Avalara : Taxing try-before-you-buy subscription services in Illinois

Though most of us wouldn't dream of buying a car before taking it for a test drive, we regularly purchase sundry other goods from ecommerce sites without trying them first. Try-before-you-buy programs offer an appealing alternative, as they combine the convenience of online shopping with the tactile experience of in-store browsing. Try-before-you-buy subscription services hold further allure for many consumers; however, determining how to tax try-before-you-buy subscription services and any subsequent sales can be challenging for the companies that offer them - particularly in Illinois.

To wit, the Illinois Department of Revenue recently fielded questions from a company that sells merchandise to consumers via a subscription-based business model. The company wished to know "how it should account for Illinois sales/use taxes, including its monthly subscription receipts and sales proceeds."

The company claims it has no store or other place of business in Illinois and is headquartered outside of Illinois. It operates an ecommerce site that offers customers a month-to-month subscription service, allowing them to try different types of merchandise to determine if they want to buy. All merchandise is shipped from and returned to a location outside of the state.

In General Information Letter ST-21-0025-GIL, the Illinois Department of Revenue broadly discussed and analyzed whether:

• Receipts for subscription service are subject to state or local sales tax in Illinois
• Receipts for subscription service are subject to Illinois rental purchase agreement occupation and use tax
• Merchandise used for demonstration purposes is subject to Illinois use tax
• Merchandise sold in Illinois would be subject to sales tax or use tax

Note: A General Information Letter (GIL) is nonbinding for the department and not a statement of department policy. It directs taxpayers to regulations and other sources of information that provide useful information.

Are subscription services subject to Illinois sales tax?

Illinois sales and use tax generally doesn't apply to charges for subscription services because subscription receipts aren't derived from a transfer of ownership of tangible personal property to a purchaser. In Illinois, a taxable "sale at retail" is defined as "any transfer of the ownership of or title to tangible personal property to a purchaser."

Are subscription services subject to Illinois rental purchase agreement occupation and use tax?

Illinois levies a rental purchase agreement occupation and use tax "upon persons engaged in this State in the business of renting merchandise under a rental purchase agreement in Illinois." The rental purchase agreement occupation and use tax rate is 6.25% of the gross receipts received from the business.

The rental purchase agreement occupation and use tax applies to "an agreement for the use of merchandise by a consumer for personal, family, or household purposes for an initial period of four months or less that is automatically renewable with each payment after the initial period and that permits the consumer to become the owner of the merchandise."

In ST-21-0025-GIL, the department explains that "transactions in which a customer can try merchandise as part of a subscription program before making a decision whether to purchase or return the merchandise are generally not intended to be covered by the rental purchase agreement occupation and use tax." The rental purchase agreement occupation and use tax is generally for "rent-to-own dealers," and "a subscription model with a separate option to purchase generally would not fit that category."

Yet the department underscored that "each arrangement must be evaluated in light of the specific contract and the other aspects of the transaction to determine whether the rental purchase agreement occupation and use tax applies."

Does Illinois use tax apply to merchandise used for demonstration purposes?

ST-21-0025-GIL explains, "Generally, when a company ships items of tangible personal property that it owns to customers in Illinois … so that the customers may try the property before making a decision whether to purchase or return the property, the company is making a taxable use of the property under the Use Tax Act." In other words, use tax would generally apply.

However, the department also said Illinois provides a demonstration exemption: The Use Tax Act generally doesn't apply to "the leasing of tangible personal property by a retailer to prospective buyers for the purpose of allowing them to ascertain whether the property suits their particular needs and for the purpose of trying to induce them to buy the property" (Ill. Admin Code tit. 86, § 150.306(b)(2)).

Furthermore, "a month-to-month subscription that allows customers to receive different items of merchandise is not the same as a lease of an item as discussed in the [Use Tax] rule."

Is merchandise sold in Illinois subject to sales tax or use tax?

ST-21-0025-GIL emphasized what can be found on the department's Sales & Use Taxes web page, summarized here:

In-state retailers (i.e., retailers that have inventory and headquarters in Illinois) must collect and remit state and local retailers' occupation tax (aka, sales tax) at the rate in effect at the origin of the sale. They can reimburse themselves by collecting use tax from buyers.

Out-of-state retailers with no physical presence in Illinois (i.e., remote retailers) are liable for state and local retailers' occupation tax as of January 1, 2021,if in the preceding 12-month period, they met one of the following thresholds:

• $100,000 or more in cumulative gross receipts from sales of tangible personal property to purchasers in Illinois; or
• 200 or more separate transactions for the sale of tangible personal property to purchasers in Illinois

Out-of-state sellers (i.e., out-of-state retailers with a physical presence in Illinois) must determine on a sale-by-sale basis if their selling activities take place in Illinois:

• If selling activities occur in Illinois, they typically owe state and local retailers' occupation tax at the rate in effect at the origin of the sale
• If selling activities occur outside of Illinois, they must collect and remit use tax

With respect to the try-before-you-buy subscription service model, the Illinois Department of Revenue made an interesting point that's worth quoting here.

"Generally, if tangible personal property is maintained as inventory in Illinois, whether eligible for the demonstration use exemption or not, the sale of the property will result in State and local Retailers' Occupation Tax liability due to the maintenance of inventory at an Illinois location. … For example, if a company ships items of tangible personal property that it owns to a customer in Illinois pursuant to a subscription so that the customer may try the property before making a decision whether to purchase or return the property, and the customer decides to purchase the item, then the sale is subject to both State and local Retailers' Occupation Tax at the customer's location, because the company's inventory is at that location at the time of the sale."

Try-before-you-buy subscriptions can be a successful business model for some companies, but it certainly doesn't make sales and use tax compliance any easier. Explore how automating sales tax calculation, collection, and remittance can.