State & Local Tax Alert Breaking state and local tax developments from Grant Thornton LLP ________________________________________________________ Chicago Department of Finance Clarifies and Offers Relief Regarding Taxation of Nonpossessory Computer Leases

Release date December 2, 2015

States Illinois

On November 19, 2015, the Chicago Department of Finance released a bulletin to clarify the city’s past guidance on nonpossessory computer leases.1 The publication provides guidance on the Personal Property Lease Transaction Tax Ruling #12, the amendments to the Personal Property Lease Transaction Tax (lease tax) enacted by the Chicago City Council on October 28, 2015, a voluntary disclosure offer for companies to comply with these provisions by January 1, 2016, and a FAQ section. The bulletin confirms the postponed effective date of the Department’s interpretation of the lease tax in Ruling #12 and further explains the amendments, which include an exemption for small new businesses and a lower rate for certain “cloud” computing products.2 The effective date for the amendments and the new effective date of Ruling #12 is January 1, 2016. The voluntary disclosure offer allows companies that have nonpossessory computer leases to come forward and receive a favorable resolution to their lease tax noncompliance. Recent Amendments to Lease Tax

Chicago’s lease tax applies to (i) the lease or rental in the city of personal property, or (ii) the privilege of using in the city personal property that is leased or rented outside the city.3 The tax is imposed on “nonpossessory computer lease[s],” for which customers access and use a provider’s computer/software to input, modify or retrieve data or information without the intervention of personnel acting on the provider’s behalf.4 The tax is also imposed on the use, but not possession, of personal property, including leased time on or use of computers, computer software, or data processing equipment.

Issue/Topic City Personal Property Lease Transaction Tax Contact details Paul Bogdanski Chicago T 312.602.8269 E [email protected] Emily Fiore Chicago T 312.602.8072 E [email protected] Jamie C. Yesnowitz Washington, DC T 202.521.1504 E [email protected] Chuck Jones Chicago T 312.602.8517 E [email protected] Lori Stolly Cincinnati T 513.345.4540 E [email protected] www.GrantThornton.com/SALT

The City Council approved Mayor Rahm Emanuel’s proposed Revenue Ordinance on October 28, 2015. The ordinance, which is effective January 1, 2016, included two major

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Information Bulletin – Nonpossessory Computer Leases, City of Chicago Department of Finance, Nov. 19, 2015. 2 Personal Property Lease Transaction Tax Ruling #12, City of Chicago Department of Finance, June 9, 2015; City of Chicago 2016 Budget Overview, Chicago Mayor Rahm Emanuel. 3 Chicago Mun. Code § 3-32-030(A). 4 Chicago Mun. Code § 3-32-020(I). The term includes time-sharing or time or other use of a computer with other users. For nonpossessory computer leases, the location of the terminal or other device by which a user accesses the computer is deemed to be the place of lease or rental and the place of use of the computer for purposes of the lease tax. .

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changes to the lease tax.5 The first amendment addressed nonpossessory computer leases, providing that “the [customer’s use of a] provider’s computer and software to input, modify or retrieve data or information supplied by the customer” will be subject to tax at a reduced tax rate of 5.25 percent, rather than the general rate of 9 percent.6 Tax imposed on the customer’s use and access of the provider’s data will remain at 9 percent.7 The general rule applicable to the first amendment states that the lower rate of 5.25 percent applies to “cloud” products such as platform as a service (PaaS), infrastructure as a service (IaaS), and software as a service (SaaS), but not to “database” products. According to the bulletin, the Department generally views “cloud” products as those that allow a customer to use the provider’s computer and software to “input, modify, or retrieve data or information that is supplied by the customer.”8 Conversely, the Department views use by a customer of a provider’s computer and software to “input, modify, or retrieve data or information that is supplied by the provider” as “database” products, and therefore, subject to the 9 percent tax rate.9 The second amendment provided an exemption for “nonpossessory computer leases” in which the lessor or lessee is a “small new business.”10 A “small new business” is defined as a business that: (i) holds a valid and current business license issued by the city or other jurisdiction; (ii) had under $25 million of “gross receipts or sales” during the most recent full calendar year prior to the tax year of which the exemption is sought (gross receipts as defined for federal income tax purposes); and (iii) has been in operation for less than 60 months.11 Under these provisions, the $25 million limitation includes the gross receipts or sales of a related entity in a single unitary business group (as defined for Illinois tax purposes). The 60-month time of operation limitation may include the time that a business is part of a previously existing unitary business group, or otherwise related to a previously existing business. If so, the business may be treated as a successor under Illinois law and, therefore, may impact qualification under the “small new business” classification. Clarification of Ruling #12

