My company's foreign brand-licensing royalties are excluded from my Illinois sales factor because they're under 50% of gross receipts -- can I get alternative apportionment to include them anyway, since they're a big, high-margin chunk of our income?

Plain-English summary

The taxpayer is a wholly owned Illinois-combined-group subsidiary of a large global consumer-goods parent based outside Illinois. The parent and its U.S. subsidiaries own valuable brand intangibles and earn substantial royalties from foreign affiliates that license those intangibles as a percentage of the affiliates' foreign sales. Because those royalties made up less than 50% of the taxpayer's (and its unitary group's) total gross receipts, Illinois's sales-factor rule -- IITA Section 304(a)(3)(B-2) -- excluded them entirely from both the numerator and denominator of the single sales factor used to apportion income to Illinois.

The taxpayer filed petitions (essentially identical, for two tax years, plus a request covering future years) arguing that this exclusion was distortive: the royalties represented a significant share of total gross income and unitary business income, carried a much higher profit margin than the taxpayer's other income, and had no connection to Illinois at all (the royalty-producing activity -- R&D, brand oversight, licensing -- happened entirely outside the state). The taxpayer proposed three possible fixes: (1) include the royalties directly in the sales factor; (2) use separate accounting to apportion the royalties apart from other activity; or (3) expand the combined group to include the "80/20" foreign affiliates paying the royalties. The taxpayer marshaled an extensive list of out-of-state and Illinois cases (Miami Corp., Colgate-Palmolive, Crocker, Twentieth Century Fox, Atlantic Richfield, Crisa, Microsoft) arguing that excluding a large, high-margin, unrepresented income stream from an apportionment factor is exactly the kind of "unusual fact pattern" that justifies departing from the standard formula.

The Department denied the petition in full. Under 86 Ill. Adm. Code 100.3390(c), a taxpayer seeking alternative apportionment must prove by clear and convincing evidence both that the standard formula produces a grossly distorted, out-of-proportion result, and that its own proposed alternative would fairly and accurately apportion income instead. The Department held the taxpayer's showing fell short on every point:

• No inherent distortion from the sales-factor exclusion itself. The 50%-of-gross-receipts threshold in Section 304(a)(3)(B-2) is a deliberate line Illinois drew to keep occasional or minor royalty streams from skewing the sales factor. There is nothing inherently distortive or unfair about excluding royalties that fall under that threshold, even if they are a meaningful share of income or carry a high margin. Citing the Michigan Supreme Court's Vectren decision, the Department characterized the taxpayer's real complaint as just "a gripe about which factors are or are not included in the formula" -- the kind of argument courts have "consistently unsuccessfully" rejected across many different apportionment-formula challenges.
• Miami Corp. is distinguishable. The taxpayer leaned heavily on Miami Corp., an Illinois case that found gross distortion from Louisiana oil-and-gas intangibles not counted in the (then three-factor) apportionment formula. The Department distinguished it two ways: the intangible rights in Miami Corp. ran with real estate located in other states, unlike the brand-licensing intangibles here, and Illinois's formula has since shifted from a three-factor formula to a single sales factor, changing the relevant baseline entirely.
• Fallback proposals unsupported. The Department found that simply asserting separate accounting or an expanded combined group "would" produce a fairer result, without explaining why those methods are more accurate than the standard formula, does not meet the taxpayer's burden of proof. It further noted that unwinding a unitary business into separate accounting risks creating new distortions of its own, since intercompany transactions and pricing within a unitary group are not easily disentangled.

Because the threshold showing of gross distortion was never made, the Department did not need to separately evaluate whether the taxpayer's proposed alternatives would themselves fairly apportion income.

What this means for you

Companies with foreign royalty or licensing income excluded from the sales factor

Illinois's 50%-of-gross-receipts test for including intangible-property royalties in the sales factor is a bright-line rule, not merely a rebuttable starting point. Being on the losing side of that threshold -- even for a large, high-margin royalty stream -- is not by itself proof of unconstitutional distortion. You need affirmative evidence that the result is grossly disproportionate to your actual Illinois activity, not just that a different treatment would produce a smaller number.

Anyone relying on Miami Corp. or similar precedent to support an alternative apportionment request

Read the facts of your precedent case carefully before leaning on it. The Department distinguished Miami Corp. on its specific facts (real-property-linked intangibles, and an apportionment formula that no longer exists in that form). A prior favorable ruling on different facts, or under an outdated formula, won't carry your petition.

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

Don't just assert that separate accounting or a different combined-group composition "would be" more accurate -- you must affirmatively show why. The Department specifically flagged that pulling a member out of a unitary group into separate accounting creates its own distortion risk from unresolved intercompany pricing, so this fallback can cut against you if not carefully substantiated.

Anyone filing near-duplicate petitions across multiple tax years

This taxpayer filed essentially the same petition, largely verbatim, for two separate tax years and asked the ruling to also cover future years. The Department addressed both years together in a single ruling and denied both -- duplicating the argument didn't strengthen it.

Common questions

Q: Why doesn't excluding a large, high-margin royalty stream from the sales factor count as distortion?
A: Because Illinois's sales-factor exclusion for intangible-property royalties (IITA Section 304(a)(3)(B-2)) is based on a specific 50%-of-gross-receipts threshold that the legislature set deliberately. The Department found no inherent unfairness in applying that threshold as written, regardless of the excluded royalties' size or profit margin -- a taxpayer must still separately prove the resulting apportionment is grossly out of proportion to its actual Illinois activity.

Q: The taxpayer cited Miami Corp., an Illinois case that found distortion -- why didn't that work here?
A: The Department distinguished Miami Corp. on its facts: that case involved intangible rights tied to out-of-state real estate under a three-factor apportionment formula Illinois no longer uses. The royalty income here came from brand licensing, not real estate, under today's single-sales-factor formula, so the same reasoning didn't transfer.

Q: Why was the separate-accounting fallback also denied?
A: Because the taxpayer only asserted that separate accounting would fairly represent its Illinois activity, without explaining why it would be more accurate than the standard formula. The Department also noted that separating a member out of a unitary group can introduce new distortions from unresolved intercompany pricing.

Q: What must a taxpayer prove to get Illinois to grant alternative apportionment?
A: By clear and convincing evidence, that the standard statutory formula results in taxation of extraterritorial values or an out-of-proportion attribution of income to Illinois, AND that the taxpayer's specific proposed alternative would fairly and accurately apportion income to Illinois instead. Showing that an alternative reaches a different (or smaller) number is not enough on its own.

Citations and references

Statutes, regulations, and cases cited:

• 35 ILCS 5/304(a) (business income apportionment; single sales factor)
• 35 ILCS 5/304(a)(3)(B-2) (intangible-property royalties excluded from sales factor unless >50% of gross receipts)
• 35 ILCS 5/304(a)(3)(B-1) (sourcing of intangible-property receipts not excluded under B-2)
• 35 ILCS 5/304(f) (alternative apportionment petition)
• 35 ILCS 5/304(h) (single sales factor apportionment requirement)
• 35 ILCS 5/1501(a)(27)(A) (80/20 company exclusion from combined group, cited by taxpayer)
• 86 Ill. Adm. Code 100.3370(a)(2)(F), (c)(6) (sourcing and treatment of intangible-property receipts)
• 86 Ill. Adm. Code 100.3380(a)(2) (Department-prescribed apportionment methods)
• 86 Ill. Adm. Code 100.3390(a), (c), (e)(1), (e)(2) (alternative apportionment procedures, burden of proof, filing requirements)
• Miami Corp. v. Dep't of Rev., 212 Ill. App. 3d 702 (1st Dist. 1991) (cited by taxpayer; distinguished by Department)
• Lakehead Pipe Line Co. v. Dep't of Rev., 192 Ill. App. 3d 756 (1st Dist. 1989) (cited by Department)
• AT&T Teleholdings, Inc. v. Dep't of Rev., 978 N.E.2d 371 (Ill. App. Ct. 2012) (cited by Department)
• Vectren Infrastructure Services Corp. v. Department of Treasury, 512 Mich. 594 (cited by Department)
• Atlantic Richfield Co. v. Alaska, 705 P.2d 418 (Alaska 1985) (cited by taxpayer and Department)
• Colgate-Palmolive Co. v. Bower, No. 01 L 50195 (Cook Cty. Cir. Ct. 2002) (cited by taxpayer)
• Crocker Equipment Leasing, Inc. v. Dep't of Rev., No. 2973, 12 OTR 16 (1992) (cited by taxpayer)
• Twentieth Century-Fox Film Corp. v. Dep't of Rev., 299 Or. 220, 700 P.2d 1035 (1985) (cited by taxpayer)
• Appeal of Crisa Corp., 2002-SBE-004 (Cal. State Bd. of Equalization 2002) (cited by taxpayer)
• Microsoft Corp. v. Franchise Tax Bd., 39 Cal. 4th 750 (2006) (cited by taxpayer)
• Private Letter Ruling IT 05-0002-PLR (3/29/2005) (cited by taxpayer)
• Private Letter Ruling IT 05-0007-PLR (10/17/2005) (cited by taxpayer)

