the sales factor, and included in the numerator of the sales factor in the same proportion that gross receipts from actual sales of commodity X during the taxable year are included in the numerator of the sales factor. If a loss is recognized on the futures contract, the loss is treated as a reduction (but not below zero) of the gross receipts from the sale of commodity X in computing the sales factor.

EXAMPLE 3: Taxpayer is a corporation on the accrual method of accounting with the U.S. dollar as its functional currency. On January 1, 2008, Taxpayer acquires 1,500 British pounds (£) for $2,250 (£1 = $1.50). The acquisition of £1,500 is properly identified by Taxpayer as a hedging transaction under IRC section 1221(b)(2)(A). On February 5, 2008, when the spot rate is £1 = $1.55, Taxpayer purchases inventory from its supplier by paying £1,500. Accordingly, Taxpayer recognizes $75 exchange gain for federal income tax purposes upon disposition of the British pounds. The $75 exchange gain shall be excluded from both the numerator and denominator of the sales factor under subsection (c)(6)(B).

EXAMPLE 4: Taxpayer is a calendar year corporation with the U.S. dollar as its functional currency. Based on past experience, Taxpayer anticipates making 2009 first quarter sales to customers in New Zealand of 100,000 New Zealand dollars (NZD). In order to hedge against currency fluctuations related to the anticipated first quarter sales, on December 31, 2008, Taxpayer enters into a forward contract to sell 100,000 NZD on March 31, 2009 for $48,000. The forward contract is identified as a hedging transaction under IRC section 1221(b)(2)(A), and the Taxpayer properly identifies the transaction as hedging its anticipated New Zealand sales in accordance with subsection (c)(6)(D). During the first quarter of its 2009 taxable year, Taxpayer makes sales to its New Zealand customers of 90,000 NZD. Under IITA Section 304(a), gross receipts from its New Zealand sales shall be included in the denominator of the Taxpayer's sales factor and excluded from the numerator of the sales factor. Under subsection (c)(6)(C), any gain or loss recognized on the forward contract shall be included in the denominator of the Taxpayer's sales factor and excluded from the numerator of the factor. This treatment is appropriate even though the Taxpayer's sales to New Zealand customers were less than anticipated. Any loss recognized on the forward contract shall be treated as a reduction (but not below zero) of the gross receipts from sales to New Zealand customers that are included in the denominator of the sales factor.

7) Section 988 Transactions

A) Section 988 Transactions. For sales factor purposes, foreign currency gain or loss that shall be computed under IRC section 988, with respect to accrued interest income or expense, gain or loss on a debt instrument, a payable, a receivable or a forward contract payable in a foreign currency described in 26 CFR 1.988-1(a)(2) shall be treated as an adjustment to the income, expense, gain or loss. Accordingly, the foreign currency gain or loss shall be included in the numerator and denominator of the sales factor only to the extent that the income to which the foreign currency gain or loss relates is included in the numerator and denominator of the sales factor. Foreign currency gains and losses with respect to expense shall be excluded from the numerator and denominator of the sales factor. The provisions of this subsection (c)(7)(A) are illustrated by the following examples:

EXAMPLE 1: Taxpayer is a corporation on the accrual method of accounting with the U.S. dollar as its functional currency. On January 1, 2008, Taxpayer converts $13,000 to 10,000 British pounds (₤) at the spot rate of ₤1 = $1.30 and loans the ₤10,000 to Y for 3 years. The terms of the loan provide that Y will make interest payments of ₤1,000 on December 31 of 2008, 2009 and 2010 and will repay Taxpayer's ₤10,000 principal on December 31, 2010. Based on average spot rates for 2008, 2009 and 2010 of ₤1 = $1.32, ₤1 = $1.37 and ₤1 = $1.42, respectively, Taxpayer accrues interest income of $1,320 for 2008, $1,370 for 2009, and $1,420 for 2010. Under IITA Section 304(a), the accrued interest income shall be included in the denominator of Taxpayer's sales factor, but excluded from the numerator of its sales factor. Based on spot rates on December 31, 2008, December 31, 2009 and December 31, 2010 of ₤1 = $1.35, ₤1 = $1.40 and ₤1 = $1.45, respectively, Taxpayer recognizes for federal income tax purposes exchange gain of $30 upon receipt of the interest on December 31 of 2008, 2009 and 2010. In addition, Taxpayer recognizes, for federal income tax purposes, exchange gain of $1,500 upon repayment of the loan principal on December 31, 2010. Under subsection (c)(7)(A), the $30 of exchange gain recognized with respect to the accrued interest for 2008, 2009 and 2010 shall be included in the denominator of Taxpayer's sales factor and excluded from the numerator of its sales factor. The $1,500 of exchange gain with respect to the repayment of principal on December 31, 2010 shall be excluded from both the numerator and denominator of Taxpayer's sales factor because repayment of principal on a loan is not included in the sales factor.

