2013 I LApp (4th) 110678 NO. 4-11- 0678 I N THE APPEL L ATE COURT OF I L L I NOI S FOU RTH DI STRI CT WENDY' S I

NTERNATI ONAL , I

NC., Plaintiff-Appellant, v. BRIAN HAMER, in His Off icial Capac ity

as Dire ctor of the Depa rtment of Reve nue; THE DE PARTMENT OF REVENUE; and A L EXI

GIANNOU L I AS, in His Offic ial Capac ity

as Tre asure r of the State of I llinois , Def endants-A

ppellees. ) ) ) ) ) ) ) ) ) Appea l from Circuit Court of Sang amon County Nos. 08TX1/04 09TX1/06 Honora ble J ohn Schmidt, J udg e Presiding

.

______________________________________________________________________________

J USTI CE TURNER delivere d the judg ment of the c ourt, with opinion. J ustices Pope and Holde r White concurr ed in the judg ment and opinion. OP INION ¶ 1 In 2004, the Depa rtment of Reve nue (D epar tment) issued two notices of de ficiencies for corpor ate income taxes ag ainst plaintiff, Wendy ' s I nternational, I nc. (Wendy ' s). In 2008, Wendy ' s paid the notices unde r protest a nd filed two sepa

rate actions ag ainst defe ndants, Br ian Hamer , in his official ca

pacity as the De partment dire ctor; the De partment; and A lexi Giannoulias, in his official c apac ity as Tre asure r of the State of I llinois , seekingto enjoin the imposit ion of corpor ate income taxes. Both parties f iled motions for summary judgme nt. I n J uly 2011, the trial cour

t allowed def

endants' motion and denied Wendy ' s motion. ¶ 2 On appe al, Wendy ' s argues the trial c ourt err ed in findingScioto I nsuranc e Company was not an insura

nce c ompany

for I llinois income tax purposes. We reve rse a nd

rema nd with directions. 

## F I L E D Oct obe r 7 , 201 3 Car la Bend er 4 Dis tr ic t Ap pel la te t h Cour t, IL¶ 3 I . BA CKGROUND

¶ 4 Wendy ' s is an Ohio corpor ation havingits commercial domicile in Ohio and the pare nt company

of an a ffiliated g roup of c orporations in t he business of ope ratingrestaur ants throug hout the United States, including I llinois . In 2001, Wendy ' s conducte d a fe asibility study and dete rmined it would be ec onomically benef icial to self-insure its risks by cre ating a wholly owned insura

nce c ompany

to meet its insurance needs. B y doing so, Wendy ' s would be able to obtain insurance cover ag e that wa s not readily available in the marke tplace a nd reduc e its insurance expenses. Moreove r, it could obtain business interruption insuranc e to protec t ag ainst losses relatingto various conting encie s, including the possibili ty of an outbre ak of bovine spong iform enc ephalopathy (mad c ow disease ), which w as of a conce rn to Wendy ' s and something Wendy ' s had bee n unable to obtain insuranc e cove rag e for in the past. ¶ 5 In acc ord with those plans, Wendy ' s formed a nd licensed Scioto Insuranc e Company in the State of Ve rmont as a " captive insura nce c ompany " that insured af filiated entities. For Scioto to be qua lified as an insura nce c ompany

under V ermont law, it had to be sufficie ntly

capitalized to cover

all of its insurance obligations, including insuranc e of c atastrophic exposures. Scioto acquire d Oldemar k L L C, a Wendy ' s aff

iliate that held Wendy ' s trade marks. Oldema

rk license d to Wendy ' s the rig ht to use and sublicense the intellectual proper ty used in Wendy ' s restaur ants in exchang e for a royalty of 3% of g ross sales of a ll of its business units in t he United States. The value of the transf

err ed tra demar

ks exceede d $900 milli on. In October

2001, the Ver

mont Depar

tment of Ba

nking, I nsuranc e, Secur ities and Hea lth Care A dminist ration (now the Ver mont Depar

tment of Fina

ncial Regulation) licensed Scioto to transac t business as an insuranc e compa ny in the State of Ve rmont.
- 2 -¶ 6 Scioto issued insurance policie s to W endy ' s and its affiliated groups and c overe d

