For the large majority of local governments in the state of Illinois, sales taxes and property taxes remain the lifeblood of their municipal revenue. The fallout from the Great Recession has made city managers even more acutely aware of their responsibility to maximize and enhance revenues whenever possible and ensure equitable assessment and collection of taxes across their communities.
But diligent financial stewardship comes in many forms, and goes far beyond simply the prudent spending of residents’ tax dollars and vigilance in keeping municipal costs to a minimum. Recent court decisions have highlighted the prevalence of tax avoidance strategies that have deprived Illinois municipalities of many millions of dollars in much needed revenue and allowed some corporations to enjoy lower tax rates and not contribute to the communities where they reside and utilize services.
How Have Municipalities Been Losing Sales Tax Revenue?
Just as municipalities are constantly looking for ways to reduce their costs, businesses too seek ways to reduce their expenses in order to stay competitive. Until recently in the State of Illinois, one of the most lucrative methods for businesses to be competitive and reduce their costs has been through participation in sales tax rebate schemes whereby shell offices are setup for the purpose of processing orders in locales where the business does not actually develop or produce its product. However, recent decisions by the Illinois Supreme Court have called into question the legality of this practice, in which a few communities have provided a lower rate of sales tax to attract businesses to process orders in their municipality through significant tax rebate agreements and other financial incentives, but the business is actually based in and uses the services of another municipality.
The history of this arrangement stretches back to the 1980s, as cities recovering from a harsh economy sought to encourage business growth and economic development by offering tax rebates. At the same time, savvy businesses also started to realize that they could reduce their own financial burden by opening satellite offices in municipalities that would provide a significant sales tax rebate, because for the last 60 years Illinois state law has dictated that sales tax is assessed based on where a product is purchased rather than where it is delivered – a principle often referred to as the “order acceptance test.”
Calling Into Question the “Order Acceptance Test”
In the wake of recent high-profile cases such as the suits filed by the Chicago Regional Transportation Authority against American Airlines, United Airlines, and the cities of Kankakee and Channahon, the Illinois Department of Revenue has implemented more stringent guidelines to establish the true source generation of sales taxes, thereby attempting to close the loophole that allowed companies to reduce their tax bills by establishing a token presence in lower-rate jurisdictions.
While this ruling will be welcomed by cash-strapped municipalities hitherto deprived of much needed income, it has also drawn attention to the lack of transparency in individual tax incentives and rebate agreements that previously were not required to be reported to the state. It also highlights the fragility of economic development in those communities that have until now relied on “ghost” income from such schemes to support their credit rating.