What does Illinois Private Letter Ruling IT 18-0011-PLR conclude about Sales Factor -Intangible Property?

Plain-English summary

The Illinois Department of Revenue ruled that a Delaware limited partnership that originates senior secured loans directly to middle-market companies (borrowers with less than $25 million EBITDA) is treated as a "dealer" for purposes of sourcing its interest income into the Illinois sales factor -- even though, for federal tax purposes, the taxpayer qualifies for a regulatory exemption that lets it avoid dealer-style mark-to-market accounting.

The taxpayer's own facts showed it regularly originates loans to customers in the ordinary course of its trade or business, which satisfies the federal definition of a "dealer in securities" under 26 U.S.C. § 475(c)(1). Because it makes only "negligible sales" of the loans it originates, Treas. Reg. § 1.475(c)-1(c)(1) lets it opt out of the mark-to-market accounting that dealers normally must use. The taxpayer asked whether that federal opt-out also meant it should be treated as a non-dealer for Illinois sales-factor sourcing purposes under 35 ILCS 5/304(a)(3)(C-5)(iii).

The Department concluded that the federal mark-to-market election (or non-election) doesn't change the Illinois sourcing analysis. Whether or not the taxpayer elects out of the mark-to-market exemption, it still earns its interest income by making loans to customers in the ordinary course of business -- the same economic activity either way. So for Illinois sales-factor purposes, the taxpayer is considered a dealer in the loans it originates, and must source that interest income to Illinois under the "customer sourcing" rule in 35 ILCS 5/304(a)(3)(C-5)(iii)(a): income is assigned to Illinois if the customer is an Illinois resident (individuals/trusts/estates) or has an Illinois commercial domicile (other customers), determined by the customer's billing address absent actual knowledge otherwise.

Had the taxpayer instead been treated as a non-dealer, its interest income would have been sourced under the alternative "income-producing activity" test in 35 ILCS 5/304(a)(3)(C-5)(iii)(b), which looks to where the taxpayer's own activities (not the customer's location) occur.

What this means for you

Loan originators, specialty finance companies, and investment funds

If your business regularly originates loans directly to customers -- even if you qualify for the federal "negligible sales" exception to dealer mark-to-market accounting -- this ruling signals the Department views you as a dealer for Illinois sales-factor sourcing regardless of whether you elect out of that federal exemption. That means your Illinois-sourced interest income turns on where your customers are (residence, commercial domicile, or billing address), not on where your own lending activity takes place.

Business owners and in-house tax staff

The federal classification choice under Treas. Reg. 1.475(c)-1(c) (mark-to-market election or not) does not, by itself, change how Illinois sources your interest income. Track your customers' billing addresses and commercial domiciles carefully, since that is what determines your Illinois sales-factor numerator under this ruling's reasoning.

Accountants and tax professionals

This PLR illustrates that the Department reads "dealer... within the meaning of Section 475" in 35 ILCS 5/304(a)(3)(C-5)(iii)(a) functionally: a taxpayer who would be a dealer under IRC 475 but for a regulatory exemption is still a dealer for Illinois sourcing purposes. Note this is one of three closely related PLRs issued the same day (IT 18-0009, IT 18-0010, IT 18-0011) on similar sales-factor/intangible-property fact patterns -- each binds the Department only as to its own requesting taxpayer, so confirm the facts of any one ruling match your client's situation before relying on its reasoning.

Common questions

Q: Does qualifying for the federal mark-to-market exemption make a loan originator a non-dealer for Illinois tax purposes?
A: No. The Department ruled that even though the taxpayer qualified for the Treas. Reg. 1.475(c)-1(c) exemption from mark-to-market accounting, it is still considered a "dealer" for purposes of sourcing income under 35 ILCS 5/304(a)(3)(C-5)(iii)(a), because it regularly originates loans to customers in the ordinary course of business either way.

Q: How is the taxpayer's interest income sourced to Illinois under this ruling?
A: As a dealer, the income is sourced to Illinois if the customer is an Illinois resident (for individuals, trusts, or estates) or has an Illinois commercial domicile (for other customers). Absent actual knowledge of the customer's residence or commercial domicile, the customer's billing address on the dealer's records controls.

Q: Can I rely on this ruling for my own business?
A: Only if you are the taxpayer who requested it. This is a Private Letter Ruling issued under 2 Ill. Adm. Code 1200.110, and it binds the Department only with respect to the requesting taxpayer, and only to the extent the facts presented were complete and correct. It is not precedent for any other taxpayer, including businesses with similar loan-origination facts -- even the Department's other same-day PLRs on this topic (IT 18-0009 and IT 18-0010) are separate rulings limited to their own requesting taxpayers.

