Chicago's New Lease Tax Applies to Personal Property and “The Cloud” - The Tax Includes "Non-Possessory Computer Leases" Unless Exemption 11 Applies

HIGHLIGHTS:

• The Chicago Department of Finance issued Lease Transaction Tax Ruling No. 12 with respect to application of Chicago's Personal Property Lease Transaction Tax to non-possessory computer leases.
• The lease tax applies to charges that are paid for the use of personal property, including charges paid pursuant to a "non-possessory computer lease," unless Exemption 11 applies.
• The ruling largely avoids the issue of whether the "lessor" of the computer in the non-possessory computer lease has sufficient nexus with the city of Chicago to require them to collect the lease tax.

The Chicago Department of Finance (the "Department") issued Lease Transaction Tax Ruling No. 12 with respect to application of Chicago's Personal Property Lease Transaction Tax (the "lease tax") to non-possessory computer leases.¹ The lease tax, issued on June 9, 2015, is imposed at a 9 percent rate. The lease tax applies to charges that are paid for the use of personal property, including charges paid pursuant to a "non-possessory computer lease," unless the charges are exempt under so-called Exemption 11.

The term "non-possessory computer lease" means a non-possessory lease in which the customer obtains access to the provider's computer primarily for the ability to use the provider's computer and its software to input, modify or retrieve data or information, in each case without the intervention (other than de minimis intervention) of personnel acting on behalf of the provider. In such events, the charge is primarily for the customer's use or control of the provider's computer and is subject to the lease tax.

Broad Expansion of the Lease Tax

The ruling provides examples of transactions that are subject to the lease tax on the charges incurred:

1. to perform legal research or similar online database searches (see Meites v. City of Chicago, 184 Ill. App. 3d 887 (1989))
2. to obtain consumer credit reports (see Personal Property Lease Transaction Tax Ruling #9 (June 1, 2004))
3. to obtain real estate listings and prices, car prices, stock prices, economic statistics, weather statistics, job listings, resumes, company profiles, consumer profiles, marketing data, and similar information or data that has been compiled, entered and stored on the provider's computer²
4. to perform functions such as word processing, calculations, data processing, tax preparation, spreadsheet preparation, presentations and other applications available to a customer through access to a provider's computer and its software. These last examples are sometimes referred to as cloud computing, cloud services, hosted environment, software as a service, platform as a service, or infrastructure as a service³

While the examples in items a. and b. are not new, the expansion of the lease tax is reflected in items c. and d. and the Department's statements in those items. Items c. and d. represent a broad expansion from the concept that evolved from taxing agreements for time-sharing on mainframe computers, and that has only been litigated one time in the Meites case more than 25 years ago, involving legal research in the city of Chicago on terminals provided by the legal search provider. The Meites case predated the Internet generally and the tremendous expansion of Internet networks that now deliver so many of the services this ruling now seeks to subject to the lease tax. This ruling represents further evolution of the city's approach to disregard contract terms and recharacterize transactions to fit its tax code definitions.

What Entity Performs the Collection?

As a technical matter, the lease tax is imposed on the consumer and it seems reasonable to assume that as the Department begins to audit and assess customers located with the city of Chicago, customers will likely demand that providers collect the lease tax as expanded by the ruling. However, it should be emphasized that the ruling largely avoids the issue of whether the "lessor" of the computer in the non-possessory computer lease has sufficient nexus with the city of Chicago to require them to collect the lease tax. Nevertheless, it is expected that providers will likely feel the need to register and collect the taxes, despite lacking nexus, and despite the fact that the provider would appear to have strong arguments against the Department's expansive interpretation of its taxing ordinances under the Federal Telecommunications Act, the Internet Tax Freedom Act, and federal and Illinois constitutional limitations on taxation. As a general matter, the Department has indicated that the lease tax will apply to customers whose residential street address or primary street address is in Chicago, as reflected by their credit card billing address, zip code or other reliable information.⁴

Effective Date Has Some Flexibility

Even though the ruling has a July 1, 2015 effective date, the Department has indicated that it will limit the effect of the ruling to periods on or after Sept. 1, 2015, to allow affected businesses time to make the required system changes.⁵ Despite this apparent September deferral, it is unclear whether this deferral provides protection against lease tax collection liability until after the Sept. 1, 2015 date.

An Unfavorable Ruling Can Be Appealed

What is clear is that the city of Chicago has mounting fiscal pressures driving this kind of tax policy. Further, the city has its own tax hearings office, a bevy of its own litigators, and both taxpayers and the city can appeal from an unfavorable ruling. With the city's interest on delinquent taxes at 12 percent a year, and typical unagreed audit penalty of 25 percent, this unprecedented taxation of the "cloud" through expansion of the lease tax cannot simply be ignored by those affected.

Notes

¹ City of Chicago, Department of Finance, Personal Property Tax Ruling #12 (June 9, 2015).

² Id. at ¶ 6.c.

³ Id. at ¶ 6.d.

⁴ Id. at ¶ 16.

⁵ Id. at ¶ 21.