Can a taxpayer exclude the inventory portion of proceeds from selling an entire business division out of its Illinois sales apportionment factor?

Subject

Alternative Apportionment

Plain-English summary

A taxpayer — a group of three unitary, affiliated corporations that filed a consolidated federal return — sold nearly all the assets of an Illinois grain division during its tax year ending May 31, 2018. The sale covered three classes of assets: accounts receivable, inventory, and fixed assets, for which the taxpayer received a lump sum of gross proceeds allocated among the three categories.

The taxpayer petitioned the Illinois Department of Revenue to use an alternative method of apportionment under 35 ILCS 5/304(f). Specifically, it asked to exclude the gross proceeds and net gains from the inventory component of the sale from both the numerator and denominator of its Illinois sales factor, arguing this would avoid distorting its Illinois-source income and would be consistent with how the other components of the sale (receivables and fixed assets) were treated.

The Department explained that because the grain division's assets were all located in Illinois, all of the sale proceeds would ordinarily be includible in the Illinois sales factor. However, Department regulation 86 Ill. Adm. Code 100.3380(c)(2) excludes gross receipts from an "incidental or occasional sale of assets used in the regular course" of a business — for example, the sale of a factory or plant. The Department agreed the fixed-asset (and, by the same reasoning, receivables) portion of the sale qualified for that exclusion because the taxpayer was not in the business of selling those assets.

Inventory was different. The Department reasoned that a taxpayer cannot have an "occasional" sale of its own inventory — inventory sales are the core, day-to-day source of the taxpayer's business income and are exactly what the sales factor is meant to capture. Illinois's statute (35 ILCS 5/304(a)(3)(B)) generally requires inventory sale proceeds to be included in the sales factor, and the "occasional sale" exclusion in 86 Ill. Adm. Code 100.3380(c)(2) does not reach bulk sales of inventory.

Turning to whether alternative apportionment under 35 ILCS 5/304(f) was nonetheless warranted, the Department applied the burden-of-proof standard in 86 Ill. Adm. Code 100.3390(c): the taxpayer must prove by clear and convincing evidence that the standard statutory formula produces a "grossly distorted result" — not merely a different result. The Department found that even assuming the inventory sale proceeds did not fairly reflect the market for the taxpayer's goods, the difference between the result under the standard statutory method and the taxpayer's proposed alternative method was only about 7%. That gap was not enough to meet the "grossly distorted result" standard set out in Illinois case law (Lakehead Pipe Line Co. v. Dep't of Rev.; Miami Corporation v. Dep't of Rev.; AT&T Teleholdings, Inc. v. Dep't of Rev.).

The Department therefore denied the taxpayer's petition for alternative apportionment as to the inventory sale proceeds. As the letter itself notes, this is a GIL, not a binding Private Letter Ruling — it does not state Department policy and is not binding on the Department.

What this means for you

Businesses selling an entire division or product line

If your business sells off an entire division that includes inventory, don't assume the inventory-sale proceeds can be excluded from your Illinois sales factor the same way proceeds from selling fixed assets or receivables might be. This letter indicates the Department views bulk inventory sales as ordinary business income — not an "occasional sale" — so those proceeds generally stay in the sales factor absent Department guidance to the contrary.

Anyone considering an alternative-apportionment petition

This letter illustrates how high the bar is under 86 Ill. Adm. Code 100.3390(c): you must show by clear and convincing evidence that the standard statutory formula is not just different, but "grossly distorted" — unreasonable and arbitrary in the percentage of income it attributes to Illinois. A roughly 7% difference between methods was not enough here, even where the Department agreed part of the underlying transaction (fixed assets, receivables) genuinely qualified for exclusion.

Accountants and tax professionals

Note the letter's two-step analysis: first, whether an item independently qualifies for exclusion under the specific "occasional sale" regulation (86 Ill. Adm. Code 100.3380(c)(2)); second, and separately, whether the taxpayer has met its burden for the broader alternative-apportionment remedy under 35 ILCS 5/304(f) and 86 Ill. Adm. Code 100.3390(c). A taxpayer can succeed on the first for some assets in a transaction (as happened here for receivables and fixed assets) while failing on the second for other assets in the very same transaction (inventory).