worke rs' compensa

tion, ge nera l liabilit y , auto liability , auto phy sical dama g e, prope rty , crime liability , business interruption, excess liability insurance , product re call, ter rorism cove rag e, strike insuranc e, pollution wrapa round, and pr ice volatility cover ag e. Scioto used ac tuarially deter minated rates to set the pre miums i t char g ed for its insurance policie s. Scioto was included in Wendy ' s fede ral c onsolidated income tax returns. ¶ 7 In November 2004, the Interna l Revenue Ser vice ( I RS) audited Wendy ' s fede ral consolidated re turns for the year s 2001, 2002, and 2003. As one of the issues under c onsideration, the I RS ex amined whe ther Scioto was a n insurance company

for f eder al income tax purposes. The I RS ul timately did not disput e Scioto' s claimed status as a n insurance company . The I RS also audited Wendy ' s fede ral c onsolidated fede ral income tax returns for the year s 2004, 2005, and 2006, and it ag ain did not dispute Scioto's status as an insura nce c ompany

for those y ear s. ¶ 8 Wendy ' s excluded Scioto from its I llinois unitary business g roup and Scioto' s income wa s not included in the unitary business g roup' s I llinois combined income tax returns from 2001 to 2006. In 2004, the Depa rtment commenc ed an a

udit of Wendy ' s I llinois combined income tax returns for

2001, 2002, and 2003. A se cond audit looked at the returns f or 2004, 2005, and 2006. In the cour se of the a udits, the Depar

tment considere d the ef

fec t of the 2004 I RS audit of W endy ' s I nternational's f eder al consolidated r eturn, in which the I RS di d not dispute Scioto's c laimed status as an insura nce c ompany

and allowe d it "loss rese rve de ductions," a tax benef it available to insuranc e compa nies. ¶ 9 The De partment' s audits concluded Scioto wa s not a true insura nce c ompany - 3 -beca

use (1) there was not ac tual risk shifting a nd risk distribution t o constitute insurance for fede ral income tax purposes, (2) the majority of Scioto' s income is derive d from interc ompany roy alty income, and ( 3) it is not reg ulated in all states in which it writes pr emiums. As a re sult of the audit, the De partment issued two notice s of def iciencie s for c orporate income a nd repla cement tax, penalty , and intere st for the 2001 to 2003 tax y ear s in the amount of $1,845,625 and f or the 2004 to 2006 tax y ear s in the amount of $645,688. ¶ 10 In 2008, Wendy ' s paid the notices unde r protest a nd filed two sepa

rate actions pursuant to the State Of

fice rs and Employ ees Mone y Disposition Act (Protest Monies Act) (30 I L CS 230/ 1 to 6a (West 2008); see a lso Hartney Fue l Oil Co. v. Hamer , 2012 I LApp (3d) 110144, ¶ 30, 976 N.E.2d 682 ( "the Protest Monies Act allows a tax pay er w illing to pay under protest to avoid the administrative pr otest proce dures pr ovided by I llinois law" )). In both case s, Wendy ' s alleg ed Scioto qualified a s an insuranc e compa ny under the I llinois Income Tax Act (35 I L CS 5/ 101 to 250 (West 2008)) and the unif ormity clause of the I llinois Constit ution (I ll. Const

. 1970, art. IX, § 2) prohibited the D epar tment from treating Scioto diffe rentlythan other insurance companies. ¶ 11 In May

2011, Wendy ' s filed a motion for summary judgme nt. Wendy ' s claimed it was not re quired to include Scioto in its I llinois combined tax returns bec ause Scioto is a bona fide insurance company . Also, Wendy ' s argued that since Scioto meets the definition of an insurance company

under f eder al law, then the Depa rtment must treat it as one a s well. Fur ther, Wendy ' s claimed Scioto is eng ag ed in the insuranc e business bec ause it ef fec tuates both risk shifting a nd risk distribution. As t o the uniformity clause , Wendy ' s argued the I llinois Constit ution prohibits t reating a

non-I llinois insurance company as any thing other

than an insura

nce - 4 -company

for I llinois tax purposes. ¶ 12 In J une 2011, def endants filed a

motion for summary

judgme nt. They

claimed Scioto does not meet the def inition of an insurance company under the Interna l Revenue Code and Scioto' s roy alty

income is not part of a

n insurance business. ¶ 13 In J uly

2011, the trial cour

t conducted a

hear ing on the cross-motions for summary judgme nt. There afte r, the c ourt enter ed a doc ket entry finding Scioto was not an insurance company

pursuant to the I llinois Income Tax Act. The court a llowed def endants' motion for summary

