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Illinois Appellate Court Holds City of Chicago Tax on Cars Rented Outside of but Used Within the City Valid

An Illinois Appellate Court, in Hertz Corp. v. City of Chicago, 2015 IL App (1st) 123210 (Sept. 22, 2015), gave the City of Chicago (City) permission to require rental car companies to collect tax on vehicle rentals from locations within three miles of the City, overturning a lower court ruling that found such taxation was an extraterritorial exercise of the City’s authority.  The appellate court granted summary judgment to the City and lifted the permanent injunction enjoining the City from enforcing the tax.

The tax at issue is the City’s Personal Property Lease Transaction Tax (Lease Tax), which is imposed upon “(1) the lease or rental in the city of personal property, or (2) the privilege of using in the city personal property that is leased or rented outside of the city.”  Mun. Code of Chi. § 3-32-030(A).  While the Lease Tax is imposed upon and must be paid by the lessee, the lessor is obligated to collect it at the time the lessee makes a lease payment and remit it to the City.  Mun. Code of Chi. §§ 3-32-030(A), 3-32-070(A).

The subject of this litigation is the City’s application of the Tax in its Personal Property Lease Transaction Tax Second Amended Ruling No. 11 (eff. May 1, 2011) (Ruling 11).  The plaintiffs argued that Ruling 11 is an extraterritorial exercise of the City’s authority because the City lacks nexus with the rental transactions.  The Ruling “concerns [short-term] vehicle rentals to Chicago residents, on or after July 1, 2011, from suburban locations within 3 miles of Chicago’s border … [excluding locations within O’Hare International Airport] by motor vehicle rental companies doing business in the City.”  Ruling 11 § 1.  The Ruling explains that “‘doing business’ in the City includes, for example, having a location in the City or regularly renting vehicles that are used in the City, such that the company is subject to audit by the [City of Chicago Department of Finance] under state and federal law.”  Ruling 11 § 3.  As for taxability of leased property, the Ruling cites the primary use exemption, exempting from Tax “[t]he use in the city of personal property leased or rented outside the city if the property is primarily used (more than 50 percent) outside the city” and stating the taxpayer or tax collector has the burden of proving where the use occurs.  Ruling 11 § 2(c) (quoting Mun. Code of Chi. § 3-32-050(A)(1)).

Ruling 11 contains a rebuttable presumption that motor vehicles rented to customers who are Chicago residents from the suburban locations of rental companies that are otherwise doing business in Chicago are subject to the Lease Tax.  The Ruling applies to companies with suburban addresses located within three miles of the City.   The presumption may be rebutted by any writing disputing the conclusion that the vehicle is is used more than 50 percent of the time in the City.  The opposite is assumed for non-Chicago residents.  Ruling 11 § 3.  The Ruling provides that such a writing can be as simple as a customer’s initialing a statement that the vehicle will be used more than 50 percent outside the City (Ruling 11 § 3), but it must be part of the lease agreement or otherwise kept in the company’s business records.  Companies that do not wish to comply with the record keeping requirements may opt to pay tax on 25 percent of its rental charges from Chicago customers.

Plaintiffs Hertz Corporation and Enterprise Leasing Company of Chicago LLC, filed separate actions against the City seeking declaratory and injunctive relief.  The cases proceeded in tandem in circuit court and the court granted summary judgment to the companies.  The court declared Ruling 11 facially unconstitutional and permanently enjoined the City from enforcing the ordinance with respect to vehicle rental transactions occurring outside the City.

On appeal, the City argued that the circuit court erred in characterizing the Lease Tax as a transaction tax, arguing instead that it should be considered a use tax on Chicago residents.  The appellate court agreed and found that Ruling 11 is not an extraterritorial exercise of Chicago’s home rule authority because the Lease Tax is imposed upon a use occurring with the City.  Although the plaintiffs conceded that they “do business” in the City, they argued that the City did not have the jurisdiction over their suburban rental locations to require those locations to collect and remit the Lease Tax. The court, however, was not persuaded and found the undisputed nexus between the plaintiffs, the taxable activity and the City to be sufficient to require plaintiffs to collect and remit the Lease Tax.

The court also  rejected the plaintiffs’ argument that Rule 11 exceeds the scope of the ordinance, instead finding the ruling was well within, and even more limited than, the ordinance.  The court found Ruling 11 narrower than the Ordinance since the ordinance imposes tax on any lease personal property that is used in the city, while the Ruling explains that it is the City’s policy to only impose the tax on city residents who use the leased vehicle primarily in the City.  The court also found that the record keeping requirements contained in Ruling 11 impose no greater documentation burden than is already imposed and permitted by the ordinance.  The court noted that Ruling 11 merely provides guidance as to appropriate documentation and an obligation to maintain records is consistent with the ordinances’ ordinary requirements for taxpayers seeking to claim an exemption.  Finally, the court rejected the plaintiffs’ argument that the Ruling’s presumption that Chicago residents will incur taxable use in the City exceeds the ordinance’s scope.  The court found that the multiple ways the Ruling allows the presumption to be rebutted (including deeming customers’ initialing a sentence containing the “magic” language regarding use outside of the City to rebut, as well as any other “written proof to the contrary”) to be a reasonable implementation of the tax.

The court did not address the plaintiffs’ Commerce Clause argument that there is no minimum connection between the City and rental car transaction occurring outside of the state, e.g., Indiana.  Since the ruling does not currently include Indiana, the court found that the plaintiffs’ argument was speculative.  Finally, the court held that the plaintiffs’ did not have standing to bring a Due Process Clause minimum contacts challenge to Ruling 11 because the ordinance taxed the use of the leased personal property in Chicago, not the rental transaction.

© 2019 McDermott Will & Emery


About this Author

Catherine A. Battin, McDermott Will Emery Law Firm, Tax Attorney

Catherine A. Battin is a partner in the law firm of McDermott Will & Emery LLP and is based in the Firm's Chicago office. 

Cate has represented clients in state and local tax controversies at the audit, administrative and judicial levels in numerous jurisdictions.  She also assists her clients with various types of planning related to income and franchise taxes, sales and use taxes, and personal income taxes.  Cate has defended numerous internet sellers in cases brought under the Illinois False Claims Act alleging fraudulent failures to collect and remit use tax.

 McDermott Will Emery Law Firm, Lauren A. Ferrante, Tax Attorney

Lauren A. Ferrante is an associate in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Chicago office. She focuses her practice on state and local taxation. Lauren represents taxpayers at all stages of state and local controversy disputes, at the audit, administrative, and judicial levels. She also assists taxpayers with planning, transactional, and compliance matters with respect to various state and local taxes, including income and franchise taxes, sales and use taxes, gross receipts taxes, and other miscellaneous taxes.

Lauren regularly speaks on state and local tax matters and has authored publications on nexus, procedure, and state tax false claims act issues.