Common questions

Q: Did the Department grant the taxpayer's request to exclude inventory sale proceeds from the sales factor?
A: No. The Department denied the petition, concluding inventory sale proceeds are not eligible for the "occasional sale" exclusion and must remain in the Illinois sales factor.

Q: Did the Department agree that any part of the division sale could be excluded?
A: Yes, implicitly. The Department found that the fixed-asset component (and, by the same reasoning, the accounts-receivable component) of the sale qualified for exclusion under 86 Ill. Adm. Code 100.3380(c)(2) as an incidental or occasional sale of business assets — only the inventory portion was at issue in the denial.

Q: Why doesn't the "occasional sale" exclusion cover inventory?
A: Because inventory sales are the taxpayer's ordinary, day-to-day source of business income, not an incidental or occasional event. The Department reasoned a taxpayer generally cannot have an "occasional" sale of its own inventory, and Illinois's sales-factor statute (35 ILCS 5/304(a)(3)(B)) requires inventory proceeds to be included in the sales factor.

Q: What standard does a taxpayer have to meet to get alternative apportionment approved?
A: Under 86 Ill. Adm. Code 100.3390(c), the taxpayer must prove by clear and convincing evidence that the standard statutory apportionment formula operates unreasonably and arbitrarily, producing a percentage of income attributed to Illinois that is grossly out of proportion to the actual market for the taxpayer's goods or services. A merely different result is not enough.

Q: How big was the difference between the standard method and the taxpayer's proposed method here?
A: About 7%. The Department found that even assuming some distortion existed, a 7% difference did not amount to a "grossly distorted result," so the petition failed on this ground as well.

Q: Is this letter binding on the Illinois Department of Revenue?
A: No. It is a General Information Letter, which by its own terms does not constitute a statement of Department policy and is not binding on the Department. Only a Private Letter Ruling, issued on a specific taxpayer's complete facts, binds the Department.

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/income-tax/2020.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/income-tax/2020/it20-0003-gil.pdf

Original ruling text

IT 20-0003-GIL 01/21/2020 ALTERNATIVE APPORTIONMENT
Alternative Apportionment Not Allowed unless Taxpayer Shows Sales Factor does not Fairly
Reflect Market for Goods or Services. (This is a GIL.)
January 21, 2020

Re:

Petition for Alternative Apportionment

Dear Xxxx:
This is in response to your request to use an alternative method of allocation or apportionment for
your taxable year ending May 31, 2018. Department of Revenue (“Department”) regulations require
that the Department issue only two types of letter rulings, Private Letter Rulings (“PLRs”) and General
Information Letters (“GILs”). PLRs are issued by the Department in response to specific taxpayer
inquiries concerning the application of a tax statute or rule to a particular fact situation. A PLR is
binding against the Department, but only as to the taxpayer issued the ruling and only to the extent
the facts recited in the PLR are correct and complete. GILs do not constitute statements of
Department policy that apply, interpret or prescribe the tax laws and are not binding against the
Department. See 2 Ill. Adm. Code 100.1200(b) and (c). For the reasons discussed below, your
petition cannot be granted at this time.
Your letter states as follows:
As provided by 35 ILCS §5/304(f) and 86 ILAC 100.3390, TAXPAYER hereby petitions for an
alternative method of apportionment for its 20XX tax year for purposes of its Corporate Income
Tax liability in Illinois. Specifically, Taxpayer asks for permission to exclude, from the
numerator and denominator of its sales apportionment factor, the gross proceeds (and net
gains) from the inventory component of its 20XX sale of an entire division. This method would
avoid distorting the Taxpayer’s Illinois source income, which is generated from the day-to-day
sale of inventory to wholesalers, and would be consistent with how Illinois law treats the
proceeds and gains from all of the other components of this sale.
Facts
Taxpayer is a group of three unitary, affiliated corporations with a DATE fiscal year end and
files Form 1120 for federal income tax purposes on a consolidated basis. During its 20XX tax
year (fiscal year ending DATE), Taxpayer sold %%% of the assets of its NAME Illinois grain
division, all of which were located in Illinois. The sale consisted of three different classes of
assets: accounts receivable, inventory, and fixed assets (collectively, the NAME Division
Assets). During the 20XX tax year, Taxpayer received $$$ in gross proceeds in exchange for
these assets, allocated as follows: $$$ to accounts receivable, $$$ to inventory, and $$$ to
fixed assets.
Law and Application
The Illinois sales factor is a fraction that generally includes total sales in Illinois in the
numerator, and total sales everywhere in the denominator. 35 ILCS 5/304(a)(3)(A). Sales of
tangible assets are sourced to Illinois if they are delivered to a purchaser in the state. 35 ILCS
5/304(a)(3)(b)(i). Because Taxpayer’s NAME Division Assets were all located in Illinois and
were thus delivered to the purchaser in Illinois immediately upon their sale, all gross receipts
from this sale would be included in the numerator and denominator of Taxpayer’s Illinois sales
factor absent contrary guidance.