Ruling #12 was published on June 9, 2015 and had an original effective date of September 1, 2015.12 However, after taxpayers raised concerns with respect to the changes the ruling made to the Department’s previous interpretation of the lease tax, the Department postponed the effective date of the ruling to January 1, 2016.13

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Ordinance SO2015-7403, approved by Chicago Mayor Rahm Emanuel on Nov. 2, 2015; City of Chicago 2016 Budget Overview, Chicago Mayor Rahm Emanuel. 6 Chicago Mun. Code § 3-32-030(B)(1). 7 Id. 8 Emphasis in original. 9 Emphasis in original. 10 Chicago Mun. Code § 3-32-050(A)(13). 11 Chicago Mun. Code § 3-32-050(A)(13)(a). For further discussion of these amendments, see GT SALT Alert: Chicago City Council Approves Budget Significantly Raising Property Taxes. 12 Personal Property Lease Transaction Tax Ruling #12, City of Chicago Department of Finance, June 9, 2015. 13 City of Chicago, Personal Property Lease Transaction Tax Note, http://www.cityofchicago.org/city/en/depts/fin/supp_info/revenue/tax_list/personal_propertyle asetransactiontax.html, last visited Nov. 20, 2015.

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The text of the Lease Tax Ordinance has not changed in decades, however, due to changes in technology, the Department’s interpretation of the ordinance has evolved. Ruling #12 specifically addressed the exempt use under Exemption 11 for the de minimis use of another’s computer. The exemption states that a nonpossessory lease of a computer is exempt from the lease tax if “the customer’s use or control of the provider’s computer is de minimis and the related charge is predominantly for information transferred to the customer rather than for the customer’s use or control of the computer, such as the nonpossessory lease of a computer to receive either current price quotations or other information having a fleeting or transitory character.”14 This exemption protects access to information or data that is entirely passive, without interactive use, or, in other cases, access to materials that are primarily proprietary. Ruling #12 attempted to clarify the scope of this exemption.15 Prior to the release of Ruling #12, the Department generally interpreted the reference to “fleeting and transitory” information as exempting certain products that provided financial market data. However, Ruling #12 noted that such uses are exempt only if the receipt, and any subsequent use, is limited to the passive receipt of information. Ruling #12 provided: “As a general rule, this means that a subscription to an interactive web site will be subject to the lease tax, and will not be exempt, even if most or all of the information available on the web site is fleeting or transitory. This would include, for example, a web site that provides financial research, information and analytical tools.” An example of an exempt product under Ruling #12 is a stock market “ticker-tape” that allows a customer to receive a one-way scrolling list of current stock prices for a set group of businesses. Further, the bulletin provides that the determination of whether a charge is predominantly for information, or whether the information is predominately proprietary, is a facts and circumstances test. In most cases, information available on the public domain is not considered proprietary, and therefore, not eligible for the exemption. This is a narrower interpretation of Exemption 11, and a departure from the way the Department has previously interpreted the language of the exemption. This approach caused taxpayer concerns and many letters were filed with the Department requesting further clarification. Additionally, given the complexities of Exemption 11, many taxpayers had concerns with the new interpretation and the timeframe in which they would need to comply. The bulletin recognizes that Ruling #12 constituted a change in the Department’s interpretation of the lease tax, reiterated the extension of the effective date of Ruling #12 to January 1, 2016, and offers favorable terms for companies to come forward voluntarily to remedy their noncompliance in a constructive way for both parties.

