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March 15, 2016

2016-Issue 9 – Chapters 3-32 and 4-156 of the Municipal Code of Chicago impose taxes on personal property leases and amusement transactions, respectively. These laws were broadly drafted, but significant technological advancements since the effective date of these chapters have further broadened their scopes. The taxability of electronic commerce and cloud computing is still an evolving issue with many states. As a matter of fact, Illinois does not tax cloud computing, but Chicago’s home rule authority allows it to tax cloud computing transactions.

On June 9, 2015, the City of Chicago Department of Finance issued two rulings addressing the city’s (1) Personal Property Lease Transaction Tax and (2) Amusement Tax. These rulings were primarily intended to clarify Chicago’s ordinances as applied to cloud computing and electronically delivered amusements.

Lease Transaction Tax
The 9 percent Lease Tax applies to, among other things, any charges for a “nonpossessory computer lease,” which is defined as a lease where the customer can use a provider’s computer and software to input, modify, or retrieve data or information. Personal Property Lease Transaction Tax Ruling No. 12 both restates existing law and provides one change to the Department’s interpretation of the Lease Tax Ordinance. Most of Ruling No. 12 restates existing law and provides examples of taxable transactions. Specifically, it lists legal research or online database searches and obtaining consumer credit reports, real estate listings and prices, car prices, stock prices and similar information that has been compiled, entered and stored on the provider’s computer as examples of taxable transactions when accessed by the customer from a terminal or other access point within the City of Chicago. Additionally, the Department specifically identifies infrastructure as a service (IaaS), platform as a service (PaaS) and software as a service (SaaS), where the customer pays for a shared infrastructure, platform or software, as taxable leases of personal property.

More importantly, however, Ruling No. 12 identifies a change in the Department’s interpretation of Code Section 3-32-050(A)(11), known as Exemption 11. Exemption 11 essentially exempts transactions where (1) the customer’s use or control of the provider’s computer is de minimus and (2) 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 current price quotations or other information having a “fleeting or transitory character.” Previously, the Department had interpreted the reference to “fleeting and transitory” information as exempting certain products that provide financial market data. Ruling No. 12 clarifies that such uses are exempt only if they constitute the passive receipt of information (one-way “streaming”) and does not exempt any use that is interactive, involves search functions or has more than one “channel” selection. It goes on to say that a subscription to an interactive website will be subject to tax even if most or all of the information on the website is fleeting or transitory. The ruling also offers specific examples of non-taxable transactions, such as streaming price quotation and news services. It should also be noted that charges to store information on a provider’s computer outside the city are not taxable, but any subsequent charge to access this information from a terminal in the city would be taxable.

On October 28, 2015, in response to tremendous criticism from the Chicago technology start-up community, Chicago City Council enacted amendments to the Lease Tax Ordinance that included two important changes to the Lease Tax, effective January 1, 2016:

  1. A reduction in the tax rate from 9 percent to 5.25 percent for transactions where a customer uses a provider’s computer and software to input, modify or retrieve data supplied by the customer. In general, this means that the 5.25 percent rate will apply to PaaS, IaaS and SaaS products, where the provider’s computer is used to input, modify or retrieve data supplied by the customer, but not to “database” products, where the provider’s computer is used to input, modify or retrieve data supplied by the provider.
  2. The addition of a “small new business” exemption. A “small new business” is a licensed business that has been in operation for less than 60 months and has under $25 million of sales as defined for federal income tax purposes.

Amusement Tax
The 9 percent Amusement Tax applies to charges paid to witness, view or participate in an amusement, which has been broadly defined by the Department to include not only charges paid to witness amusements in person but also via electronic delivery.

Amusement Tax Ruling No. 5, effective July 1, 2015, but not implemented until September 1, 2015, provides specific examples of taxable transactions, such as charges for watching electronically delivered television shows, movies or videos if the show is delivered to a customer in Chicago. Electronically delivered music and games are also subject to the tax. Consequently, subscriptions for streaming movies via Netflix, listening to music via Spotify or playing the new Madden Football through GameFly are now taxable at the 9 percent rate if these activities are performed within the City of Chicago.

Specific examples of non-taxable transactions include the sale of shows, movies, music or games. This is because the sale of electronic products is generally accomplished via permanent download, as opposed to a temporary stream or tentative download.

Ruling No. 5 also addresses the bundling of services. It states that unless it is clearly proven that at least 50 percent of the price is not for the amusement, the entire charge, except separately stated non-amusement charges, is subject to the tax. It is recommended that companies separately state services provided on invoices. For example, bars or restaurants that charge a cover fee to view a sporting event should pay attention to these rules.

Ruling No. 12 and the aforementioned October 28, 2015, amendments became effective on January 1, 2016, noting the delayed effective date (originally effective July 1, 2015, and implemented September 1, 2015) was made to allow businesses more time to seek assistance in complying with the law and to change their billing systems. However, the Department did not delay the effective date of Ruling No. 5, which became effective as of July 1, 2015, and implemented on September 1, 2015. It should be noted that to the extent that both rulings restate existing law, the Department did not intend the effective date of these rulings to mean the release of liability for periods before that date.

Both rulings also use the guidelines set forth in the Mobile Telecommunications Sourcing Conformity Act (35 ILCS 638) and apply tax based on the location of consumers. This will be determined based on the primary address of the consumer as reflected by credit card billing address or other reliable information. This could present a problem once the Department begins to audit and assess customers located within the city. Netflix has already started to make arrangements to add the tax to the bills of its Chicago subscribers. We can expect costs to consumers to rise and it will only be a matter of time before other companies, like LexisNexis, Amazon and Spotify, follow suit.

Alvarez & Marsal Taxand Says:
Chicago’s move to expand its tax structure to include the above-mentioned online services has taxpayers and service providers wondering whether other jurisdictions will begin imposing similar taxes. As more jurisdictions start taxing online services, the need to monitor sales and use tax legislation, regulations and rulings will be greater than ever. Companies should regularly monitor legislative changes to keep abreast of updates in the ever-evolving taxation of electronic commerce. 

For More Information

Craig Beaty
Managing Director, Houston
+1 713 221 3933

Benjamin Diaz
Managing Director, Miami
+1 305 704 6650

Brian Pedersen
Managing Director, Seattle
+1 206 664 8911

The information contained herein is of a general nature and based on authorities that are subject to change. Readers are reminded that they should not consider this publication to be a recommendation to undertake any tax position, nor consider the information contained herein to be complete. Before any item or treatment is reported or excluded from reporting on tax returns, financial statements or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisers. The information reported in this publication may not continue to apply to a reader's situation as a result of changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisers before determining if any information contained herein remains applicable to their facts and circumstances.

About Alvarez & Marsal Taxand
Alvarez & Marsal Taxand, an affiliate of Alvarez & Marsal (A&M), a leading global professional services firm, is an independent tax group made up of experienced tax professionals dedicated to providing customized tax advice to clients and investors across a broad range of industries. Its professionals extend A&M's commitment to offering clients a choice in advisers who are free from audit-based conflicts of interest and bring an unyielding commitment to delivering responsive client service. A&M Taxand has offices in major metropolitan markets throughout the United States and serves the United Kingdom from its base in London.

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