IT 20-0003-GIL
Page 2
However, under 86 ILAC 100.3380(c)(2), gross receipts from an “incidental or occasional sale
of assets used in the regular course” of a seller’s trade or business are excluded from the
seller’s sales factor, both numerator and denominator, and this regulation further provides that
“For example, gross receipts from the sale of a factory or plant will be excluded.” As a result,
Taxpayer’s receipts from the sale of the NAME Division Assets are excluded from its Illinois
sales factor to the extent they qualify as an occasional sale of assets used in the regular
course of business. Under Illinois’s general regulatory framework, Taxpayer’s $$$ gross
receipts from the sale of the fixed asset component of its NAME Division Asset sale are
excluded from its Illinois sales factor because Taxpayer is clearly not in the business of selling
its fixed assets and because the sale of a “factory or plant” is specifically provided as an
example of the type of assets subject to Illinois’ exclusionary rule.
Illinois does not appear to have published any guidance interpreting whether the bulk sale of
inventory would be considered an “occasional sale” of assets “used” in the regular course of a
person’s trade or business assets under 86 ILAC 100.3390(c)(2). As a result, Illinois’ guidance
regarding other tax types may be instructive in interpreting these sales apportionment factor
concepts.
For Illinois Retailer’s Occupation Tax (ROT) purposes, it is generally not possible for a
taxpayer engaged in the business of selling tangible personal property at retail to make an
occasional sale of that same tangible personal property. Isolated or occasional sale treatment
for the Illinois ROT generally only applies to companies who do not habitually engage in selling
tangible personal property at retail. 35 ILCS § 120/1; 86 ILAC 130.110(a). Further, if a taxpayer
takes an item out of inventory to use in its trade or business, then that taxpayer is generally
required to pay Illinois Use tax on that item of inventory. Taxpayer has not used any of these
inventory items in its business and is thus not required to pay Illinois Use Tax on them. As a
result, absent guidance to the contrary, it seems likely that for Illinois sales apportionment
purposes a company could not have an “occasional” sale of its own inventory, and would not
be considered to “use” its own inventory in its business unless it paid Use Tax on it.
Because Illinois’s sales factor clearly requires corporations’ sales factors to generally include
the proceeds from their sale of inventory (35 ILCS §5/304(a)(3)(B)), Illinois’s statutes and
regulations do not generally appear to allow or require the receipts of bulk inventory sales to
be excluded from the sales factor using the occasional sale or isolated sale rule. As a result,
even though the regular/ordinary course of Taxpayer’s business is to sell inventory on a dayto-day basis to wholesalers within and outside Illinois, unless the proceeds from the sale of this
inventory are excluded from the Taxpayer’s sales factor, the resulting apportionment would fail
to fairly represent the market for Taxpayer’s goods simply because the inventory happened to
be located in Illinois at the time that the buyer stepped into Taxpayer’s shoes and took over the
operations of its NAME Division.
Under 35 ILCS §5/304(f), however, Illinois provides alternative apportionment as a remedy for
situations like the one faced by Taxpayer; specifically, ones in which the application of Illinois’
general allocation and apportionment laws do not “fairly represent the market for [Taxpayer’s]
goods.” In fact, one of the statutory justifications specified in Illinois’s regulations for the
exclusion of gross receipts from an occasional or isolated sale from the sales factor under 86
ILAC 100.3390(c)(2)(D), is that, “in the case of asset sales that are made in connection with a
partial or complete withdrawal from the market in the state in which the assets are located,