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/income-tax/2024.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/income-tax/2024/IT24-0006-GIL.pdf

Original ruling text

IT 24-0006-GIL 06/24/2024 ALTERNATIVE APPORTIONMENT
Alternative apportionment not appropriate where royalties earned from licensing
the use of intangible personal property did not comprise more than 50% of
taxpayer’s total gross receipts included in gross income and are excluded from
sales factor pursuant to IITA Section 304(a)(3)(B-2). (This is a GIL.)
June 24, 2024
NAME
TITLE, BUSINESS
COMPANY1
ADDRESS
Re:

Petition for Alternative Apportionment
COMPANY1
FEIN: ##-#######
Tax Years Ended: MM/DD/YEAR1, MM/DD/YEAR2

Dear NAME:
This is in response to your April 22, 2024, petition to use an alternative method of
allocation or apportionment. The nature of your request and the information you have
provided require that we respond with a General Information Letter, which is designed to
provide general information, is not a statement of Department policy, and is not binding on
the Department. See 2 Ill. Adm. Code Section 1200.120(b) and (c), which may be found on
the Department’s website at https://tax.illinois.gov/. For the reasons discussed below,
your petition cannot be granted based on the information provided.
Your petition for the YEAR1 tax year ended states as follows:
COMPANY1 (“COMPANY1” or “Taxpayer”) timely filed an original YEAR3 Illinois
Corporate Income and Replacement Tax Return (“Return”). The Taxpayer is now
amending its YEAR3 Return to revise the Taxpayer’s apportionment. Taxpayer
respectfully requests that the Illinois Department of Revenue (“Department”)
approve the utilization of alternative apportionment and accept the Amended
Return as filed and for prospective tax years ending on or after YEAR4.
Background Information
COMPANY1 is a wholly owned subsidiary of COMPANY2 (“COMPANY2”).
COMPANY2 was formed in YEAR5 when the firm made its initial public offering, and
was later incorporated in STATE in YEAR6. COMPANY2 operates solely outside of
Illinois in southwest STATE. COMPANY2, along with its subsidiaries, is a global
leader in the consumer goods industry providing branded products of superior
quality and value.

NAME/COMPANY1
Page 2
June 24, 2024
The COMPANY2 business revolves around five major segments: Beauty; Grooming;
Health Care; Fabric and Home Care; and Baby, Feminine, and Family Care. 1
COMPANY2’s products are instantly recognizable when browsing the aisles of most
stores. Brands available around the globe include: NAME, among many others.
These products are sold in more than ### countries and territories, primarily
through mass merchandisers, e-commerce, grocery stores, membership club
stores, drug stores, department stores, distributors and pharmacies. 2 The United
States (“U.S.”) accounts for roughly %%% of the company’s worldwide net sales. 3
Europe is responsible for %%% of sales, Asia contributes %%% and Latin America
%%%. 4 To facilitate such activities, the company has on-the-ground manufacturing
and commercial operations in approximately ### countries. 5
COMPANY2, along with other U.S. subsidiaries that are included in the Illinois
combined filing group, own many valuable intangibles used in the U.S. and globally.
COMPANY2 and its U.S. subsidiaries are responsible for all corporate governance
and administrative duties, advertising, and research and development for its global
brands. As a result, in addition to sales of consumer goods, COMPANY2 and certain
U.S. subsidiaries receive royalties from foreign affiliates through licensing
arrangements for the intangibles owned by COMPANY2 and its U.S. subsidiaries.
These foreign royalties are earned as a percentage of sales from foreign affiliates
and represent the primary source of royalties reported on the Federal 1120. The
income producing activities related to the royalty income, including research and
development, monitoring, and supervision of the intangible personal property, take
place entirely outside of Illinois. These royalties represent a significant amount of
income and have a relative profit margin much higher than other apportionable
income as further discussed below.
Pursuant to 35 ILCS 5/304(h) of the Illinois Income Tax Act (“IITA”, “35 ILCS 5/”, “the
Act”, “ILCS Chapter 35 Section 5/”), Taxpayer filed its original return following the
standard apportionment method using a single sale factor formula. Taxpayer’s
sales factor consisted primarily of sales of tangible personal property representing
consumer goods sold by members of the Illinois combined group. However,
COMPANY2 and certain U.S. subsidiaries were unable to include in the Taxpayer’s
sales factor the royalties earned from licensing the use of intangible personal
property because such income did not comprise more than 50% of Taxpayer’s total
gross receipts included in gross income as required under IITA 35 ILCS
5/304(a)(3)(B-2).
COMPANY2, Annual Report (Form 10-K) (June 30, 2018).
Id.
3
Id.
4
Id.
5
Id.
1
2

NAME/COMPANY1
Page 3
June 24, 2024
Alternative Apportionment
Law
ILCS Chapter 35 Section 5/304(f) provides that if the normal allocation and
apportionment methods do not fairly represent the market for the person’s goods,
services, or other sources of business income in Illinois, the person can petition the
Director of Revenue to permit separate accounting or the use of any other method
to create an equitable allocation and apportionment of the taxpayer’s business
income.
Ill. Admin. Code §100.3390(a)(c) (IITA Section 304(f)) reads as follows:
A departure from the required apportionment method is allowed only when
those methods do not accurately and fairly reflect business activity in Illinois
(for taxable years ending before December 31, 2008) or market in Illinois (for
taxable years ending on or after December 31, 2008). An alternative
apportionment method may not be invoked, either by the Director or by a
taxpayer, merely because it reaches a different apportionment percentage than
the required statutory formula. However, if the application of the statutory
formula will lead to a grossly distorted result in a particular case, a fair and
accurate alternative method is appropriate. The party (the Director or the
taxpayer) seeking to utilize an alternative apportionment method has the
burden or going forward with the evidence and proving by clear and convincing
evidence that the statutory formula results in the taxation of extraterritorial
values or operates unreasonably and arbitrarily in attributing to Illinois a
percentage of income that is out of all proportion to the business transacted in
this State (for taxable years ending before December 31, 2008) or the market for
the taxpayer’s goods, services or other sources of business income in this State
(for taxable years ending on or after December 31, 2008). In addition, the party
seeking to use an alternative apportionment formula must go forward with the
evidence and prove that the proposed alternative apportionment method fairly
and accurately apportions income to Illinois based upon business activity in
this State (for taxable years ending before December 31, 2008) or the market for
the taxpayer’s goods, services or other sources of business income in this State
(for taxable years ending on or after December 31, 2008).
The Appellate Court of Illinois held in Miami Corp v. Dept. Rev., 571 N.E.2nd 800
that use of the statutory method was inappropriate. It was determined that the
taxpayer was entitled to utilize separate accounting. The statutory apportionment
formula (the three-factor method) did not fairly represent activities in Illinois with
respect to Louisiana oil and gas reserves which generated in excess of 80% of the

NAME/COMPANY1
Page 4
June 24, 2024
taxpayer’s total income. The court found that the distortion created by the use of
the statutory formula amounted to an unfair representation of the taxpayer’s
activities within Illinois. Part of the court’s reasoning was based on the fact that
intangibles (sourced to Louisiana) were not included in the property factor and
substantial out-of-state independent contractors were not considered in the payroll
factor.
The Department has granted alternative apportionment requests when the statutory
apportioned income attributable to business activity in Illinois does not fairly reflect
the activities of the taxpayer in Illinois. In Private Letter Ruling IT 05-0002-PLR
(3/29/2005), the Department granted the use of separate accounting when the
taxpayer demonstrated that the statutory apportionment method attributed more
income to Illinois than was earned by the individual unitary group members who
were conducting business in Illinois. The Department further approved a separate
accounting method for the same taxpayer in Private Letter ruling IT 05-0007-PLR
(10/17/2005).
The Illinois Administrative Code sets forth the rules and requirements for alternative
apportionment petitions. 6 Subsection (e) of the Regulation prescribes three options
for requesting alternative apportionment. In relevant part, the Regulation provides
that a petition for alternative apportionment may be filed as an attachment to a
return amending an original return which was filed using the statutory allocation
and apportionment rules. 7
Subsection (a) of the Regulation identifies the types of alternative apportionment
that may be requested. If reasonable, a taxpayer may petition for the following: (1)
separate accounting; (2) the exclusion of any one or more of the factors; (3) the
inclusion of one or more additional factors which will fairly represent the person’s
business activity in the state; or (4) the employment of any other method to
effectuate an equitable allocation and apportionment of the person’s income. 8
Discussion
In Taxpayer’s case, the standard apportionment formula does not fairly represent
the market for its business income, which includes royalties earned from the
licensing of intangible personal property. Taxpayer is petitioning for an equitable
allocation and apportionment of its income under 86 Ill. Admin. Code
§100.3390(a)(4).

