Hertz Ruling Spells Trouble for Chicago Cloud Computing Tax

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By Michael J. Bologna

An Illinois Supreme Court ruling striking down Chicago’s lease transaction tax on rental cars raises questions about the city’s ability to continue taxing cloud computing services, tax practitioners told Bloomberg BNA.

In a widely watched ruling, the Supreme Court on Jan. 20 agreed with rental company powerhouses Hertz Corp. and Enterprise Leasing Co. and declared Chicago’s Personal Property Lease Transaction Tax Second Amended Ruling No. 11 unconstitutional. The court found the tax scheme to be an extraterritorial exercise of Chicago’s authority under the home rule article of the Illinois Constitution. It expressed particular concern with a tax environment in which multiple jurisdictions, particularly in the Chicago region, attempt to capture transactions beyond their boundaries ( Hertz Corp. v. City of Chicago , Ill., No. 119945, 1/20/17 ).

Ruling 11 specifically sought to impose Chicago’s 8 percent lease transaction tax on suburban short-term vehicle rental locations within three miles of the city’s borders. Rental companies Hertz and Enterprise successfully challenged the program.

Tax practitioners said the court’s logic could also apply to Chicago’s Personal Property Lease Transaction Tax Second Amended Ruling No. 12, which imposes a 9 percent transaction tax on nonpossessory computer leases. The program imposes tax collection duties on dozens of online service providers including Google Inc., Microsoft Corp., Oracle Corp., Amazon.com Inc. Web Services, Parallels and Citrix Systems Inc.

Ruling 12 has been controversial since Chicago’s Finance Department unveiled it in June 2015, but no parties have gone to court to challenge it.

Courage to Challenge

Catherine A. Battin, a partner with McDermott Will & Emery in Chicago, said the Hertz ruling could give cloud computing companies or Chicago-based users of cloud services courage to challenge the scheme. As with Ruling 11, Battin said Ruling 12 appears to be an example of Chicago slapping a tax on business activity outside of its jurisdictional authorities.

“I think we are ripe for a challenge on Ruling 12 alleging there is an extraterritorial impact,” Battin told Bloomberg BNA. “And if we have other jurisdictions in the state adopting similar provisions—even with different or the same sourcing laws—you have the same mess the Illinois Supreme Court was concerned about in Hertz. So I’m hopeful this decision will resurrect some of the parties thinking about challenging Ruling 12.”

Stanley R. Kaminski, who represented Enterprise in the Hertz litigation, agreed.

“The Hertz case could provide a basis for a new challenge to the imposition of the transaction tax to cloud services,” said Kaminski, a partner with Duane Morris LLP in Chicago.

An attorney with the Chicago-based Liberty Justice Center, a libertarian legal advocacy group that has challenged other Chicago tax initiatives like the so-called Netflix tax, said the Hertz precedent would be important in any potential challenge to Ruling 12.

Long Arms?

Jeffrey Schwab, a Liberty Justice staff attorney, said the Hertz ruling begs the question, “why should Chicago’s taxing arm be that long?” He waived off a suggestion that his organization would represent plaintiffs in any upcoming challenge to Ruling 12.

“We haven’t looked into the cloud thing yet,” he said. “I’m not going to say whether we will or we won’t. But if a taxpayer wanted to bring this, I think it would be most likely that a public interest firm would represent them because of the cost and the time issues.”

Michael Wynne, who filed an amicus brief on behalf of the Taxpayers Federation of Illinois in the Hertz case, said Ruling 11 and Ruling 12 are examples of Chicago’s creativity in a quickly evolving business environment. At the same time, Wynne said the Hertz ruling demonstrates the pitfalls that can beset municipalities engaging in regulatory overreach.

Wynne warned taxpayers to watch for legislative fixes to both rulings in a Jan. 24 memorandum distributed to clients.

“The City is at the forefront of municipal efforts to adapt existing tax codes to modern business practices. In this case, Chicago’s Ruling 11 was an overreach through administrative policy,” wrote Wynne, a partner with Reed Smith LLP in Chicago. “The Illinois Supreme Court’s ruling prevents similar or further overreach in the case of other types of transactions subject to the Lease Tax, such as cloud services. In Illinois, legislation usually follows court actions that clamp down on administrative excesses, so the Chicago Lease Tax should remain on taxpayers’ radars.”

To contact the reporter on this story: Michael J. Bologna in Chicago at mbologna@bna.com

To contact the editor responsible for this story: Ryan C. Tuck at rtuck@bna.com

For More Information

Text of the Hertz opinion is at http://www.illinoiscourts.gov/Opinions/SupremeCourt/2017/119945.pdf.

Text of Ruling No. 11 is at http://src.bna.com/lLf.

Text of Ruling No. 12 is at http://src.bna.com/lMa.

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