IT 20-0003-GIL
Page 3
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. This
is the exact situation Taxpayer is facing here: Taxpayer has exited its business market in
NAME Illinois by selling its entire NAME Illinois grain division.
86 ILAC 100.3390, which provides the procedural framework for making Illinois alternative
apportionment petitions, provides that “the party …seeking to utilize apportionment method
has the burden of going forward with the evidence and proving by clear and convincing
evidence that the statutory formula … operates unreasonably and arbitrarily in attributing to
Illinois a percentage of income that is out of all proportion to … the market for the taxpayer’s
goods, services, and other sources of business income in this State.” 86 ILAC 100.3390(c).
In this case, the Taxpayer’s situation clearly meets its burden or proof for being granted an
alternative method of apportionment. Because the Taxpayer is selling its entire line of business
in NAME Illinois, it is fully exiting that business market. This is expressly listed in 86 ILAC
100.3380 as a justification for using Illinois’s alternative apportionment power to require the
sales factor exclusion of receipts from occasional sales of assets used in a taxpayer’s
business, such as the accounts receivable and fixed asset components of the sale of its NAME
Division Assets. Because there does not appear to be any principled reason for not extending
this same treatment to the inventory component of that same sale, that same treatment should
be extended to the inventory in this case.
RULING
Section 304(a) of the Illinois Income Tax Act (“IITA”; 35 ILCS 5/304) provides that when a nonresident
derives business income from Illinois and one or more other states, such income shall be apportioned
to Illinois by multiplying the income by the taxpayer’s apportionment factor. For taxable years ending
on and after December 31, 1998, except in the case of an insurance company, financial organization,
transportation company, or federally regulated exchange, the apportionment factor is equal to the
sales factor. IITA Section 304(a)(3) defines the sale factor as a fraction, the numerator of which is the
total sales of the person in Illinois during the taxable year, and the denominator of which is the total
sales of the person everywhere during the taxable year.
Section 304(f) of the IITA states:
If the allocation and apportionment provisions of subsections (a) through (e) and of subsection
(h) do not, for taxable years ending before December 31, 2008,
fairly represent the extent of a
person’s business activity in this State, or, for taxable years ending on or after December 31, 2008,
fairly represent the market for the person’s goods, services, or other sources of business income, the
person
may petition for, or the Director may, without a petition, permit or require, in
respect of all or any part of the person’s business activity, if reasonable:
(1) Separate Accounting;
(2) The exclusion of any one or more factors;
(3) The inclusion of one or more additional factors which will fairly represent the person’s
business activities or market in this State; or
(4) The employment of any other method to effectuate an equitable allocation and
apportionment of the person’s business income.