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

NAME/COMPANY1
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June 24, 2024
As stated above, Taxpayer was unable to include in its sales factor royalties earned
from licensing the use of intangible personal property primarily consisting of
royalties paid by foreign affiliates through licensing arrangements for the intangibles
owned by COMPANY2 and its U.S. subsidiaries included in the Illinois combined
group. Taxpayer asserts that the application of the standard single sales factor
which excludes the royalties from the sales factor is distortive and does not fairly
represent the market for the taxpayer’s business income.
For the fiscal years ending DATE - DATE, the royalties earned by COMPANY2 and its
subsidiaries included in the Illinois combined filing group represents %%% of total
gross income, while the net royalty income represents %%% of Illinois combined
unitary income. The royalties earned by the Taxpayer are included in business
income subject to formula apportionment in Illinois. However, there is no
representation of the royalties in the sales factor because the royalties are excluded
pursuant to IITA 35 ILCS 5/304(a)(3)(B-2).
IITA 35 ILCS 5/304(a)(3)(B-2) provides as follows:
Gross receipts from the license, sale, or other disposition of patents,
copyrights, trademarks, and similar items of intangible personal property, other
than gross receipts governed by paragraph (B-7) of this item (3), may be
included in the numerator or denominator of the sales factor only if gross
receipts from licenses, sales, or other disposition of such items comprise more
than 50% of the taxpayer’s total gross receipts included in gross income during
the tax year and during each of the 2 immediately preceding tax years; provided
that, when a taxpayer is a member of a unitary business group, such
determination shall be made on the basis of the gross receipts of the entire
unitary business group.
The standard apportionment formula allows gross receipts from the licensing of
intangible property (e.g., royalties) to be included in the sales factor only if gross
receipts from licensing of such items comprise more than 50% of the taxpayer’s
total gross receipts included in gross income during the tax year and during each of
the 2 immediately preceding tax years. Because Taxpayer’s royalty income consists
of only %%% of total gross income, the royalty income is excluded from the sales
factor. Note, if Taxpayer’s royalty income was included in the sales factor, the gross
receipts would be sourced to Illinois if the income producing activity of such
income is performed in the state based on costs of performance.
Effective for tax years ending on or after December 31, 2008, gross receipts from
transactions involving intangible personal property when the taxpayer is not a
dealer with respect to the intangible personal property, are attributed to Illinois if

NAME/COMPANY1
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June 24, 2024
the income producing activity is performed in the state, based on costs of
performance. 9 Such gross receipts are sourced in Illinois when the income
producing activities are performed both in and outside the state and, based on
costs of performance, a greater proportion of the income producing activity is
performed in Illinois than in any other state. 10
However, the standard apportionment formula was not created with Taxpayer’s
facts in mind. It does not consider the significant impact the earned royalties
represent of total business income. The net royalty income represents %%% of the
total combined business income for the tax years ended DATE - DATE. Yet there is
no connection between Illinois and the foreign royalties, including from where they
were paid and received, as well as the income producing activity which takes place
outside of Illinois. Furthermore, including the foreign royalties in the sales factor
results in relief from the disparate taxation of extraterritorial income (i.e., the foreign
royalties) earned from the Taxpayer’s unitary business and paid by unitary foreign
affiliates. Without such relief, the statutory formula operates unreasonably and
arbitrarily in attributing income to Illinois when the royalties have no representation
in the sales factor as further discussed below.
Moreover, the profit margin on the royalty income, representing branded consumer
product sales outside of the United States, is significantly higher than the profit
margin earned on the other sales earned by the Taxpayer. In aggregate for fiscal
years ending DATE – DATE, the average profit margin for royalty income was %%%.
In contrast, the average profit margin earned by the Taxpayer’s other income was
%%% for fiscal years ending DATE – DATE. This further supports that there is a
grossly distorted result when the royalties have no representation in the sales
factor, while the profit margin for the royalties is approximately %%% to %%%
higher than the profit margin earned by the Taxpayer’s other income.
In Colgate-Palmolive Company, Inc. (“Colgate-Palmolive”) v. Bower, No. 01 L 50195
(10/15/2002) (“Colgate”), the Cook County Judicial Circuit Court held that a
Delaware corporation that had business operations in Illinois was not allowed to
modify the standard apportionment formula (the three-factor formula method).
Colgate-Palmolive filed for alternative apportionment to add a fourth intangible
property factor to the Illinois three-factor formula to fairly represent foreign royalties
and dividends from foreign subsidiaries. The Administrative Law Judge ruled that
Colgate-Palmolive failed to meet its burden of establishing that the standard
formula failed to “fairly represent the extent” of Colgate-Palmolive’s business in
Illinois. 11 The court found that “ ... each part of Illinois’ statutory three factor
86 Ill. Admin. Code §100.3370(c)(6).
86 Ill. Admin. Code §100.3370(c)(6)(C)(ii).
11
Colgate.
9

10

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June 24, 2024
formula takes into account the ordinary income producing activities and expenses
related to Colgate-Palmolive’s production of the income at issue, as well as the fact
the income producing activities related to the particular income at issue were not
performed within Illinois.” 12
In reaching the decision that Colgate-Palmolive failed to meet its burden, the court
reasoned that all three factors had representation of the activities associated with
the foreign royalties and dividends from foreign subsidiaries. Specifically, the sales
factor included the dividends from foreign corporations and royalty income earned
from licensing intangible personal property to foreign subsidiaries. Regarding the
royalty income in particular, the sales factor was specifically designed to take into
account where the costs of performance related to a taxpayer’s licensing or other
disposition of business intangibles occurred, in order to apportion the receipts
realized by such activities in the ordinary course of the taxpayer business. 35 ILCS
5/304(a)(3), 5/1501(21); 86 Ill. Admin. Code §100.3370(a), (b). 13
It should be noted that the foreign royalties and dividends from foreign subsidiaries
earned by Colgate-Palmolive were included in the sales factor despite the fact that
they did not comprise more than 50% of the total gross receipts of the taxpayer. 14
The court’s reasoning in Colgate can be applied in the Taxpayer’s case. In contrast
to Colgate, the standard apportionment formula today fails to represent the market
for the royalty income in the Taxpayer’s case because the royalties earned from
licensing of intangible property are excluded from the sales factor (i.e., the royalties
do not comprise more than 50% of Taxpayer’s gross income). The lack of inclusion
in the factor fails to take into account the ordinary income producing activities and
expenses related to Taxpayer’s royalty income (i.e., no factor representation), as
well as the fact the income producing activities related to the particular income at
issue were not performed in Illinois. Further, Illinois administrative code specifies
that income shall be included in the denominator (and numerator) of the sales
factor when the income producing activity relative to the sourcing of business
income from intangible personal property can be readily identified, such as in the
Taxpayer’s case. 15
Other State Alternative Apportionment Decisions

12

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

NAME/COMPANY1
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June 24, 2024
In Crocker Equipment Leasing, Inc. (“Crocker”) v. Department of Revenue, No.
2973, 12 OTR 16 (1992), the Court found that the taxpayer’s alternative formula was
a reasonable method of attributing income to the state. The three-factor
apportionment formula used by the Department of Revenue to apportion the
Oregon business income of the subsidiary of a U.S. chartered national bank for
corporate excise tax purposes did not fairly represent the extent of the
corporation’s business activity in Oregon, because the calculation did not include
intangible property in the property factor. Crocker maintained that 98 percent of its
earning assets were intangible, so the property must be included in the factor to
avoid distortion. The court found that the taxpayer’s methodology was reasonable,
as it established a “realistic relationship to how the income is earned.”
The court’s reasons can be applied to the Taxpayer’s case. Including royalties in the
sales factor realistically represents the relationship between licensing of intangible
property and the income earned from sale of those consumer goods. By not
including the royalties, the apportionment formula does not reasonably represent
the Taxpayer’s activities in Illinois. Stated differently, similar to Crocker, the
inclusion of the royalties in the sales factor establishes a realistic relationship to
how the Taxpayer earns its income, because the royalties represent the income
earned from branded consumer product sales worldwide by unitary foreign
affiliates as a result of the use of the same intangible property for the sale of
branded consumer goods in the United States.
In Twentieth Century-Fox Film Corp. (“Twentieth Century Fox”) v. Department of
Revenue, 299 Or. 220, 700 P.2d 1035 (1985), Twentieth Century Fox used the
statutory three-factor formula for apportionment of income to Oregon. The taxpayer
included in the numerator of the property factor only the cost of the positive prints
of its films, which were the only tangible personal property distributed in Oregon.
Film negatives, which were not included in the numerator, are valued at the cost of
producing the film, making them quite valuable. The court determined that it was
unfair to merely include the value of the positive prints and ignore the negatives,
because it ignored the economic reality of the film industry. The Oregon
Department of Revenue modified the property factor by including the value of the
film negatives in the value of the positive prints.
The court’s reasoning can also be applied to the Taxpayer’s case. In order to convey
the economic reality of the Taxpayer’s business, the sales factor needs to include
activity from both the sales of tangible personal property and royalties received
from licensing of intangible property. The income generated by the licensing of
intangible property is effectively a portion of the sales of consumer goods, because
the royalty income is based on a percentage of the sales of branded consumer
goods by certain unitary foreign affiliates. It is unreasonable to exclude the royalties

