* From the Department of Revenue…
TO: Representative Jeanne M. Ives
FROM: Mark Dyckman General Counsel
Illinois Department of Revenue DATE: May 24, 2017
RE: Senate Bill 9 Constitutional Issues
This memorandum is in response to your request that the Department discuss constitutional issues associated with the tax provisions of Senate Bill 9. These issues are explained below.
1. Service tax provisions. The bill inserts 5 discrete services in the Retailers’ Occupation Tax Act (ROT) (storage; laundry and dry cleaning; private detective, private alarm, and private security service; structural pest control service; and tattooing and body piercing). These servicemen are taxed on 100% of the selling price and enjoy an exemption for sales to businesses making purchases of service for the benefit of the business (other than resale). All other servicemen in Illinois continue to be taxed under the Service Occupation Tax Act/Use Tax on only the tangible personal property transferred incident to service; they enjoy no business exemption.
It is the Department’s opinion that there is a substantial risk that the service tax components violate the uniformity clause of the Illinois Constitution (Art. IX, Sec. 2). In order to survive scrutiny under the uniformity clause, a non-property tax classification must (1) be based on real and substantial differences between those taxed and not taxed; and (2) must bear some reasonable relationship to the object of the legislation or to public policy. Illinois service tax classifications have previously been invalidated under the uniformity clause, notably in the case of Fiorito v. Jones, 39 Ill.2d 531, 236 N.E.2d 698 (1968). In that case, existing service taxes were replaced with a tax on only 4 itemized service categories. The Illinois Supreme Court could find no reasonable differences between servicemen who were taxed and those who were not taxed. Senate Bill 9 carries similar risks since it chooses only 5 categories of servicemen from the thousands of servicemen in Illinois and taxes them differently. A court may struggle to find the “real and substantial differences” that justify this differential treatment. Any service tax that simply picks and chooses services at random to be taxed or exempt from tax runs this substantial risk of being unconstitutional.
While not focused on in Fiorito, it is also possible for uniformity violations to be found within specific classifications made in a bill. For instance, the bill continues to tax retailers making sales of tangible personal property to other businesses for business purposes (e.g., a retailer selling security cameras to a business). However, the bill does not tax servicemen (now included in the ROT) when they make sales of service for business purposes (e.g., a serviceman selling alarm services to a business).
2. Entertainment Tax Fairness Act. The bill creates a new 1% tax on subscribers of entertainment (paid video programming through numerous methods including cable). It is our opinion that this tax could be challenged under the Federal Internet Tax Freedom Act (ITFA). ITFA, in part, prohibits states from imposing discriminatory taxes on electronic commerce. A discriminatory tax under ITFA is a tax that is not generally imposed and legally collectible by a State on transactions involving similar property, goods, services, or information accomplished through other [than electronic commerce] means. SB 9 imposes tax on subscribers renting movies on an internet or cable platform. However, when a subscriber rents the same movie from a video store, he or she incurs no tax liability. As a result, the bill appears to impose a discriminatory tax because it taxes transactions made through electronic commerce more harshly than those made through non-electronic commerce. The Illinois Supreme Court used a similar analysis to strike down Illinois’ first “Amazon law” related to click-through nexus for certain internet links in Performance Marketing v. Hamer, 2013 IL 11496 (2013). The General Assembly corrected that constitutional infirmity in subsequent legislation. It is the Department’s opinion that there is a substantial risk that these provisions violate ITFA.
3. Video Service Tax Modernization Act. SB 9 creates a new 5% tax on providers of direct-to-home satellite service, direct broadcast satellite service, and digital audio-visual work. The bill does not tax cable companies. It is very likely that this tax will be challenged by satellite service providers. Across the country, satellite companies have argued that such laws are discriminatory because they do not tax cable companies. While results have been mixed, challenges have been consistent. As noted in the discussion of Fiorito, above, such a challenge could be asserted under the State Constitution’s Uniformity Clause.
Senate Democrats noted Rauner had recommended service taxes.
“Yikes! How’d the governor take that news? Sales taxes on services have been part of his economic agenda going back to 2014,” said John Patterson, spokesman for Illinois Senate President John Cullerton. “I’m sure he can get this resolved with his Revenue Department.”
That’s true. Rauner proposed a service tax during the 2014 campaign. Unfortunately, the plan has since been deleted from his campaign website. But you can click here to see it.
The governor also touted expanding the sales tax base during his budget address back in February.