IT 20-0003-GIL
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In applying Section 304(f), Department Regulations Section 100.3380(c)(2) provides the following
special rule:
When gross receipts arise from an incidental or occasional sale of assets used in the regular
course of the person's trade or business, those gross receipts shall be excluded from the sales
factor. For example, gross receipts from the sale of a factory or plant will be excluded. Gross
receipts from an incidental or occasional sale of stock in a subsidiary will also be excluded.
Exclusion of these gross receipts from the sales factor is appropriate for several reasons, more
than one of which may apply to a particular sale, including:
A) incidental or occasional sales are not made in the market for the person's goods, services
or other ordinary sources of business income;
B) to the extent that gains realized on the sale of assets used in a taxpayer's business are
comprised of recapture of depreciation deductions, the economic income of the taxpayer was
understated in the years in which those deductions were taken. The recapture gains that
reflect a correction of that understatement should be allocated using a method approximating
the factors that were used in apportioning the deductions. If the business otherwise remains
unchanged, including the gross receipts from the sale in the sales factor numerator of the state
in which the assets were located would allocate a disproportionate amount of the recapture
gains to that state compared to how the deductions being recaptured were allocated;
C) to the extent the gain on the sale is attributable to goodwill or similar intangibles
representing the value of customer relationships, including the gross receipts from the sale in
the sales factor will not reflect the market for the taxpayer's goods, services or other ordinary
sources of business income to the extent the sourcing of the receipts from that sale differs
from the sales factor computed without regard to that sale; and
D) in the case of sales of assets that are made in connection with a partial or complete
withdrawal from the market in the state in which the assets are located, including the gross
receipts from those sales in the sales factor would increase the business income apportioned
to that state when the taxpayer's market in that state has decreased.
As indicated above, the special rule under Regulations Section 100.3380(c)(2) applies only in the
case of an incidental or occasional sale of assets used in the regular course of the person’s trade or
business. It does not apply to gross receipts from the sale of property that is properly included in the
inventory of the taxpayer. The sale of inventory is the quintessential source of a taxpayer’s business
income, the sale of which serves to primarily establish the market for the taxpayer’s sources of
business income. Gross receipts from the sale of inventory property, whether or not a bulk sale, are
not excluded from the sales factor under Regulations Section 100.3380(c)(2).
As indicated above, for taxable years ending or after December 31, 2008, alternative apportionment
under IITA Section 304(f) is appropriate in cases where the allocation and apportionment provisions
under IITA Sections 304(a) through (e) do not fairly represent the market for the taxpayer’s goods,
services, or other sources of business income. Department Regulations Section 100.3390 allows
taxpayers to petition the Department for application of an alternative apportionment method. Section
100.3390(c) sets forth the taxpayer’s burden of proof, as follows:

IT 20-0003-GIL
Page 5
Burden of Proof. A departure from the required apportionment method is allowed only when
those methods do not accurately and fairly reflect business activity in Illinois (for taxable years
ending before December 31, 2008) or market in Illinois (for taxable years ending on or after
December 31, 2008). An alternative apportionment method may not be invoked, either by the
Director or by a taxpayer, merely because it reaches a different apportionment percentage
than the required statutory formula. However, if the application of the statutory formula will lead
to a grossly distorted result in a particular case, a fair and accurate alternative method is
appropriate. The party (the Director or the taxpayer) seeking to utilize an alternative
apportionment method has the burden or going forward with the evidence and proving by clear
and convincing evidence that the statutory formula results in the taxation of extraterritorial
values or operates unreasonably and arbitrarily in attributing to Illinois a percentage of income
that is out of all proportion to the business transacted in this State (for taxable years ending
before December 31, 2008) or the market for the taxpayer's goods, services or other sources
of business income in this State (for taxable years ending on or after December 31, 2008). In
addition, the party seeking to use an alternative apportionment formula must go forward with
the evidence and prove that the proposed alternative apportionment method fairly and
accurately apportions income to Illinois based upon business activity in this State (for taxable
years ending before December 31, 2008) or the market for the taxpayer's goods, services or
other sources of business income in this State (for taxable years ending on or after December
31, 2008).
In any event, your petition fails to meet this burden. Even assuming, arguendo, the sales at issue do
not reflect the market for the taxpayer’s business income, the difference between the taxpayer’s
Illinois market applying the statutory method and the Illinois market under your proposed method is
approximately 7%. Therefore, your petition would have nonetheless failed to demonstrate that the
statutory method would lead to a grossly distorted result in attributing to Illinois a percentage of
income that is out of all proportion to the market for the taxpayer's goods, services or other sources of
business income in this State. See Lakehead Pipe Line Co. v. Dep’t of Rev., 192 Ill. App. 3d 756 (1st
Dist. 1989); Miami Corporation v. Dep’t of Rev., 212 Ill. App. 3d 702 (1st Dist. 1991); AT&T
Teleholdings, Inc. v. Dep’t of Rev., 978 N.E.2d 371 (Ill. App. Ct. 2012).
As stated above, this is a GIL. A GIL does not constitute a statement of policy that applies, interprets
or prescribes the tax laws, and it is not binding on the Department.

Sincerely,

Brian Stocker
Associate Counsel (Income Tax)