judgme nt and denied Wendy ' s motion. This appea l followed. ¶ 14 I I . ANALYSI S ¶ 15 A. Standard of Review ¶ 16 "Summary judgme nt is appropriate wher e ' the pleading s, depositions, and admissions on file, toge ther with the a ffidavits, if any , show that there is no ge nuine issue as to any materia l fac t and that the moving party is entitled to a judgme nt as a matter of law.' " Ioerge r v. Halve rson Constr uction Co. , 232 I ll. 2d 196, 201, 902 N.E.2d 645, 648 (2008) (quoting735 I L CS 5/ 2-1005(c ) (West 2000)). Where , as her e, cr oss-motions for summary judgme nt were filed, the pa

rties " ag ree only

a question of law

is involved, and the cour t should decide the issue based on the rec ord." Farmers Automobile Insuranc e Ass'n v. Danner , 2012 I LApp (4th) 110461, ¶ 30, 967 N.E.2d 836. On a ppeal f rom a trial c ourt' s decision grantinga motion for summary judgme nt, our revie w is de novo

. Bagent v. Ble ssing Care Corp. , 224 I ll. 2d 154, 163, 862 N.E.2d 985, 991 (2007)

. ¶ 17 B. The I llinois Income Tax Act ¶ 18 I llinois imposes a tax on corporations for the privileg e of e arningor re ceiving

- 5 -income in I llinois . 35 I L CS 5/ 201(a) (West 2008). A taxpay er c orporation doing business inside

and outside the State must apportion its business income by a pre scribed f

ormula. 35 I L CS 5/304(a) ( West 2008). "Appor tionment is i ntended to assig n the amount of income to a state that is proportional to the amount of income- producingactivities in that state." Automatic Data Processing, Inc . v. De

partment of Reve nue , 313 I ll. App. 3d 433, 438, 729 N.E.2d 897, 902 (2000). ¶ 19 Acc ordingto section 1501(a) (27) of the I llinois Income Tax Act (35 I L CS 5/1501(a)( 27) (West 2008)), " ' unitary business g roup' means a

g roup of pe rsons rela

ted through

common owner ship whose business ac tiviti es ar e integ rate d with, depende nt upon and contribute to eac h other." A taxpay er c orporation operatingas par t of an I llinois unitary

business g roup is treated as a

single taxpay er a

nd must apportion its i ncome to I llinois toge ther with the income of the member s of its unitary business g roup throug h a unitary combined re turn. 35 I L CS 5/ 502(e) (West 2008). The law

prohibits including in an I llinois combined re turn aff iliates that are require d to apportion their business income pur suant to differ ent subsections of se ction 304 of the I llinois Income Tax Act than other members of

the unitary

g roup. 35 I L CS 5/ 1501(a) (27) (West 2008). Under

I llinois law, an insura

nce c ompany

is require d to apportion its business income under

a diffe rent subsec tion of section 304 than noninsuranc e compa nies, and thus it cannot be included in a c ombined repor t with its noninsurance company aff iliates (35 I L CS 5/1501(a)( 27) (West 2008)). ¶ 20 C. I s Scioto an Insuranc e Company Under the I llinois Income Tax Act? ¶ 21 Wendy ' s arg ues Scioto constitutes an insuranc e compa ny for f eder al income tax purposes a

nd there fore is one for I llinois income tax purposes. Def endants point out the I llinois
- 6 -Income Tax Act does not de fine a n "insura nce c ompany " but note I llinois follows the fe dera l definition. See 35 I L CS 5/ 102 (West 2008) (statingany term, not otherwise define d, shall have the same me aningas whe n used in a c ompara ble context in the I nterna l Revenue Code)

. Def endants c ontend Scioto did not meet the fede ral test for an insuranc e compa

ny for the 2001 throug h 2006 tax y ear s and thus its income was prope rly included with that of Wendy ' s unitary business g roup. ¶ 22 Our supre me cour t has stated taxation is t he rule and tax ex emption is the exception. Chicago Bar Ass'n v. Department of Rev enue , 163 I ll. 2d 290, 301, 644 N.E.2d 1166, 1171-72 (1994) . Acc ording ly , the taxpay er ha s the burden of provingit should be ex cluded f rom the unitary

business g roup and the apportionment re quirement. Zebra Technologies Corp. v. Topinka , 344 I ll. App. 3d 474, 484, 799 N.E.2d 725, 733 (2003); see also National Commercial Titl e &Mortgage Guaranty Co. v. D uffy , 132 F.2d 86, 88 ( 3d Cir. 1942) (statingthe taxpay er ha s the burde n of establishingthat a par ticular c orpora

tion is an insurance company under the

reve nue laws)

