On November 11^th, 2013, the City of Cupertino extended a sales tax rebate agreement with Baz Industries, Inc., a consulting company representing Apple. Anticipating that Apple’s proposed second campus may significantly impact the local traffic and impose a greater challenge for Cupertino to provide adequate public services, the extended agreement reduced the sales tax rebate rate from 50% of sales tax increment generated by Apple product sales to 35%.

Cupertino and Apple first entered into a sales tax rebate agreement in 1997. Because local governments in California receive 1% of local sales taxes for all sales occurred in their jurisdiction, incremental sales taxes are used as an economic development tool.  To foster economic development and incentivize more sales taxes, Cupertino agreed to reimburse approximately 50% of the local sales tax increment generated by Apple. In return, Apple agreed to designate Cupertino as its point of sales for a portion of its online sales. Such a sales arrangement enabled Cupertino to receive more local sales taxes. The incremental sales taxes were calculated as the difference between the total amount of Apple’s products related sales taxes Cupertino received and the portion of sales taxes attributable to sales occurred at the Apple store located in Cupertino R&D campus.

The agreement has been extended for several times since 1997 and brought mutual benefits to Apple and Cupertino. In 2012 alone, Apple reported approximately $1.3 billion taxable sales occurred in Cupertino with a majority attributable to its online sales of Apple’s products. Based on the 1% local sales tax rate and the 50% rebate rate, it is estimated that Apple received over $6 million from Cupertino as sales tax incentives and Cupertino also strengthened its tax base by over $6 million in sales taxes.

Illinois Supreme Court’s recent opinion (Hartney Fuel Oil Company v. Hamer) closed a regulatory loophole regarding local sales tax sourcing. The Supreme Court declared that the bright-line test currently used by the Illinois Department of Revenue to determine sales tax situs narrowed the scope of the related tax regulations and was therefore invalid.

The case examines the tax strategy of Hartney. To minimize its Illinois sales tax liability, Hartney accepted purchase orders in the Village of Mark, Illinois, where the overall sales tax rate was lower, but conducted all of its sales related activities in the Village of Forest View, Illinois, where the rate was higher. The Department of Revenue applied its bright-line test to determine the sales situs, “where purchase orders are accepted, tax liability is incurred.” By establishing an office in the Village of Mark to accept purchase orders, Hartney established the Village of Mark as its sale situs and lowered its sales tax liability in 2005 through 2007.  In 2008, the Department of Revenue determined that Hartney’s sales situs should be the Village of Forest View and found Hartney liable in the amount of approximately $23 million in unpaid sales tax.

Hartney paid the $23 million in back taxes, interests and penalty but subsequently filed a challenge to the Department of Revenue’s decision. The Department of Revenue lost at the trial and appellate court levels and then appealed to the Supreme Court. In November 2013, the Supreme Court stated “While we do not find Hartney’s approach to retail occupation tax liability consistent with the statute . . . the Company did act consistently with the Department’s regulations published at the time.” The Supreme Court upheld the lower court decisions entitling Hartney to reimbursement of sums paid.

It is anticipated that the Supreme Court’s opinion in this case may discourage similar sales tax strategies in Illinois.