EXAMPLE 2: Taxpayer is a corporation on the accrual method of accounting with the U.S. dollar as its functional currency. On January 15, 2008, Taxpayer sells inventory for 10,000 Canadian dollars (C$). The spot rate on January 15, 2008 is C$1 = U.S. $.55. Under IITA Section 304(a), $5,500 in gross receipts from this sale shall be included in the denominator of Taxpayer's sales factor and excluded from the numerator of the sales factor. On February 23, 2008, when Taxpayer receives payment of the C$10,000, the spot rate is C$1 = U.S. $.50. For federal income tax purposes, Taxpayer recognizes ($500) of exchange loss upon receipt of C$10,000 on February 23, 2008. Under subsection (c)(7)(A), the ($500) exchange loss with respect to the January 15, 2008 sale shall be included in the denominator of the Taxpayer's sales factor and excluded from the numerator of the sales factor. The exchange loss is reflected as a reduction of the denominator of the Taxpayer's sales factor.

B) Section 986(c)(1) Foreign Exchange Gain or Loss on Distributions of Previously Taxed Income. Foreign currency gain or loss recognized pursuant to IRC section 986(c)(1) on distributions of amounts previously taxed to the recipient as subpart F income or as earnings of a qualified electing fund shall be excluded from both the numerator and denominator of the sales factor because those distributions are excluded from federal gross income and, therefore, from the sales factor.

8) Vendor allowances. Retailers often enter into agreements with their vendors regarding the payment of certain allowances to induce sales. These vendor allowances fall into two distinct categories: buying allowances and merchandising allowances.

A) Buying allowances. Rebates and other buying allowances generally are considered reductions to the cost of goods sold and, therefore, are excluded from the sales factor numerator and denominator. These may include, for example, a cash discount for prompt payment, a trade discount for a specified volume of purchase, markdown participation allowances to cover shortfalls in the sales price received by the retailer, defective or damaged merchandise allowances, and sales-based allowances for short-term promotions. The provisions of this subsection (c)(8)(A) are illustrated by the following examples:

EXAMPLE 1: Retailer purchases 1,000 moccasins from vendor, who provides a margin guarantee of $17. The moccasins retail for $25 each. At the end of the season, the 20 remaining moccasins are marked down to $9. Vendor remits $160 to retailer, computed as follows: 20 X ($17-$9). The $160 does not constitute gross receipts includable in the sales factor, as it is a reduction to the cost of the moccasins.

EXAMPLE 2: Retailer runs a promotion offering buy-one-get-one-half-off for Minty Toothpaste. Retailer and Vendor have an arrangement for vendor to provide a $0.75 discount for each item sold at a reduced price. Retailer sells 1,000 tubes of Minty Toothpaste during the promotional period. Vendor provides a $375 discount to Retailer for the items sold at a reduced price, computed as follows: 500 X $0.75. The $375 does not constitute gross receipts includable in the sales factor, as it is a reduction to the cost of Minty Toothpaste.