Q: What would happen if the taxpayer were NOT a dealer?
A: The ruling explains that non-dealers source interest income and other income from intangible property under 35 ILCS 5/304(a)(3)(C-5)(iii)(b) instead -- based on where the taxpayer's own income-producing activity is performed, not where the customer is located.

Citations and references

Statutes and regulations:

• 35 ILCS 5/304(a)(3)(A) (Illinois Income Tax Act sales factor, general definition)
• 35 ILCS 5/304(a)(3)(C-5)(iii)(a) (customer-based sourcing for dealers in intangible property)
• 35 ILCS 5/304(a)(3)(C-5)(iii)(b) (income-producing-activity sourcing for non-dealers)
• 26 U.S.C. § 475(c)(1) (federal definition of "dealer in securities")
• 26 U.S.C. § 475(a), (b) (mark-to-market accounting requirement and exceptions)
• Treas. Reg. § 1.475(c)-1(c)(1) (negligible-sales exemption from dealer status)
• 2 Ill. Adm. Code 1200.110 (private letter ruling procedure; binding only on requesting taxpayer)

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/income-tax/2018.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/income-tax/2018/it-18-0011-plr.pdf

Original ruling text

IT 18-0011-PLR 11/29/2018 SALES FACTOR -INTANGIBLE PROPERTY
Taxpayer originating loans to customers in ordinary course of business is Dealer
November 29, 2018

Re:

Request for Private Letter Ruling
TAXPAYER
FEIN: ####

Dear Xxxxx:
This is in response to your letter dated June 12, 2018 in which you request a Private Letter Ruling on
behalf of TAXPAYER. Review of your request for a Private Letter Ruling indicates that all information
described in paragraphs 1 through 8 of subsection (b) of 2 Ill. Adm. Code 1200.110 is contained in
your request. This Private Letter Ruling will bind the Department only with respect to TAXPAYER.
Issuance of this ruling is conditioned upon the understanding that TAXPAYER and/or any related
taxpayer(s) is not currently under audit or involved in litigation concerning the issues that are the
subject of this ruling request.
The facts and analysis as you have presented states as follows:
On behalf of our client, TAXPAYER (FEIN: ####), hereinafter referred to as “Taxpayer”), we
respectfully request the issuance of a private letter ruling (“PLR”) by the Illinois Department of
Revenue (“Department”) pursuant to 2 Ill Adm. Code 1200.110.
General Information

1. This PLR is not requested for hypothetical or alternatively proposed transactions; but rather
   to determine the income tax consequences of an actual transaction engaged in by Taxpayer,
   as described below.
2. Taxpayer is not currently engaged in litigation with the Department with regard to this or any
   other tax matter.
3. The Department has not previously ruled regarding this matter for Taxpayer. Neither
   Taxpayer nor TAX PRACTIONER has submitted the same or similar issue to the Department
   on behalf of Taxpayer.
4. We are aware of no authority contrary to the authorities referred to and cited below.
   Statement of Facts
   Taxpayer is a Delaware limited partnership established to provide partners with current income
   and long-term capital appreciation. This is achieved primarily by originating senior secured
   loans directly to North American middle market companies. The taxpayer serves as a senior
   secured lender primarily to U.S. companies with less than $25 million EBITDA which require
   financing to fund corporate events such as a buyout, recapitalization, ownership transfer,
   sourcing of expansion and capital growth or refinancing.