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related to the sale of branded consumer goods by the unitary foreign affiliates that
is earned as a percentage royalty, just as it was unreasonable to exclude the
negative prints from apportionment for Twentieth Century Fox.
While the Twentieth Century Fox case may be an industry related issue, the
Taxpayer has an economic reality that differs from most other companies within its
industry. The Taxpayer generates a significant amount of revenue from foreign
royalties as a result of their brand strategy and recognition and generates
substantial revenue from royalties which have no representation in the sales factor.
By subjecting the Taxpayer to an apportionment formula excluding one of their
major revenue producing activities, there is gross distortion in the amount of
income apportioned to Illinois and it is not representative of the Illinois market.
In Atlantic Richfield Co. (“Atlantic Richfield”) v. Alaska, 705 P.2d 418 (Alaska 1985)
(“Atlantic Richfield”), as addressed in the GIL, the Alaska supreme court wrote that:
A unique characteristic of unitary oil and gas businesses is that the major
income-producing element is the value of the oil and gas reserves in the
ground. While this element can be readily identified, it is not recognized
under traditional formula apportionment methods. *** [S]eparate
accounting, not formula apportionment, is the prevailing method throughout
the United States for reporting income for oil production. 16
The case of Atlantic Richfield shows that failure to reflect income that is prevalent
and a major income producing element to a company is distortive. Atlantic
Richfield’s major income producing element was their gas and oil reserves, which
was not recognized using traditional apportionment methods. In the instant case,
Taxpayer’s major income-producing element is the use of the intangible property
related to the business’s branded consumer product sales. The intangible property
is used by the Taxpayer to earn revenue from the selling of branded consumer
goods inside and outside of the United States. The character of the gross receipt
from the consumer goods sold inside the United States represents the sale of
tangible personal property, while the character of the gross receipts from the
consumer goods sold outside the United States is royalty income. Both gross
receipt characters must be included in the sales factor in order for the sales factor
to fairly and accurately reflect the Taxpayer’s major income-producing element (i.e.,
the sale of consumer goods). Again, without their intangibles, COMPANY2 would
not have the ability to produce and sell its consumer branded products. The
intangible property related to their brands is a central part of their business model,
which relies on the success of existing brands as well as creation of new products
16

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

NAME/COMPANY1
Page 10
June 24, 2024
and brands. COMPANY2 attributes their financial success directly with the success
of their brands. 17
In Appeal of Crisa Corporation, 2002-SBE-004 (6/20/02), California State Board of
Equalization (“SBE”) found the taxpayer’s numerical comparisons standing alone
are not sufficient to prove distortion and the taxpayer’s request was ultimately
denied. The SBE ruled that the central question related to alternative apportionment
is not whether there is a large enough numerical distortive change, but rather
whether there are unusual facts that lead to unfair representation under the
standard apportionment factor. They provided five examples of “unusual
transactions” that could trigger application of alternative apportionment, one of
which reading as follows:
A particular factor does not have material representation in either the
numerator or denominator, rendering that factor useless as a means of
reflecting business activity. For example, because a company does not own
or rent any tangible or real personal property, the numerator and
denominator of the property factor are zero. (See Appeal of Oscar
Enterprises, LTD, 87-SBE-069, Oct. 6, 1987.)
This example of an “unusual transaction” can be applied to Taxpayer’s activity in
Illinois. The royalty revenues represent a significant portion of the profitability of the
Taxpayer, but are not represented in the sales factor numerator or denominator.
When looking at profit margin, the margin earned on royalty revenues is
approximately %%% to %%% higher than the profit margin earned on other gross
income of the Taxpayer for fiscal years ending DATE - DATE. However, only the other
gross income earned by the Taxpayer is represented in the statutory sales formula
resulting in a material misrepresentation. Furthermore, the exclusion of the
royalties from the sales factor leads to unfair representation under the standard
apportionment factor because the sales factor is not representing all of the income
earned from the Taxpayer’s intangible property in connection with the sale of
branded consumer products as described above.
In Microsoft Corp. (“Microsoft”) v. Franchise Tax Board, 39 Ca. 4th 750, 771 (2006)
(“Microsoft Corp.”), the court found that treasury receipts were distortive where the
receipts generated less than 2 percent of Microsoft’s income but 73 percent of its
gross receipts. 18 However, the court also noted that the FTB’s approach of removing
large receipts can result in an exaggeration of California tax when the receipts

17
18

COMPANY2., Annual Report (Form 10-K) (June 30, 2021).
Microsoft Corp., 39 Cal. 4th at 771.

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account for a substantial portion of the taxpayer’s income. 19 Specifically, the court
stated:
We caution, however, that in other cases the Board’s approach may go too
far in the opposite direction and fail the test of reasonableness. By mixing
net receipts for a particular set of out-of-state transactions with gross
receipts for all other transactions, it minimizes the contribution of those outof-state transactions to the taxpayer’s income and exaggerates the resulting
California tax. If, unlike here, treasury operations provide a substantial
portion of a taxpayer’s income, this exaggeration may result in an
apportionment that does not fairly represent California business activity. 20
The situation that Microsoft Corp. warned of is present in this case. The royalty
income at issue “provide[s] a substantial portion of a taxpayer’s income.” As
discussed above, Taxpayer’s net royalty income represents %%% of the Taxpayer’s
combined business income for the tax years ended DATE – DATE. Further, as stated
above, the royalties have a much higher profit margin than other gross income
earned by the Taxpayer. The royalty income gets no factor representation but
contributes an aggregate average %%% profit margin towards apportionable
income. The aggregate average profit margin for other gross income earned by the
Taxpayer is only %%%.
This is not a situation where including the royalty income defeats the purpose of the
sales factor to reflect the market for Taxpayer’s activities, which is the intended
purpose of the special apportionment rule to exclude certain revenues earned from
licensing of intangible property as required under IITA 35 ILCS 5/304(a)(3)(B-2). In
this case, including the royalty income in the sales factor properly represents the
“market” for Illinois. Otherwise, the exclusion of the royalty income from the sales
factor exaggerates Illinois tax and does not fairly represent Taxpayer’s unitary
business income in Illinois.
Conclusion
Based on the above, Taxpayer requests a deviation from the Illinois’ statutory
apportionment method as it relates to the royalty earned from licensing of
intangible personal property because the application of Illinois’s tax apportionment
formula produces a tax that fails to represent the activities or market in Illinois. As a
result of this distortion, Taxpayer requests the use of an alternative method to fairly
represent the market for Taxpayer’s business income by including its royalty income
on Schedule UB Step 4, Line 2 “net sales everywhere” in the amount of $$$$$$.

19
20

Id.
Id.

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Alternative Position
In the event that the Department challenges or denies the Taxpayer’s alternative
apportionment position and refund request, the Taxpayer also requests the
Department consider and apply another method to effectuate an equitable
allocation and apportionment of Taxpayer’s royalties.
Another method is the use of separate accounting to apportion the Taxpayer’s
royalties separate and apart from all other activity. Using separate accounting,
Taxpayer’s apportionment will fairly represent Taxpayer’s activity in Illinois, as it will
no longer be skewed by the inclusion of the royalties which are not fairly reflected in
the apportionment formula.
Finally, yet another method to use is to include as members of the Illinois combined
group all of the 80/20 companies that are excluded from the combined group under
IITA 35 ILCS 5/1501(a)(27)(A) that are paying the royalties to the Taxpayer. The
inclusion of the 80/20 companies would serve to include the business income of
the foreign corporations, as well as include the sales of such corporations into the
apportionment formula. This method will also fairly represent Taxpayer’s activity in
Illinois as it would have matching representation between business income and
sales in the sales factor.
Your petition for the YEAR2 tax year ended states as follows:
COMPANY1 (“COMPANY1” or “Taxpayer”) timely filed an original YEAR1 Illinois
Corporate Income and Replacement Tax Return (“Return”). The Taxpayer is now
amending its YEAR1 Return to revise the Taxpayer’s apportionment. Taxpayer
respectfully requests that the Illinois Department of Revenue (“Department”)
approve the utilization of alternative apportionment and accept the Amended
Return as filed and for prospective tax years ending on or after YEAR4.
Background Information
COMPANY1 is a wholly owned subsidiary of COMPANY2 (“COMPANY2”).
COMPANY2 was formed in YEAR5, when the firm made its initial public offering, and
was later incorporated in STATE in YEAR6. COMPANY2 operates solely outside of
Illinois in southwest STATE. COMPANY2, along with its subsidiaries, is a global
leader in the consumer goods industry providing branded products of superior
quality and value.
The COMPANY2 business revolves around five major segments: Beauty; Grooming;
Health Care; Fabric and Home Care; and Baby, Feminine, and Family Care. 21
COMPANY2 products are instantly recognizable when browsing the aisles of most
21