B) Merchandising allowances.

i) Merchandising allowances are part of the product’s selling price and may be reportable as gross income. Accordingly, merchandising allowances shall be included in the numerator and denominator of the sales factor to the extent that the merchandising allowances promote sales included in the numerator and denominator of the sales factor. The following are types of merchandising allowances:

· Cooperative advertising, which is a sharing arrangement for the costs of advertising depicting the vendor’s products, such as a weekly circular;

· Salary or payroll allowances, which are an incentive to provide more space or staff; and

· Up-front cash payments and long-term agreements that compensate the retailer for a commitment to purchase a targeted volume of goods over a period of time. These are recorded as a liability when received and recognized as income when purchases are made.

ii) The amount includable in the numerator shall be determined in one of the following manners, at the taxpayer’s election, consistently applied:

· The ratio of the number of retail locations in Illinois over the total number of retail locations, or

· The ratio of the gross receipts from retail locations in Illinois over the total gross receipts.

EXAMPLE: Retailer W sells greeting cards for all occasions. Retailer W and Vendor Q have entered into an agreement under which Vendor Q pays Retailer W an allowance of $5 per hour to remove damaged cards and maintain the seasonal greeting card inventory. Retailer W’s employee spends 300 hours monitoring the inventory during the year, and Vendor Q pays Retailer W $1,500 ($5 times 300 hours). This income is considered gross receipts and must be included in the sales factor denominator. Retailer W has 15 stores in Illinois and 5 stores in Wisconsin, so $1,125 ($1,500 times 15/20) would be included in the sales factor numerator.

9) Cost sharing agreements.

A) Payments received pursuant to a cost sharing agreement under Treasury Regulation 1.482-7 in exchange for intercompany services provided to a foreign person who would be a member of the same unitary business group but for the fact the foreign person’s business activity outside the United States is 80% or more of the foreign person’s business activity shall be excluded from both the numerator and denominator of the sales factor because those receipts do not reflect the market for the taxpayer’s goods, services or other ordinary sources of business income and are merely a contra adjustment to the costs of providing those goods and services. In a cost sharing agreement, related parties share the costs and risks of development, e.g. of intangible property, and also share in the reasonably anticipated benefits. A cost sharing agreement may also include a markup over costs, which may be considered receipts from sales of services under IITA section 304(a)(3)(C-5)(iv).

EXAMPLE: Company Software, headquartered in Illinois, has three foreign affiliates: Software France, Software Germany and Software Hungary. They enter into a contract to jointly develop a new tax preparation software package. Company Software will provide the programming and each foreign affiliate will contribute knowledge of the language and tax laws in their country. The total cost of developing the software is $5,000,000. Each affiliate reimburses Company Software for 20% of the costs ($3,000,000 total) plus each affiliate will pay Company Software 2% of the costs as an administrative fee ($60,000 total). When completed, Company Software will own a 60% interest in each country’s version of the software and the foreign affiliate will own a 40% interest. The foreign affiliates are 80/20 companies and are not included in Company Software’s Illinois income tax return. Because Company Software and the affiliates will share in the expected benefits of the agreement, this should be characterized as a cost-sharing agreement with a markup. The reimbursed expenses will be excluded from Company Software’s apportionment factor. The markup is an administrative fee. As such, the markup will be considered receipts from the sale of services and will be included in the apportionment factor.

B) Under a cost-plus service contract, the service provider bears none of the economic costs and risks associated with development, nor does it share in the anticipated benefits. The service provider merely receives a payment for the services rendered, and that payment is considered receipts from the sale of services under IITA section 304(a)(3)(C-5)(iv).

EXAMPLE: Company Pharma, headquartered in Illinois, has a foreign affiliate Pharma Ireland, which owns intellectual property for a drug that it wants to distribute in the United States. Pharma Ireland pays Company Pharma to conduct drug trials for obtaining FDA approval to distribute the drugs. The drug trials are conducted in Illinois. Pharma Ireland reimburses Company Pharma its costs of $100,000 for conducting the trials plus a 5% markup ($105,000 total). The ownership of the intellectual property remains entirely with Pharma Ireland after the drug is approved. Pharma Ireland is an 80/20 company and is not included in Company Pharma’s Illinois income tax return. The contract is a cost-plus service contract because ownership of the intellectual property remains with Pharma Ireland, and Company Pharma will not share in the profits from sales of the drug. Both the reimbursed costs ($100,000) and the markup ($5,000) may be included in the denominator of Company Pharma’s sales factor under 86 Ill. Adm. Code 100.3370(a)(1)(b). Continuing the analysis for determining whether the receipts will be included in the sales factor numerator, the services were received in Illinois where the drug trials were conducted, but Pharma Ireland does not have a place of business in Illinois, so the services will be sourced to the location where the services were ordered. Provided that Company Pharma is subject to tax in Ireland, the $105,000 will be sourced to that country. If Company Pharma is not subject to tax in Ireland, the $105,000 will be excluded from both the numerator and the denominator of the sales factor.