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Chicago Mun. Code § 3-32-050(A)(11). For further discussion of Ruling #12, see GT SALT Alert: Chicago Department of Finance Addresses Sales Taxation of Cloud Computing Transactions. 15

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Voluntary Disclosure Offer

The City of Chicago has an existing general voluntary disclosure program.16 Further, the comptroller may compromise on any tax, interest, or penalty due under the law.17 Under these provisions, and with the approval of the Department of Law, the bulletin explains that the Department is offering two alternatives for businesses that deal in nonpossessory computer leases and that would otherwise be eligible for the general voluntary disclosure program. The first offer allows businesses that were exempt under Exemption 11 prior to the publication of Ruling #12 to come forward by January 1, 2016 and pay no tax liability, interest, or penalties based on those charges for any periods ending before January 1, 2016. This allows businesses that were previously exempt to come forward, register for the appropriate tax, and begin to remit the appropriate tax to the city without any negative financial repercussions. The second offer allows any business that deals in any other nonpossessory computer lease to make payment of the lease tax due for the period of January 1, 2015 to December 31, 2015 (a one-year period), and pay no interest or penalties on those charges. This offer allows businesses that have any nonpossessory computer leases, with the exception of those that were covered by Exemption 11 prior to the publication of Ruling #12, to come forward, register for the appropriate tax, remit their lease tax liability for the past year (with no payment of interest or penalties), and prospectively remit the appropriate tax to the city. The amount of tax payable under this offer may be substantially less than a business would normally be required to pay under the standard voluntary disclosure program, which requires a business to pay its tax liability for the past four years, plus interest.18 Both offers require businesses to contact the Department by January 1, 2016 to accept the limited lookback and terms contained in the bulletin.19 All other business subject to the lease tax may come forward under the general voluntary disclosure program in which tax liabilities and interest must be paid for the previous fouryear period. However, no penalties are assessed against those changes.20 Commentary

The Department drafted and published the bulletin to make lessors more fully aware of changes to the lease tax. The complexities of the lease tax now include varying rates for different transactions, an exemption for applicable small new businesses, and a change in

16 Chicago Mun. Code § 3-4-265. Under the standard program, the comptroller is directed to issue written guidelines that allow eligible taxpayers to pay their outstanding tax liabilities and interest in exchange for the waiver of all penalties. The guidelines may permit a lower rate of interest and a four-year lookback period. 17 Chicago Mun. Code § 3-4-150. 18 Chicago Mun. Code § 3-4-265. 19 Businesses are instructed to contact the Department by sending a message to [email protected]. 20 Chicago Mun. Code § 3-4-265.

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the interpretation of Exemption 11. These complexities will create challenges for lessors as they attempt to comply with the law. Businesses now subject to the lease tax should consider taking advantage of the voluntary disclosure offer provided by the Department in the bulletin. The Department’s offer should provide significant cost savings for companies that were unaware of their tax liabilities for their nonpossessory computer leases. Under both offers, no penalty or interest is due on tax owed to the Department. This is a cost savings as under the general program, interest is normally not waived. Further, under the second offer, companies will only have to pay one year of taxes owed, rather than up to four years under the general program. This could benefit many companies as either lessors or lessees. If a company is the lessor, it may be unable collect this tax from its customers based on the customers’ previous liability. Additionally, if a company is the lessee, but is required to self-assess and remit the lease tax under the law, it would avoid paying up to three years of back taxes owed to the city for its nonpossessory computer leases. This voluntary disclosure offer is limited to those companies that come forward by January 1, 2016. Companies will have to analyze their business and computer/software contracts quickly to understand how these changes to the lease tax impact them. Taxpayers that may be subject to these changes should carefully consider the legal rulings and bulletin to determine their next steps with respect to the lease tax soon so that they may take advantage of the voluntary disclosure offer, if needed.

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