. ¶ 23 1. Taxable Y ears 2001 Through 2003 ¶ 24 In 1932, the United States Supreme Court he ld that "[w]hil e name , char ter power s, and subjection to state insura nce la ws have signific ance as to the business which a corpor ation is authorized and intends to car ry on, the cha

rac ter of the business actua lly done in the tax y ear s determines whether it was taxable as an insura nce c ompany ." Bowers v. Lawyers' Mortg. Co. , 285 U.S. 182, 188 (1932). Prior to 2004, Tre asury regulation 1.801-3(a) (26 C.F.R. § 1.801-3(a ) (2003) ) def

ined an insura

nce c ompany

as follows: "T he ter m insurance company

means a company whose primar

y - 7 -and pre dominant business activity duringthe taxable y ear

is the issuing of insura

nce or annuity contra cts or the r einsuringof risks underwritten by

insurance companies. Thus, thoug h its name, char ter powe rs, and subjec tion to S tate insuranc e laws a re sig nificant in dete rmining the business which a c ompany is authorized and intends to ca

rry on, it is t he cha

rac ter of the business actua lly done in the taxable y ear

which dete rmines whethe r a c ompany is taxable as an insura

nce c ompany

under the Interna l Revenue Code." ¶ 25 For

the 2001 to 2003 tax y ear s, Scioto's income br eakdown was a s follows: 12/31/2001 12/31/2002 12/31/2003 Premiums 18,156,759 25,059,030 14,960,726 Roy alty Income 47,157,394 207,384,178 217,620,152 Intere st I ncome 108,757 5,543,883 13,772,406 Total $65,422,910 $237,897,091 $246,353,284. ¶ 26 Whil e Scioto' s income fr om insurance premiums was dwa rfe d by its roy alty

and interest income, " it is not any perc entag e of inc ome that deter mines whether

a compa ny is tax able as an insura

nce c ompany

but rather

the cha rac ter of the business actua lly done by the company ." Servic e Life InsuranceCo. v. United States , 189 F. Supp. 282, 285-86 (D . Neb. 1960) . In this

case , Scioto was licensed by Ver mont as an insuranc e compa ny . Scioto's only

business was to furnish insuranc e to Wendy ' s and other a ffiliates. Its ownership of Olde mark, a disreg arde d entity for tax purposes, does not alter this conclusion since Scioto, unlike Oldemark, w as not eng ag ed in the business of lice nsing intellec tual proper ty . Moreove r, Scioto' s ownership of
- 8 -Oldemar

k was dire ctly

related to Scioto's c onduct as a n insurance company

beca use it enable d Scioto to satisfy

the ca pitaliz ation require ments under Ve rmont insurance law. L ooking a t these fac ts leads to the conc lusion that the chara cter of Scioto' s business was one of insurance . Thus, Scioto constitut ed a va lid insurance c ompany for f eder al income tax purposes for the 2001 to 2003 tax y ear s. ¶ 27 2. Taxable Y ears 2004 Through 2006 ¶ 28 In 2004, section 831(c ) of the I nterna l Revenue Code ( 26 U.S.C. § 831(c) (2000) )

was amended to def

ine the ter m "insura nce c ompany " a s having"the meaningg iven to it by section 816(a )." Under

section 816(a ), an insura nce c ompany

is defined a s "a

ny company more than half of

the business of which dur ing the taxable y ear is the issuing of insura

nce or annuity contra cts or the r einsuringof risks under written by

insurance companies." 26 U.S.C. § 816(a) (Supp. I ll. 2004). ¶ 29 For

the 2004 throug h 2006 tax y ear s, Scioto's income br eakdown was a s follows: 12/31/2004 12/31/2005 12/31/2006 Premiums 18,304,358 19,526,916 19,940,927 Roy alty Income 234,470,739 231,413,458 327,546,586 Intere st I ncome 18,228,723 27,658,079 42,566,583 Total $271,003,820 $278,598,453 $389,354,096. ¶ 30 The bulk of Scioto' s income duringthose three y ear s came from the r oy alties and not the premiums. Howeve r, the fa cts and c ircumstance s indicate Scioto was pr incipally eng ag ed in the insurance business during the 2004 to 2006 tax y ear s. I ts business was not one of lice nsing intellectual prope rty . Scioto ge nerated its own business income sepa rate from the income of Oldemar k. Thus, it would be inappropriate to consider the income g ener ated f rom Oldemar

k as
- 9 -coming from Scioto. The fa cts indicate Scioto constituted an insura nce c ompany