d) Unitary Partners: Inclusion of Shares of Partnership Unitary Business Income and Factors in Combined Unitary Business Income and Factors of Partners

1) IITA Section 304(e) provides that whenever 2 or more persons are engaged in a unitary business as described in IITA Section 1501(a)(27), a part of which is conducted in this State by one or more members of the group, the business income attributable to this State by any member or members shall be apportioned by means of the combined apportionment method. Because partnerships may be members of a unitary business group within the meaning of IITA Section 1501(a)(27), this provision requires a partnership to use combined apportionment when it is engaged in a unitary business with one or more of its partners. However, partners who are not engaged in a unitary business with the partnership shall include their shares of the partnership's business income apportioned to Illinois in their Illinois net incomes under IITA Section 305(a), and those partners' business activities or share of the partnership's market in Illinois would not be represented fairly by their shares of partnership income computed by combining the business income and apportionment factors of the partnership with the business income and apportionment factors of its unitary partners.

2) Accordingly, except in a case in which substantially all of the interests in the partnership (other than a publicly-traded partnership under IRC section 7704) are owned or controlled by members of the same unitary business group, when the business activities of a partnership and any of its partners' business activities constitute a unitary business:

A) The partner's distributive share of the business income and apportionment factors of the partnership shall be included in that partner's business income and apportionment factors. Also, for taxable years ending on or after December 31, 2017, the partner's distributive share of the everywhere sales of the partnership shall be included in the partner's everywhere sales for purposes of applying Section 100.3600. In determining the business income of the partnership, transactions between the unitary partner (or members of its unitary business group) and the partnership shall not be eliminated. However, all transactions between the unitary business group and the partnership shall be eliminated for purposes of computing the apportionment factors of the partner and of any other member of the unitary business group.

EXAMPLE: Partner and Partnership are engaged in a unitary business. Partner owns a 20% interest in Partnership. Partnership has $10,000,000 in sales everywhere, $3,000,000 of which are to Partner, and $4,000,000 in Illinois sales, $1,000,000 of which are to Partner. In computing its apportionment factor, Partner shall include $1,400,000 from Partnership in its everywhere sales (20% of Partnership's $10,000,000 in everywhere sales, after eliminating the $3,000,000 in sales to Partner) and $600,000 from Partnership in its Illinois sales (20% of Partnership's $4,000,000 in Illinois sales, after eliminating the $1,000,000 in sales to Partner). Also, Partner must eliminate any sales it made to Partnership.

B) If a partnership and one of its partners are engaged in a unitary business and the partnership is itself a partner in a second partnership:

i) If the partner is not engaged in a unitary business with the second partnership, the partner's share of the first partnership's share of the business income and apportionment factors of the second partnership shall not be included in the partner's business income and apportionment factors. Instead, the partner's share of the first partnership's share of the base income apportioned to Illinois by the second partnership shall be included in the partner's Illinois net income.

ii) If the partner is engaged in a unitary business with the second partnership, the partner's share of the first partnership's share of the business income and apportionment factors of the second partnership shall be included in the partner's business income and apportionment factors.

C) If, for taxable years ending on or after December 31, 2017, a partner and a partnership engaged in a unitary business apportion their business income using different apportionment formulas under IITA Section 304:

i) The apportionment percentage of the partnership shall computed under Section 100.3600 by treating the partnership as a member of the unitary business group, but using only that partner's distributive share of the partnership's apportionment factors and sales. That partner's apportionment percentage is equal to that partner's apportionment percentage computed under Section 100.3600 plus the partnership's apportionment percentage computed under Section 100.3600.

ii) If a partnership has more than one partner in the same unitary business group, and the partnership uses a different apportionment formula than one or more of the partners, each partner that uses the same apportionment formula as the partnership shall compute its apportionment factor as provided in subsection (d)(2)(A) and each partner that uses a different apportionment formula shall compute its apportionment factor as provided in subsection (d)(2)(C)(i).