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

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June 24, 2024
stores. Brands available around the globe include: NAME, among many others.
These products are sold in more than ### countries and territories, primarily
through mass merchandisers, e-commerce, grocery stores, membership club
stores, drug stores, department stores, distributors and pharmacies. 22 The United
States (“U.S.”) accounts for roughly %%% of the company’s worldwide net sales. 23
Europe is responsible for %%% of sales, Asia contributes %%% and Latin America
%%. 24 To facilitate such activities, the company has on-the-ground manufacturing
and commercial operations in approximately ## countries. 25
COMPANY2 along with other U.S. subsidiaries that are included in the Illinois
combined filing group, own many valuable intangibles used in the U.S. and globally.
COMPANY2 and its U.S. subsidiaries are responsible for all corporate governance
and administrative duties, advertising, and research and development for its global
brands. As a result, in addition to sales of consumer goods, COMPANY2 and certain
U.S. subsidiaries receive royalties from foreign affiliates through licensing
arrangements for the intangibles owned by COMPANY2 and its U.S. subsidiaries.
These foreign royalties are earned as a percentage of sales from foreign affiliates
and represent the primary source of royalties reported on the Federal 1120. The
income producing activities related to the royalty income, including research and
development, monitoring, and supervision of the intangible personal property, take
place entirely outside of Illinois. These royalties represent a significant amount of
income and have a relative profit margin much higher than other apportionable
income as further discussed below.
Pursuant to 35 ILCS 5/304(h) of the Illinois Income Tax Act (“IITA”, “35 ILCS 5/”, “the
Act”, “ILCS Chapter 35 Section 5/”), Taxpayer filed its original return following the
standard apportionment method using a single sale factor formula. Taxpayer’s
sales factor consisted primarily of sales of tangible personal property representing
consumer goods sold by members of the Illinois combined group. However,
COMPANY2 and certain U.S. subsidiaries were unable to include in the Taxpayer’s
sales factor the royalties earned from licensing the use of intangible personal
property because such income did not comprise more than 50% of Taxpayer’s total
gross receipts included in gross income as required under IITA 35 ILCS
5/304(a)(3)(B-2).
Alternative Apportionment
Law
22

Id.
Id.
24
Id.
25
Id.
23

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June 24, 2024
ILCS Chapter 35 Section 5/304(f) provides that if the normal allocation and
apportionment methods do not fairly represent the market for the person’s goods,
services, or other sources of business income in Illinois, the person can petition the
Director of Revenue to permit separate accounting or the use of any other method
to create an equitable allocation and apportionment of the taxpayer’s business
income.
Ill. Admin. Code §100.3390(a)(c) (IITA Section 304(f)) reads as follows:
A departure from the required apportionment method is allowed only when
those methods do not accurately and fairly reflect business activity in Illinois
(for taxable years ending before December 31, 2008) or market in Illinois (for
taxable years ending on or after December 31, 2008). An alternative
apportionment method may not be invoked, either by the Director or by a
taxpayer, merely because it reaches a different apportionment percentage than
the required statutory formula. However, if the application of the statutory
formula will lead to a grossly distorted result in a particular case, a fair and
accurate alternative method is appropriate. The party (the Director or the
taxpayer) seeking to utilize an alternative apportionment method has the
burden or going forward with the evidence and proving by clear and convincing
evidence that the statutory formula results in the taxation of extraterritorial
values or operates unreasonably and arbitrarily in attributing to Illinois a
percentage of income that is out of all proportion to the business transacted in
this State (for taxable years ending before December 31, 2008) or the market for
the taxpayer’s goods, services or other sources of business income in this State
(for taxable years ending on or after December 31, 2008). In addition, the party
seeking to use an alternative apportionment formula must go forward with the
evidence and prove that the proposed alternative apportionment method fairly
and accurately apportions income to Illinois based upon business activity in
this State (for taxable years ending before December 31, 2008) or the market for
the taxpayer’s goods, services or other sources of business income in this State
(for taxable years ending on or after December 31, 2008).
The Appellate Court of Illinois held in Miami Corp v. Dept. Rev., 571 N.E.2nd 800
that use of the statutory method was inappropriate. It was determined that the
taxpayer was entitled to utilize separate accounting. The statutory apportionment
formula (the three-factor method) did not fairly represent activities in Illinois with
respect to Louisiana oil and gas reserves which generated in excess of 80% of the
taxpayer’s total income. The court found that the distortion created by the use of
the statutory formula amounted to an unfair representation of the taxpayer’s
activities within Illinois. Part of the court’s reasoning was based on the fact that
intangibles (sourced to Louisiana) were not included in the property factor and

NAME/COMPANY1
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June 24, 2024
substantial out-of-state independent contractors were not considered in the payroll
factor.
The Department has granted alternative apportionment requests when the statutory
apportioned income attributable to business activity in Illinois does not fairly reflect
the activities of the taxpayer in Illinois. In Private Letter Ruling IT 05-0002-PLR
(3/29/2005), the Department granted the use of separate accounting when the
taxpayer demonstrated that the statutory apportionment method attributed more
income to Illinois than was earned by the individual unitary group members who
were conducting business in Illinois. The Department further approved a separate
accounting method for the same taxpayer in Private Letter ruling IT 05-0007-PLR
(10/17/2005).
The Illinois Administrative Code sets forth the rules and requirements for alternative
apportionment petitions. 26 Subsection (e) of the Regulation prescribes three
options for requesting alternative apportionment. In relevant part, the Regulation
provides that a petition for alternative apportionment may be filed as an attachment
to a return amending an original return which was filed using the statutory
allocation and apportionment rules. 27
Subsection (a) of the Regulation identifies the types of alternative apportionment
that may be requested. If reasonable, a taxpayer may petition for the following: (1)
separate accounting; (2) the exclusion of any one or more of the factors; (3) the
inclusion of one or more additional factors which will fairly represent the person’s
business activity in the state; or (4) the employment of any other method to
effectuate an equitable allocation and apportionment of the person’s income. 28
Discussion
In Taxpayer’s case, the standard apportionment formula does not fairly represent
the market for its business income, which includes royalties earned from the
licensing of intangible personal property. Taxpayer is petitioning for an equitable
allocation and apportionment of its income under 86 Ill. Admin. Code
§100.3390(a)(4).
As stated above, Taxpayer was unable to include in its sales factor royalties earned
from licensing the use of intangible personal property primarily consisting of
royalties paid by foreign affiliates through licensing arrangements for the intangibles
owned by COMPANY2 and its U.S. subsidiaries included in the Illinois combined
group. Taxpayer asserts that the application of the standard single sales factor
See 86 Ill. Admin. Code §100.3390 (the “Regulation”).
86 Ill. Admin. Code §100.3390(e)(2).
28
86 Ill. Admin. Code §100.3390(a)(1)-(4).
26
27

NAME/COMPANY1
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June 24, 2024
which excludes the royalties from the sales factor is distortive and does not fairly
represent the market for the taxpayer’s business income.
For the fiscal years ending DATE - DATE, the royalties earned by COMPANY2 and its
subsidiaries included in the Illinois combined filing group represents %%% of total
gross income, while the net royalty income represents %%% of Illinois combined
unitary income. The royalties earned by the Taxpayer are included in business
income subject to formula apportionment in Illinois. However, there is no
representation of the royalties in the sales factor because the royalties are excluded
pursuant to IITA 35 ILCS 5/304(a)(3)(B-2).
IITA 35 ILCS 5/304(a)(3)(B-2) provides as follows:
Gross receipts from the license, sale, or other disposition of patents,
copyrights, trademarks, and similar items of intangible personal property, other
than gross receipts governed by paragraph (B-7) of this item (3), may be
included in the numerator or denominator of the sales factor only if gross
receipts from licenses, sales, or other disposition of such items comprise more
than 50% of the taxpayer’s total gross receipts included in gross income during
the tax year and during each of the 2 immediately preceding tax years; provided
that, when a taxpayer is a member of a unitary business group, such
determination shall be made on the basis of the gross receipts of the entire
unitary business group.
The standard apportionment formula allows gross receipts from the licensing of
intangible property (e.g., royalties) to be included in the sales factor only if gross
receipts from licensing of such items comprise more than 50% of the taxpayer’s
total gross receipts included in gross income during the tax year and during each of
the 2 immediately preceding tax years. Because Taxpayer’s royalty income consists
of only %%% of total gross income, the royalty income is excluded from the sales
factor. Note, if Taxpayer’s royalty income was included in the sales factor, the gross
receipts would be sourced to Illinois if the income producing activity of such
income is performed in the state based on costs of performance.
Effective for tax years ending on or after December 31, 2008, gross receipts from
transactions involving intangible personal property when the taxpayer is not a
dealer with respect to the intangible personal property, are attributed to Illinois if
the income producing activity is performed in the state, based on costs of
performance. 29 Such gross receipts are sourced in Illinois when the income
producing activities are performed both in and outside the state and, based on
29