IT 18-0011-PLR
Page 2

Taxpayer is managed by COMPANY (hereinafter “COMPANY”). Through COMPANY’s
management, the taxpayer has access to an asset management and origination platform,
which includes a national transaction sourcing network. It is noteworthy that while the taxpayer
is not directly subject to regulation as an investment company, COMPANY is subject to
regulation by the United States Securities and Exchange Commission as a Registered
Investment Advisor.
Taxpayer is actively engaged in the business of originating and investing in senior secured
loans and is treated as such for federal income tax purposes. Accordingly, under the Internal
Revenue Code interest income earned by the taxpayer is treated as ordinary income and
included on its Form 1065. Taxpayer generates interest income in Illinois and other states from
loans secured by assets located across the United States.
By statute, Taxpayer would be considered a dealer in securities for federal income tax
purposes. However, the taxpayer qualifies for an exemption under Treas. Reg. 1.475(c)-1(c).
This regulation provides a taxpayer with an exception from using the mark-to-market method
of accounting. Taxpayer is trying to determine if it would still be considered a dealer for Illinois
Income Tax purposes, and thus, allowed to apportion its income under Illinois Income Tax Act
304(a)(3)(C-5)(iii)(a).
Requested Rulings
Though Taxpayer is not a dealer for federal income tax purposes because of the regulatory
exemption under Treas. Reg. 1.475(c)-1(c), Taxpayer is otherwise a dealer as defined by 26
USC 475 and thus is considered a dealer for purposes of Illinois Income Tax Act 304(a)(3)(C5)(iii)(a)?
Analysis
Illinois has various methods of sourcing interest income; the sourcing depends upon whether
the taxpayer is classified as a dealer within the meaning of 26 USC 475. If the taxpayer is not
a dealer, interest income is sourced to Illinois if the taxpayer’s income-producing activity is
performed in Illinois. However, if the taxpayer is a dealer, 35 ILCS 5/304(a)(3)(C-5)(iii)(a)
states:
“in the case of a taxpayer who is a dealer in the item of intangible property within the meaning
of Section 475 of the Internal Revenue Code, the income or gain is received from a customer
in this State. For purposes of this subparagraph, a customer is in this State if the customer is
an individual, trust or estate who is a resident of this State and, for all other customers, if the
customer’s commercial domicile is in this State. Unless the dealer has actual knowledge of the
residence or commercial domicile of a customer during the taxable year, the customer shall be
deemed to be a customer in this State if the billing address of the customer, as shown in the
records of the dealer, is in this State.”
In looking to federal tax law, Section 475(c)(1) of the Internal Revenue Code (“Code”) defines
a “dealer in securities” as a taxpayer who:

IT 18-0011-PLR
Page 3
(A)

regularly purchases securities from or sells securities to customers in the ordinary
course of a trade or business; or

(B)

regularly offers to enter into, assume, offset, assign, or otherwise terminate
positions in securities with customers in the ordinary course of a trade or business.

In the ordinary course of business, Taxpayer originates loans directly with customers, that is,
Taxpayer makes loans by advancing cash in exchange for debt obligations of its customers.
As Taxpayer regularly originates loans to customers, Taxpayer meets the definition of a “dealer
in securities” as defined in the Code.
In general, Section 475 of the Code requires a dealer in securities to use a merk-to-market
method of accounting. By regulatory grace, however, the IRS effectively provides a taxpayer
with an exception (by not viewing the taxpayer as a dealer) from this mark-to-market accounting
if the taxpayer does not engage in more than “negligible sales” of securities it has originated to
customers. (Treas. Reg. 1.475-1(c)(1)(i)).
A taxpayer with “negligible sales” nonetheless may elect out of this regulatory exemption by
filing its return using the mark-to-market method of accounting described in Section 475(a).
(Treas. Reg. 1.475(c)-1(c)(1)(ii))
In summary, Taxpayer meets the definition of a “dealer in securities” as defined by the Code.
Taxpayer, however, qualifies for a regulatory exemption not to use the mark-to-market method
of accounting. Since taxpayer would technically meet the dealer definition under 475(c) but for
the exemption, the rule allows them to elect dealer status if they want it. As a result, it would
appear Taxpayer could still be considered a dealer for Illinois income tax purposes.
Conclusion
If the Taxpayer is not a dealer because they qualify for the exemption under Treas. Reg.
1.475(c)-1(c), the taxpayer would still be considered a dealer for purposes of IITA 304(a)(3)(C5)(iii)(a).
We respectfully request a private letter ruling from the Department regarding this matter.
Should you disagree with this opinion, please contact me to discuss this opinion prior to issuing
a ruling. If you have any further questions or require any additional information, please contact
me.

RULING
Section 304(a)(3)(A) of the Illinois Income Tax Act (“IITA” ; 35 ILCS 5/304(a)(3)(A)) defines the sales
factor for taxpayers other than insurance companies, financial organizations, federally regulated
exchanges, and transportation companies, as follows:
The sales factor is a fraction, the numerator of which is the total sales of the person in this State
during the taxable year, and the denominator of which is the total sales of the person
everywhere during the taxable year.

IT 18-0011-PLR
Page 4
IITA Section 304(a)(3)(C-5) provides, in part, that, for taxable years ending on or after December 31,
2008, sales, other than sales governed by paragraphs (B), (B-1), (B-2), (B-5) and (B-7), are in this
State if any of the following criteria are met:
(iii) In the case of interest, net gains (but not less than zero) and other items of income from
intangible personal property, the sale is in this State if:
(a) in the case of a taxpayer who is a dealer in the item of intangible personal property
within the meaning of Section 475 of the Internal Revenue Code, the income or gain
is received from a customer in this State. For purposes of this subparagraph, a
customer is in this State if the customer is an individual, trust or estate who is a
resident of this State and, for all other customers, if the customer’s commercial
domicile is in this State. Unless the dealer has actual knowledge of the residence or
commercial domicile of a customer during a taxable year, the customer shall be
deemed to be a customer in this State if the billing address of the customer, as shown
in the records of the dealer, is in this State; or
(b) in all other cases, if the income-producing activity of the taxpayer is performed in
this State or, if the income-producing activity of the taxpayer is performed both within
and without this State, if a greater proportion of the income-producing activity of the
taxpayer is performed within this State than any other state, based on performance
costs.
Section 475 of the Internal Revenue Code (IRC) prescribes use of the mark-to-market accounting
method for dealers in securities. Section 475(c)(1) defines a “dealer in securities” to mean a taxpayer
who:
(A)

regularly purchases securities from or sells securities to customers in the ordinary
course of a trade or business; or