3) This subsection (d) does not apply to a partner's shares of business income and apportionment factors from any partnership that cannot be included in a unitary business group with that partner.

A) This subsection (d) does not apply because:

i) for taxable years ending prior to December 31, 2017, the partner and the partnership are required to apportion their business income using different apportionment formulas under IITA Section 304, and therefore cannot be members of a unitary business group under IITA Section 1501(a)(27); or

ii) the business activities of either the partner or the partnership outside the United States are equal to or greater than 80% of the total worldwide business activities of that partner or partnership, as determined under IITA Section 1502(a)(27). In applying this 80/20 test to a taxpayer, no apportionment factors of any partnership shall be included in the apportionment factors of that taxpayer pursuant to this subsection (d).

B) For taxable years ending prior to December 31, 2017, if the partnership is itself a partner in a second partnership, and one of its partners is engaged in a unitary business with the second partnership and is not prohibited from being a member of a unitary business group that includes the second partnership under subsection (d)(3)(A)(i) or (ii), that partner shall include in its business income and apportionment factors its share of the partnership's share of the second partnership's business income and apportionment factors.

4) If substantially all of the interests in a partnership (other than a publicly-traded partnership under IRC section 7704) are owned or controlled by members of the same unitary business group as the partnership, the partnership shall be treated as a member of the unitary business group for all purposes, and, for purposes of applying IITA Section 305(a) to any nonresident partner who is not a member of the same unitary business group, the business income of the partnership apportioned to this State shall be determined using the combined apportionment method prescribed by IITA Section 304(e). For purposes of this subsection (d), substantially all of the interests in a partnership are owned or controlled by members of the same unitary business group if more than 90% of the federal taxable income of the partnership is allocable to one or more of the following persons:

A) any member of the unitary business group;

B) any person who would be a member of the unitary business group if not for the fact that 80% or more of that person's business activities are conducted outside the United States;

C) any person who would be a member of the unitary business group except for the fact that the person and the partnership apportion their business incomes under different subsections of IITA Section 304 and, therefore, for taxable years ending prior to December 31, 2017, would be excluded from a unitary business group in which the partnership is a member; or

D) any person who would be disallowed a deduction for losses by IRC section 267(b), (c) and (f)(1) by virtue of being related to any person described in subsection (d)(4)(A), (B) or (C), as well as any partnership in which a person described in subsection (d)(4)(A), (B) or (C) is a partner.

5) Examples

EXAMPLE 1: Corporation A owns a 50% interest in P-1, a partnership. Corporation A and P-1 are engaged in a unitary business within the meaning of IITA Section 1501(a)(27). P-1 itself conducts no business activities in Illinois, and the Illinois numerator of its apportionment factor is zero. P-1 holds a 50% interest in P-2, a partnership doing business exclusively in Illinois. P-1 has $1.4 million of taxable business income, not including any income from P-2. P-2 has base income of $1 million, all of which is business income, and on a separate-entity basis, all of its business income would be apportioned to Illinois.

EXAMPLE 2: If Corporation A and P-2 are not members of the same unitary business group, Corporation A would compute its business income apportioned to Illinois by including $700,000 (50% of $1.4 million) of P-1's business income in Corporation A's business income, and 50% of P-1's apportionment factors in its apportionment factors. Corporation A also would include in its Illinois net income its 50% share of P-1's 50% share of the base of P-2 apportionable to Illinois, or $250,000 (50% of 50% of $1 million).

EXAMPLE 3: If Corporation A, P-1 and P-2 are members of the same unitary business group, P-1 shall include 50% of P-2's business income and 50% of P-2's apportionment factors in its own business income and apportionment factors. Accordingly, P-1's business income will be $1.9 million (the $1.4 million it earned directly plus its 50% share of P-2's $1 million in business income). Corporation A will then compute its business income apportioned to Illinois by including its 50% share of P-1's business income, or $950,000 (50% of $1.9 million) with its business income and its 50% share of P-1's apportionment factors (which will include P-1's share of P-2's apportionment factors) in its apportionment factors.