86 Ill. Admin. Code §100.3370(c)(6).

NAME/COMPANY1
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June 24, 2024
costs of performance, a greater proportion of the income producing activity is
performed in Illinois than in any other state. 30
However, the standard apportionment formula was not created with Taxpayer’s
facts in mind. It does not consider the significant impact the earned royalties
represent of total business income. The net royalty income represents %%% of the
total combined business income for the tax years ended DATE - DATE. Yet there is
no connection between Illinois and the foreign royalties, including from where they
were paid and received, as well as the income producing activity which takes place
outside of Illinois. Furthermore, including the foreign royalties in the sales factor
results in relief from the disparate taxation of extraterritorial income (i.e., the foreign
royalties) earned from the Taxpayer’s unitary business and paid by unitary foreign
affiliates. Without such relief, the statutory formula operates unreasonably and
arbitrarily in attributing income to Illinois when the royalties have no representation
in the sales factor as further discussed below.
Moreover, the profit margin on the royalty income, representing branded consumer
product sales outside of the United States, is significantly higher than the profit
margin earned on the other sales earned by the Taxpayer. In aggregate for fiscal
years ending DATE – DATE, the average profit margin for royalty income was %%%.
In contrast, the average profit margin earned by the Taxpayer’s other income was
%%% for fiscal years ending DATE – DATE. This further supports that there is a
grossly distorted result when the royalties have no representation in the sales
factor, while the profit margin for the royalties is approximately %%% to %%%
higher than the profit margin earned by the Taxpayer’s other income.
In Colgate-Palmolive Company, Inc. (“Colgate-Palmolive”) v. Bower, No. 01 L 50195
(10/15/2002) (“Colgate”), the Cook County Judicial Circuit Court held that a
Delaware corporation that had business operations in Illinois was not allowed to
modify the standard apportionment formula (the three-factor formula method).
Colgate-Palmolive filed for alternative apportionment to add a fourth intangible
property factor to the Illinois three-factor formula to fairly represent foreign royalties
and dividends from foreign subsidiaries. The Administrative Law Judge ruled that
Colgate-Palmolive failed to meet its burden of establishing that the standard
formula failed to “fairly represent the extent” of Colgate-Palmolive’s business in
Illinois. 31 The court found that “ ... each part of Illinois’ statutory three factor
formula takes into account the ordinary income producing activities and expenses
related to Colgate-Palmolive’s production of the income at issue, as well as the fact

30
31

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

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June 24, 2024
the income producing activities related to the particular income at issue were not
performed within Illinois.” 32
In reaching the decision that Colgate-Palmolive failed to meet its burden, the court
reasoned that all three factors had representation of the activities associated with
the foreign royalties and dividends from foreign subsidiaries. Specifically, the sales
factor included the dividends from foreign corporations and royalty income earned
from licensing intangible personal property to foreign subsidiaries. Regarding the
royalty income in particular, the sales factor was specifically designed to take into
account where the costs of performance related to a taxpayer’s licensing or other
disposition of business intangibles occurred, in order to apportion the receipts
realized by such activities in the ordinary course of the taxpayer business. 35 ILCS
5/304(a)(3), 5/1501(21); 86 Ill. Admin. Code §100.3370(a), (b). 33
It should be noted that the foreign royalties and dividends from foreign subsidiaries
earned by Colgate-Palmolive were included in the sales factor despite the fact that
they did not comprise more than 50% of the total gross receipts of the taxpayer. 34
The court’s reasoning in Colgate can be applied in the Taxpayer’s case. In contrast
to Colgate, the standard apportionment formula today fails to represent the market
for the royalty income in the Taxpayer’s case because the royalties earned from
licensing of intangible property are excluded from the sales factor (i.e., the royalties
do not comprise more than 50% of Taxpayer’s gross income). The lack of inclusion
in the factor fails to take into account the ordinary income producing activities and
expenses related to Taxpayer’s royalty income (i.e., no factor representation), as
well as the fact the income producing activities related to the particular income at
issue were not performed in Illinois. Further, Illinois administrative code specifies
that income shall be included in the denominator (and numerator) of the sales
factor when the income producing activity relative to the sourcing of business
income from intangible personal property can be readily identified, such as in the
Taxpayer’s case. 35
Other State Alternative Apportionment Decisions
In Crocker Equipment Leasing, Inc. (“Crocker”) v. Department of Revenue, No.
2973, 12 OTR 16 (1992), the Court found that the taxpayer’s alternative formula was
a reasonable method of attributing income to the state. The three-factor
32

Id.
Id.
34
The facts of the Colgate decision detail that Colgate-Palmolive reported net sales of $2,085,271,427 on Line 1 of
its 1990 Federal return, while Colgate-Palmolive received $247,818,837 in royalty and dividend income.
Accordingly, the royalty and dividend income represented approximately 10.62% of the summation of Line 1 of its
1990 Federal return and the royalty and dividend income earned in 1990.
35
86 Ill. Admin. Code §100.3380(c)(3).
33

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June 24, 2024
apportionment formula used by the Department of Revenue to apportion the
Oregon business income of the subsidiary of a U.S. chartered national bank for
corporate excise tax purposes did not fairly represent the extent of the
corporation’s business activity in Oregon, because the calculation did not include
intangible property in the property factor. Crocker maintained that 98 percent of its
earning assets were intangible, so the property must be included in the factor to
avoid distortion. The court found that the taxpayer’s methodology was reasonable,
as it established a “realistic relationship to how the income is earned.”
The court’s reasons can be applied to the Taxpayer’s case. Including royalties in the
sales factor realistically represents the relationship between licensing of intangible
property and the income earned from sale of those consumer goods. By not
including the royalties, the apportionment formula does not reasonably represent
the Taxpayer’s activities in Illinois. Stated differently, similar to Crocker, the
inclusion of the royalties in the sales factor establishes a realistic relationship to
how the Taxpayer earns its income, because the royalties represent the income
earned from branded consumer product sales worldwide by unitary foreign
affiliates as a result of the use of the same intangible property for the sale of
branded consumer goods in the United States.
In Twentieth Century-Fox Film Corp. (“Twentieth Century Fox”) v. Department of
Revenue, 299 Or. 220, 700 P.2d 1035 (1985), Twentieth Century Fox used the
statutory three-factor formula for apportionment of income to Oregon. The taxpayer
included in the numerator of the property factor only the cost of the positive prints
of its films, which were the only tangible personal property distributed in Oregon.
Film negatives, which were not included in the numerator, are valued at the cost of
producing the film, making them quite valuable. The court determined that it was
unfair to merely include the value of the positive prints and ignore the negatives,
because it ignored the economic reality of the film industry. The Oregon
Department of Revenue modified the property factor by including the value of the
film negatives in the value of the positive prints.
The court’s reasoning can also be applied to the Taxpayer’s case. In order to convey
the economic reality of the Taxpayer’s business, the sales factor needs to include
activity from both the sales of tangible personal property and royalties received
from licensing of intangible property. The income generated by the licensing of
intangible property is effectively a portion of the sales of consumer goods, because
the royalty income is based on a percentage of the sales of branded consumer
goods by certain unitary foreign affiliates. It is unreasonable to exclude the royalties
related to the sale of branded consumer goods by the unitary foreign affiliates that
is earned as a percentage royalty, just as it was unreasonable to exclude the
negative prints from apportionment for Twentieth Century Fox.

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June 24, 2024
While the Twentieth Century Fox case may be an industry related issue, the
Taxpayer has an economic reality that differs from most other companies within its
industry. The Taxpayer generates a significant amount of revenue from foreign
royalties as a result of their brand strategy and recognition and generates
substantial revenue from royalties which have no representation in the sales factor.
By subjecting the Taxpayer to an apportionment formula excluding one of their
major revenue producing activities, there is gross distortion in the amount of
income apportioned to Illinois and it is not representative of the Illinois market.
In Atlantic Richfield Co. (“Atlantic Richfield”) v. Alaska, 705 P.2d 418 (Alaska 1985)
(“Atlantic Richfield”), as addressed in the GIL, the Alaska supreme court wrote that:
A unique characteristic of unitary oil and gas businesses is that the major
income-producing element is the value of the oil and gas reserves in the
ground. While this element can be readily identified, it is not recognized
under traditional formula apportionment methods. *** [S]eparate
accounting, not formula apportionment, is the prevailing method throughout
the United States for reporting income for oil production. 36
The case of Atlantic Richfield shows that failure to reflect income that is prevalent
and a major income producing element to a company is distortive. Atlantic
Richfield’s major income producing element was their gas and oil reserves, which
was not recognized using traditional apportionment methods. In the instant case,
Taxpayer’s major income-producing element is the use of the intangible property
related to the business’s branded consumer product sales. The intangible property
is used by the Taxpayer to earn revenue from the selling of branded consumer
goods inside and outside of the United States. The character of the gross receipt
from the consumer goods sold inside the United States represents the sale of
tangible personal property, while the character of the gross receipts from the
consumer goods sold outside the United States is royalty income. Both gross
receipt characters must be included in the sales factor in order for the sales factor
to fairly and accurately reflect the Taxpayer’s major income-producing element (i.e.,
the sale of consumer goods). Again, without their intangibles, COMPANY2 would
not have the ability to produce and sell its consumer branded products. The
intangible property related to their brands is a central part of their business model,
which relies on the success of existing brands as well as creation of new products
and brands. COMPANY2 attributes their financial success directly with the success
of their brands. 37

36
37

Atlantic Richfield Co., 705 P.2d at 418, 426.
COMPANY2., Annual Report (Form 10-K) (June 30, 2021).