(B)

regularly offers to enter into, assume, offset, assign or otherwise terminate positions in
securities with customers in the ordinary course of a trade or business.

Section 475(a) requires that a dealer in securities apply the mark-to-market method of accounting.
Section 475(b) allows for exceptions to mark-to-market accounting for dealers, providing that
subsection (a) shall not apply to certain securities held by a dealer including:
(B)(i) any security described in subsection (c)(2)(C) which is acquired (including originated) by
the taxpayer in the ordinary course of a trade or business of the taxpayer and which is not held
for sale, and (ii) any obligation to acquire a security described in clause (i) if such obligation is
entered into in the ordinary course of such trade or business and is not held for sale.
Pursuant to these provisions, Treas. Reg. § 1.475(c)-1(c)(1) provides for the following exemption from
dealer status:
A taxpayer that regularly purchases securities from customers in the ordinary course of a trade
or business (including regularly making loans to customers in the ordinary course of a trade or
business of making loans) but engages in no more than negligible sales of the securities so
acquired is not a dealer in securities within the meaning of section 475(c)(1) unless the taxpayer

IT 18-0011-PLR
Page 5
elects to be so treated or, for purposes of section 471, the taxpayer accounts for any security
(as defined in section 475(c)(2)) as inventory.
Under IITA Section 304(a)(3)(C-5)(iii), whether interest, net gains, and other items of income from
intangible personal property are assigned to Illinois for sales factor purposes depends on whether the
taxpayer “is a dealer in the item of intangible personal property within the meaning of Section 475 of
the Internal Revenue Code.” If the taxpayer is a dealer within the meaning of IRC Section 475, the
gross receipts are assigned to Illinois if the customer is in Illinois. If the taxpayer is not a dealer within
the meaning of IRC Section 475, the gross receipts are assigned to Illinois under Section 304(a)(3)(C5)(iii)(b) if the income-producing activity is in Illinois. For this purpose, a taxpayer is a dealer with
respect to an item of intangible personal property if the taxpayer is actually a dealer with respect to
the item under IRC Section 475, or would be a dealer with respect to the item under IRC Section 475
if the item were a security as defined in IRC Section 475(c)(2).
Your letter represents that the Taxpayer derives interest income by making loans to customers in the
ordinary course of its trade or business. You represent that the Taxpayer is not a dealer in securities
within the meaning of IRC Section 475(c)(1) by virtue of the exemption allowed under Treas. Reg. §
1.475(c)-1(c)(1) to taxpayers who make only negligible sales of loans that they originate and who do
not elect out of the exemption. The particular sourcing rule under IITA Section 304(a)(3)(C-5)(iii) to be
applied should not depend on whether a taxpayer does or does not elect out of the dealer exemption
available under Treas. Reg. 1.475(c)-1(c)(1). In either case, the taxpayer earns interest by making
loans to customers in the ordinary course of its trade or business. Accordingly, for purposes of IITA
Section 304(a)(3)(C-5)(iii), a taxpayer who is eligible for the exemption under Treas. Reg. 1.475(c)1(c)(1) is considered a dealer in securities with respect to loans it originates to customers whether or
not the taxpayer elects out of the exemption. In this case, then, Taxpayer must include the interest
income from loans made to its customers in the numerator of its Illinois sales factor under IITA Section
304(a)(3)(C-5(iii)(a) if the customer is a resident of Illinois or its commercial domicile is in this State.
This ruling shall bind the Department as provided herein. The facts upon which this ruling is based
are subject to review by the Department during the course of any audit, investigation or hearing and
this ruling shall bind the Department only if the material facts as recited and incorporated in this ruling
are correct and complete. This ruling shall bind the Department for all taxable years, except as limited
pursuant to 2 Ill. Adm. Code 1200.110(d) and (e).This ruling will cease to bind the Department if there
is a pertinent change in statutory law, case law, rules or in the material facts recited in this ruling.
Sincerely,

Brian L. Stocker
Chairman, PLR Committee (Income Tax)