EXAMPLE 4: If Corporation A, P-1 and P-2 are unitary, but P-1 is excluded from the unitary business group of Corporation A and P-2 because those entities apportion their business income under IITA Section 304(a) and P-1 is a financial organization that apportions its business income under IITA Section 304(c) and the taxable year ends prior to December 31, 2017, Corporation A shall include in its business income and apportionment factors its 50% share of P-1's 50% share of the business income and apportionment factors of P-2. Also, Corporation A's Illinois net income includes 50% of the business income of P-1 apportioned to Illinois by P-1 using its own apportionment factors. Because, in this example, P-1 is not doing business in Illinois, none of its business income is included in Corporation A's Illinois net income.

EXAMPLE 5: In a taxable year ending December 31, 2017, a combined group is comprised of two corporations: Financial Organization (which apportions its business income using the financial organization formula under IITA Section 304(c)) and Insurance Company (which apportions its business income using the premiums factor under IITA Section 304(b)). Financial Organization is a 20% partner in Partnership, which apportions its business income using the sales factor formula under IITA Section 304(a). Partnership is engaged in a unitary business with the members of the combined group. The apportionment data for the members of the unitary business group are as follows:

Everywhere Sales

Respective Section 304 Formula

Company

Numerator

Denominator

Percentage

Insurance Co.

$200

$9

$150

6.000%

Financial Org.

$300

$75

$250

30.000%

Partnership

$500

$100

$500

Financial Org.'s

Partnership Share

$100

$20

$100

20.000%

Grand Total

$600

The apportionment percentages of each member of the group are computed as follows:

A

B

C

D

E

Company

Section 304 Apportionment Percentage

Subgroup Everywhere Sales

A * B

Group Everywhere Sales

C ÷ D

Insurance Co.

6.000%

$200

$12.00

$600

2.000%

Financial Org.

30.000%

$300

$90.00

$600

15.000%

Financial Org.'s

Partnership Share

20.000%

$100

$20.00

$600

3.333%

Financial Organization's apportionment percentage is 18.333% (the 15.000% computed under Section 100.3600 and its 3.333% share of Partnership's apportionment percentage computed under Section 100.3600) and the apportionment percentage of the group is 20.333%.

e) Apportionment of Business Income by Foreign Taxpayers.

1) Under IRC section 882, foreign corporations include only effectively-connected income in their federal taxable income. Foreign taxpayers may exclude other items of income from their federal taxable income if authorized under treaty, as provided in IRC section 894. Using a foreign taxpayer's worldwide apportionment factors to determine how much of its domestic business income shall be apportioned to Illinois would not fairly represent that taxpayer's business activities or market within Illinois. Accordingly, a foreign taxpayer shall use only the apportionment factors related to its domestic business income when apportioning its business income to Illinois. Similarly, in determining whether 80% or more of a foreign taxpayer's total business activity is conducted outside the United States for purposes of IITA Section 1501(a)(27), that taxpayer shall use only the apportionment factors related to the business income included in its federal taxable income (plus addition modifications), rather than use all of its worldwide factors.

2) Foreign Sales Corporations. Under IRC section 921, "exempt foreign trade income" of a foreign sales corporation is treated as foreign source income excluded from gross income. "Exempt foreign trade income" is defined in IRC section 923 to equal the sum of the amounts of income derived from various categories of transaction, with the income from each category multiplied by specific percentages. As a general rule, there is no systematic relationship between transactions qualifying for this treatment and any particular item of property or payroll of a foreign sales corporation. Accordingly, the provisions of subsection (e)(1) shall not apply to a foreign sales corporation and, in apportioning its business income and in determining whether 80% or more of its business activity is conducted outside the United States, a foreign sales corporation uses all of its apportionment factors.

# Source

(Source: Amended at 47 Ill. Reg. 6030, effective April 12, 2023)