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June 24, 2024
In Appeal of Crisa Corporation, 2002-SBE-004 (6/20/02), California State Board of
Equalization (“SBE”) found the taxpayer’s numerical comparisons standing alone
are not sufficient to prove distortion and the taxpayer’s request was ultimately
denied. The SBE ruled that the central question related to alternative apportionment
is not whether there is a large enough numerical distortive change, but rather
whether there are unusual facts that lead to unfair representation under the
standard apportionment factor. They provided five examples of “unusual
transactions” that could trigger application of alternative apportionment, one of
which reading as follows:
A particular factor does not have material representation in either the
numerator or denominator, rendering that factor useless as a means of
reflecting business activity. For example, because a company does not own
or rent any tangible or real personal property, the numerator and
denominator of the property factor are zero. (See Appeal of Oscar
Enterprises, LTD, 87-SBE-069, Oct. 6, 1987.)
This example of an “unusual transaction” can be applied to Taxpayer’s activity in
Illinois. The royalty revenues represent a significant portion of the profitability of the
Taxpayer, but are not represented in the sales factor numerator or denominator.
When looking at profit margin, the margin earned on royalty revenues is
approximately %%% to %%% higher than the profit margin earned on other gross
income of the Taxpayer for fiscal years ending DATE - DATE. However, only the other
gross income earned by the Taxpayer is represented in the statutory sales formula
resulting in a material misrepresentation. Furthermore, the exclusion of the
royalties from the sales factor leads to unfair representation under the standard
apportionment factor because the sales factor is not representing all of the income
earned from the Taxpayer’s intangible property in connection with the sale of
branded consumer products as described above.
In Microsoft Corp. (“Microsoft”) v. Franchise Tax Board, 39 Ca. 4th 750, 771 (2006)
(“Microsoft Corp.”), the court found that treasury receipts were distortive where the
receipts generated less than 2 percent of Microsoft’s income but 73 percent of its
gross receipts. 38 However, the court also noted that the FTB’s approach of removing
large receipts can result in an exaggeration of California tax when the receipts
account for a substantial portion of the taxpayer’s income. 39 Specifically, the court
stated:
We caution, however, that in other cases the Board’s approach may go too
far in the opposite direction and fail the test of reasonableness. By mixing
38
39

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

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net receipts for a particular set of out-of-state transactions with gross
receipts for all other transactions, it minimizes the contribution of those outof-state transactions to the taxpayer’s income and exaggerates the resulting
California tax. If, unlike here, treasury operations provide a substantial
portion of a taxpayer’s income, this exaggeration may result in an
apportionment that does not fairly represent California business activity. 40
The situation that Microsoft Corp. warned of is present in this case. The royalty
income at issue “provide[s] a substantial portion of a taxpayer’s income.” As
discussed above, Taxpayer’s net royalty income represents %%% of the Taxpayer’s
combined business income for the tax years ended DATE – DATE. Further, as stated
above, the royalties have a much higher profit margin than other gross income
earned by the Taxpayer. The royalty income gets no factor representation but
contributes an aggregate average %%% profit margin towards apportionable
income. The aggregate average profit margin for other gross income earned by the
Taxpayer is only %%%.
This is not a situation where including the royalty income defeats the purpose of the
sales factor to reflect the market for Taxpayer’s activities, which is the intended
purpose of the special apportionment rule to exclude certain revenues earned from
licensing of intangible property as required under IITA 35 ILCS 5/304(a)(3)(B-2). In
this case, including the royalty income in the sales factor properly represents the
“market” for Illinois. Otherwise, the exclusion of the royalty income from the sales
factor exaggerates Illinois tax and does not fairly represent Taxpayer’s unitary
business income in Illinois.
Conclusion
Based on the above, Taxpayer requests a deviation from the Illinois’ statutory
apportionment method as it relates to the royalty earned from licensing of
intangible personal property because the application of Illinois’s tax apportionment
formula produces a tax that fails to represent the activities or market in Illinois. As a
result of this distortion, Taxpayer requests the use of an alternative method to fairly
represent the market for Taxpayer’s business income by including its royalty income
on Schedule UB Step 4, Line 2 “net sales everywhere” in the amount of $$$$$$.
Alternative Position
In the event that the Department challenges or denies the Taxpayer’s alternative
apportionment position and refund request, the Taxpayer also requests the
Department consider and apply another method to effectuate an equitable
allocation and apportionment of Taxpayer’s royalties.
40

Id.

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Another method is the use of separate accounting to apportion the Taxpayer’s
royalties separate and apart from all other activity. Using separate accounting,
Taxpayer’s apportionment will fairly represent Taxpayer’s activity in Illinois, as it will
no longer be skewed by the inclusion of the royalties which are not fairly reflected in
the apportionment formula.
Finally, yet another method to use is to include as members of the Illinois combined
group all of the 80/20 companies that are excluded from the combined group under
IITA 35 ILCS 5/1501(a)(27)(A) that are paying the royalties to the Taxpayer. The
inclusion of the 80/20 companies would serve to include the business income of
the foreign corporations, as well as include the sales of such corporations into the
apportionment formula. This method will also fairly represent Taxpayer’s activity in
Illinois as it would have matching representation between business income and
sales in the sales factor.
RULING
Section 304(a) of the Illinois Income Tax Act (“IITA”, 35 ILCS 5/304) provides that when a
nonresident derives business income from Illinois and one or more other states, such
income shall be apportioned to Illinois by multiplying the income by the taxpayer’s
apportionment factor. For taxable years ending on and after December 31, 1998, except in
the case of an insurance company, financial organization, transportation company, or
federally regulated exchange, the apportionment factor is equal to the sales factor. IITA
Section 304(a)(3) defines the sale factor as a fraction, the numerator of which is the total
sales of the person in Illinois during the taxable year, and the denominator of which is the
total sales of the person everywhere during the taxable year.
For taxable years ending on or after December 31, 1999, IITA Section 304(a)(3)(B-2)
provides that gross receipts from the license, sale, or other disposition of patents,
copyrights, trademarks, and similar items of intangible personal property may be included
in the sales factor only if gross receipts from the license, sale, or other disposition of such
items comprise more than 50% of the taxpayer’s total gross receipts included in gross
income during the tax year and during each of the two immediately preceding tax years,
and provided that when a taxpayer is a member of a unitary business group, such
determination shall be made on the basis of the gross receipts of the entire unitary
business group. If not excluded from the sales factor under the 50% B-2 test, these
receipts are sourced to Illinois according to IITA Section 304(a)(3)(B-1).
Section 304(f) of the IITA provides:
If the allocation and apportionment provisions of subsections (a) through (e) and of
subsection (h) do not, for taxable years ending before December 31, 2008, fairly

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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:

the

(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

person’s business activities or market in this State; or
(4) The employment of any other method to effectuate an equitable
allocation and
apportionment of the person’s business income.
86 Ill. Adm. Code Section 100.3380(a)(2) provides:
The Director has determined that, in the instances described in this Section, the
apportionment provisions provided in IITA Section 304(a) through (e) and (h) do not
fairly represent the extent of a person’s business activity or market within Illinois.
For tax years beginning on or after the effective date of a rulemaking amending this
Section to prescribe a specific method of apportioning business income, all
nonresident taxpayers shall apportion their business income employing that
method in order to properly apportion their business income to Illinois. Taxpayers
whose business activity or market within Illinois is not fairly represented by a
method prescribed in this Section and who want to use another method for a tax
year beginning after the effective date of the rulemaking adopting that method may
obtain permission to use that other method by filing a petition under Section
100.3390. For tax years beginning prior to the effective date of the rulemaking
adopting a method of apportioning business income, the Department will not
require a taxpayer to adopt that method; provided, however, if any taxpayer has
used that method for any of those tax years, the taxpayer must continue to use that
method for that tax year. Moreover, a taxpayer may file a petition under Section
100.3390 to use a method of apportionment prescribed in this Section for any open
tax year beginning prior to the effective date of the rulemaking adopting that
method, and that petition shall be granted in the absence of facts showing that that
method will not fairly represent the extent of a person’s business activity or market
in Illinois.
Taxpayers who wish to use an alternative method of apportionment under these provisions
are required to file a petition complying with the requirements of 86 Ill. Adm. Code Section
100.3390. Subsection (c) of that regulation provides:

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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 of going forward with the evidence and proving by clear and convincing
evidence that the statutory formula results in the taxation of extraterritorial values
or operates unreasonably and arbitrarily in attributing to Illinois a percentage of
income that is out of all proportion to the business transacted in this State (for
taxable years ending before December 31, 2008) or the market for the taxpayer’s
goods, services or other sources of business income in this State (for taxable years
ending on or after December 31, 2008). In addition, the party seeking to use an
alternative apportionment formula must go forward with the evidence and prove
that the proposed alternative apportionment method fairly and accurately
apportions income to Illinois based upon business activity in this State (for taxable
years ending before December 31, 2008) or the market for the taxpayer’s goods,
services or other sources of business income in this State (for taxable years ending
on or after December 31, 2008).
Your petition for alternative apportionment indicates that gross receipts from the foreign
royalties are not more than 50% of COMPANY1’s total gross receipts for the tax years
ended YEAR1 and YEAR2, and are therefore excluded from the sales factor under IITA
Section 304(a)(3)(B-2). Your petition asserts that the royalties earned by COMPANY1 are
included in business income subject to formula apportionment in Illinois but the failure to
include such receipts in the sales factor results in an Illinois tax liability that is distortive
and does not fairly represent the market for COMPANY1’s business income in the State.
The primary basis for this assertion is that for fiscal years ending DATE – DATE, the
statutory apportionment formula fails to take into account that the gross receipts from the
foreign royalties earned by COMPANY1 represents %%% of total gross income, while the
net royalty income represents %%% of Illinois combined unitary income. In addition, you
state there is a grossly distorted result when the royalties have no representation in the
sales factor but the profit margin for the royalties is approximately %%% - %%% higher
than the profit margin earned by the Taxpayer’s other income.
The facts stated in your petition are not sufficient to satisfy the burden set forth in Ill. Adm.
Code Section 100.3390(c). As indicated above, for taxable years ending on or after
December 31, 2008, alternative apportionment under IITA Section 304(f) is appropriate in
cases where the allocation and apportionment provisions under IITA Sections 304(a)

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through (e) do not fairly represent the market for the taxpayer’s goods, services, or other
sources of business income. In this case, your petition does not meet the regulatory
requirement and cannot be granted at this time. Your request merely states that due to the
statutory exclusion of foreign royalty from the sales factor pursuant to IITA Section
304(a)(3)(B-2), an alternative apportionment formula would more accurately represent
COMPANY1’s market in Illinois. An alternative apportionment method may not be invoked,
either by the Department or by a taxpayer, merely because it reaches a different
apportionment percentage than the required statutory formula.
In this case, IITA Section 304(a)(3)(B-2) and 86 Ill. Adm. Code Section 100.3370(a)(2)(F)
provide that for taxable years ending on or after December 31, 1999, gross receipts from
the licensing, sale, or other disposition of a patent, copyright, trademark, or similar item of
intangible personal property may be included in the sales factor only if gross receipts from
licenses, sales, or other dispositions of these items comprise more than 50% of the
taxpayer’s total gross receipts included in gross income during the tax year and during
each of the two immediately preceding tax years. Exclusion of such receipts from the sales
factor thereby prevents distortion of the sales factor that would otherwise occur.
Section 304(f) relief is proper where the income allocated to the State by the otherwise
applicable statutory formula is unfairly disproportionate to the business activity conducted
in the State. There is nothing inherently distortive or unfair in excluding from the sales
factor those royalties that do not comprise more than 50% of gross receipts from royalties
earned from the licensing of intangible property based on the activities of the taxpayer. See
also Vectren Infrastructure Services Corp., successor in interest to Minnesota Limited,
Inc., v. Department of Treasury, 512 Mich. 594. In that case, the Michigan Supreme Court
held that the inclusion of income from an asset sale in the tax base apportionment under
the Michigan Business Tax Act did not violate the Due Process Clause nor the Commerce
Clause, and that the taxpayer failed to prove the statutory apportionment formula,
excluding the sale of assets from the sales factor, created a grossly disproportionate result
when applied to this one-time asset sale.
“ML and Justice Zahra’s dissent further argue that removing the value of the asset
sale from the denominator of the sales factor leads to gross distortion because,
without it, the sales factor fails to adequately consider how the income was
generated. This is nothing more than a gripe about which factors are or are not
included in the formula, and it is unpersuasive. Whether a one- or three-factor test
is used (or any other number of factors), litigants have consistently unsuccessfully
argued exactly what ML argues here—that a different combination is required. Just
as the courts in Moorman, Kraft, Container Corp,and Trinova II rejected these
endless propositions of different proportionality factor combinations, so too do we.
Michigan chose a single-factor modifier based upon sales generated within the
state. Courts have routinely upheld the use of both a sales-factor modifier and

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other single-factor modifiers. The same courts have also upheld the end result even
when the difference using an alternative modifier would have resulted in a much
lower tax bill.”
Vectren, 512 Mich. 594 at 648.
In addition, your proposed alternative methods fail to demonstrate that the statutory
method would lead to a distorted result in attributing to Illinois a percentage of income that
is out of all proportion to the market for the taxpayer’s goods, services, or other sources of
business income in this State. See Lakehead Pipe Line Co. v. Dep’t of Rev., 192 Ill. App. 3d
756 (1st Dist. 1989); Miami Corp. v. Dep’t of Rev., 212 Ill. App. 3d 702 (1st Dist. 1991); AT&T
Teleholdings, Inc. v. Dep’t of Rev., 978 N.E.2d 371 (Ill. App. Ct. 2012). Merely indicating
separate accounting would effectuate equitable allocation and apportionment of
COMPANY1’s royalties, without any explanation of why these methods are more accurate
than formulary apportionment, is insufficient to meet the burden of proof imposed by 86 Ill.
Adm. Code Section 100.3390(c) on taxpayers requesting permission to use an alternative
method of apportionment. As a unitary business enterprise, there are intercompany
transactions that are not reflected in your calculations. Separating companies from their
unitary group often creates more distortions due to intercompany pricing issues.
This conclusion is also warranted by a review of Illinois cases involving a taxpayer’s
request to invoke an alternative apportionment method pursuant to IITA Section 304(f). For
example, in Miami Corp. v. Dep’t of Rev., which you cite as an authority in support of your
petition to use an alternative formula, the Illinois appellate court affirmed the circuit
court’s decision that the Illinois three-factor formula, as applied by the Department in that
case, grossly distorted the amount of income to be apportioned to Illinois. The facts of
that case, however, are distinguishable from the facts presented in your petition, and
distinguishable in a way that warrants a different result. The primary difference is the fact
that the intangible income at issue in Miami Corp. arose from the taxpayer’s ownership of
real estate situated in other states, and the fact that Miami Corp. had no such intangible
property rights regarding land owned in Illinois. Both the appellate and the trial court in
Miami Corp. relied to a great degree on the reasoning of the Alaska supreme court in
Atlantic Richfield Co. v. Alaska, 705 P.2d 418 (Alaska 1985) app. dism’d, 474 U.S. 1043,
106 S.Ct. 74, 88 L.ed.2d 754 (1985). Specifically, the Alaska supreme court wrote that:
A unique characteristic of unitary oil and gas businesses is that the major incomeproducing element is the value of the oil and gas reserves in the ground. While this
element can be readily identified, it is not recognized under traditional formula
apportionment methods. *** [S]eparate accounting, not formula apportionment, is
the prevailing method throughout the United States for reporting income for oil
production.

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Atlantic Richfield Co., 705 P.2d 418 at 418, 426.
Furthermore, the statutory apportionment formula has since changed from three-factor
apportionment formula (property, payroll, and sales) to a one factor formula (sales). The
intangibles at issue here are not like the intangible rights that ran with the land in Miami
Corp.
Accordingly, your petition for alternative apportionment for tax years ended YEAR1, and
YEAR2, and for prospective tax years ending on or after YEAR4, cannot be granted.
However, if you have additional information related to this request that was not previously
submitted, you may supplement your petition and we will reconsider your request. Please
note that 86 Ill. Adm. Code Section 100.3390(e)(1) requires a petition to be filed at least
120 days prior to the due date (including extensions) for the first return for which
permission is sought to use the alternative apportionment method.
As stated above, this is a General Information Letter which does not constitute a statement
of policy that applies, interprets or prescribes the tax laws, and it is not binding on the
Department.
Sincerely,

Jennifer Uhles
Associate Counsel (Income Tax)