Appeal from Circuit Court of Sangamon County Nos. 08TX1/04 09TX1/06 Honorable John Schmidt, Judge Presiding.
Justices Pope and Holder White concurred in the judgment and opinion.
¶ 1 In 2004, the Department of Revenue (Department) issued two notices of deficiencies for corporate income taxes against plaintiff, Wendy's International, Inc. (Wendy's). In 2008, Wendy's paid the notices under protest and filed two separate actions against defendants, Brian Hamer, in his official capacity as the Department director; the Department; and Alexi Giannoulias, in his official capacity as Treasurer of the State of Illinois, seeking to enjoin the imposition of corporate income taxes. Both parties filed motions for summary judgment. In July 2011, the trial court allowed defendants' motion and denied Wendy's motion.
¶ 2 On appeal, Wendy's argues the trial court erred in finding Scioto Insurance Company was not an insurance company for Illinois income tax purposes. We reverse and remand with directions.
¶ 3 I. BACKGROUND
¶ 4 Wendy's is an Ohio corporation having its commercial domicile in Ohio and the parent company of an affiliated group of corporations in the business of operating restaurants throughout the United States, including Illinois. In 2001, Wendy's conducted a feasibility study and determined it would be economically beneficial to self-insure its risks by creating a wholly owned insurance company to meet its insurance needs. By doing so, Wendy's would be able to obtain insurance coverage that was not readily available in the marketplace and reduce its insurance expenses. Moreover, it could obtain business interruption insurance to protect against losses relating to various contingencies, including the possibility of an outbreak of bovine spongiform encephalopathy (mad cow disease), which was of a concern to Wendy's and something Wendy's had been unable to obtain insurance coverage for in the past.
¶ 5 In accord with those plans, Wendy's formed and licensed Scioto Insurance Company in the State of Vermont as a "captive insurance company" that insured affiliated entities. For Scioto to be qualified as an insurance company under Vermont law, it had to be sufficiently capitalized to cover all of its insurance obligations, including insurance of catastrophic exposures. Scioto acquired Oldemark LLC, a Wendy's affiliate that held Wendy's trademarks. Oldemark licensed to Wendy's the right to use and sublicense the intellectual property used in Wendy's restaurants in exchange for a royalty of 3% of gross sales of all of its business units in the United States. The value of the transferred trademarks exceeded $900 million. In October 2001, the Vermont Department of Banking, Insurance, Securities and Health Care Administration (now the Vermont Department of Financial Regulation) licensed Scioto to transact business as an insurance company in the State of Vermont.
¶ 6 Scioto issued insurance policies to Wendy's and its affiliated groups and covered workers' compensation, general liability, auto liability, auto physical damage, property, crime liability, business interruption, excess liability insurance, product recall, terrorism coverage, strike insurance, pollution wraparound, and price volatility coverage. Scioto used actuarially determinated rates to set the premiums it charged for its insurance policies. Scioto was included in Wendy's federal consolidated income tax returns.
¶ 7 In November 2004, the Internal Revenue Service (IRS) audited Wendy's federal consolidated returns for the years 2001, 2002, and 2003. As one of the issues under consideration, the IRS examined whether Scioto was an insurance company for federal income tax purposes. The IRS ultimately did not dispute Scioto's claimed status as an insurance company. The IRS also audited Wendy's federal consolidated federal income tax returns for the years 2004, 2005, and 2006, and it again did not dispute Scioto's status as an insurance company for those years.
¶ 8 Wendy's excluded Scioto from its Illinois unitary business group and Scioto's income was not included in the unitary business group's Illinois combined income tax returns from 2001 to 2006. In 2004, the Department commenced an audit of Wendy's Illinois combined income tax returns for 2001, 2002, and 2003. A second audit looked at the returns for 2004, 2005, and 2006. In the course of the audits, the Department considered the effect of the 2004 IRS audit of Wendy's International's federal consolidated return, in which the IRS did not dispute Scioto's claimed status as an insurance company and allowed it "loss reserve deductions, " a tax benefit available to insurance companies.
¶ 9 The Department's audits concluded Scioto was not a true insurance company because (1) there was not actual risk shifting and risk distribution to constitute insurance for federal income tax purposes, (2) the majority of Scioto's income is derived from intercompany royalty income, and (3) it is not regulated in all states in which it writes premiums. As a result of the audit, the Department issued two notices of deficiencies for corporate income and replacement tax, penalty, and interest for the 2001 to 2003 tax years in the amount of $1, 845, 625 and for the 2004 to 2006 tax years in the amount of $645, 688.
¶ 10 In 2008, Wendy's paid the notices under protest and filed two separate actions pursuant to the State Officers and Employees Money Disposition Act (Protest Monies Act) (30 ILCS 230/1 to 6a (West 2008); see also Hartney Fuel Oil Co. v. Hamer, 2012 IL App (3d) 110144, ¶ 30, 976 N.E.2d 682 ("the Protest Monies Act allows a taxpayer willing to pay under protest to avoid the administrative protest procedures provided by Illinois law")). In both cases, Wendy's alleged Scioto qualified as an insurance company under the Illinois Income Tax Act (35 ILCS 5/101 to 250 (West 2008)) and the uniformity clause of the Illinois Constitution (Ill. Const. 1970, art. IX, § 2) prohibited the Department from treating Scioto differently than other insurance companies.
¶ 11 In May 2011, Wendy's filed a motion for summary judgment. Wendy's claimed it was not required to include Scioto in its Illinois combined tax returns because Scioto is a bona fide insurance company. Also, Wendy's argued that since Scioto meets the definition of an insurance company under federal law, then the Department must treat it as one as well. Further, Wendy's claimed Scioto is engaged in the insurance business because it effectuates both risk shifting and risk distribution. As to the uniformity clause, Wendy's argued the Illinois Constitution prohibits treating a non-Illinois insurance company as anything other than an insurance company for Illinois tax purposes.
¶ 12 In June 2011, defendants filed a motion for summary judgment. They claimed Scioto does not meet the definition of an insurance company under the Internal Revenue Code and Scioto's ...