duringthe 2004 to 2006 tax y ear s. ¶ 31 3. Risk Shifting and Risk Distri bution ¶ 32 Wendy ' s also arg ues Scioto is eng ag ed in the insuranc e business bec ause it eff ectuates risk shifting a

nd risk distribution. Under fede ral tax law, insuranc e involves both risk shifting a nd risk distribution. Helve ring v. Le Gierse , 312 U.S. 531, 539 (1941). It is "an ag ree ment to protect the insure d ag ainst a direc t or indirect e conomic loss arisingfrom a de fined conting ency

wher eby the insurer

undertakes no pre sent duty of per formanc e but stands re ady to assume the f

inancial bur den of a

ny cover ed loss." Allied Fidelity Corp. v. Commissioner , 572 F.2d 1190, 1193 ( 7th Cir. 1978). Risk shi fting "e ntails the transfe r of the impac t of a potential loss from the insured to the insure r." Clougherty Pack ing Co. v. Commissioner , 811 F.2d 1297, 1300 (9th Cir. 1987). Risk dist ribution involves spreadingsmaller risks over a lar g e number

to avoid the possibility

that a sing le costly

claim will exceed the a

mounts taken in as pre miums and set aside f or the pa y ment of such a

claim. Clougherty , 811 F.2d at 1300. ¶ 33 Courts have he ld an ar rang ement betwe en an insura nce subsidiar

y and other subsidiaries of the same par ent qualify as insuranc e for

fede ral income tax purposes, even if ther e

are not insured policy

holders outside the a ffiliated g roup, provided the requisite risk shiftingand risk distribution are pre sent. Humana, Inc . v. Commissioner , 881 F.2d 247, 255 ( 6th Cir. 1989). "A bsent a fa ct patter

n of sham or la ck of business pur pose, a c ourt should acc ept transa ctions betwee n related thoug h separ ate c orporations as proper a nd not disreg ard the m beca use of the relationship between the pa rties." Humana , 881 F.2d at 255. ¶ 34 Her e, Scioto was for med for the purpose of

providing insurance to Wendy ' s and
- 10 -its affiliates. This included business interr uption insurance to pr otect ag ainst losses from var ious conting encie s, such as a

n outbreak of mad c ow disease , for whic h Wendy ' s had bee n unable to obtain insurance cover ag e. Insuranc e cove rag e provide d by Scioto also included worke rs' compensation, ge nera l liabilit y , auto liability , auto phy sical dama g e, prope rty , crime liability , excess liability

insurance , product re call, ter rorism cove rag e, strike insura nce, pollution wra

paround, a nd price volatility

cover ag e. Polices we re written, and the pr emiums charg ed we re actua rially deter mined and re flec ted fa ir marke t rates. ¶ 35 The c hara cter of Scioto' s business was one of insurance . Under

fede ral income tax l aw, Scioto' s insurance arr ang ements with its affiliates met the r equire ments of risk shifting and risk distribution. As Scioto was a provider of insuranc e contr acts a

nd eng ag ed in the requisite risk shifting and risk distribution, it consti tuted an insuranc e compa ny for f eder al income tax purposes. ¶ 36 4. IRS Inv olveme nt, Federal Conformity, and Vermont Law ¶ 37 Wendy ' s arg ues the I RS determined Scioto was an insura nce c ompany

in separate audits. The I RS audited Scioto for the y ear s 2001 throug h 2003 and tre ated it as a n insurance company , even making a djustments to t he compa ny ' s loss reserve s deductions consistent with that treatment. The I RS audited W endy ' s for the year s 2004 throug h 2006 and did not dispute Scioto's c laimed status as an insura nce c ompany . ¶ 38 Wendy ' s also arg ues that if Scioto meets the de finition of an insuranc e compa ny under f eder al law, then de fenda

nts must t reat it as an insuranc e compa ny in acc ordanc e with the I llinois Income Ta

x Act. Wendy ' s relies on the te stimony of tax ex pert a

nd profe ssor Richard D

. Pomp, who prepar ed a r eport for the trial cour

t and conc luded Scioto is a bona fide insurance

- 11 -company

under f eder al and Ve rmont law and should be similarly rec og nized under I llinois law. He e x plained the tax policy benef it of fede ral c onformity

as follows: "I f Scioto were not rec og nized by I llinois as an insura

nce c ompany the administrative and c ompliance be nefits of c onformingState law with fe dera l law would be lost. Fur ther, the a dvantag es of predic tability

and ce rtainty

would be nullified and tax pay ers would not be able to r ely

on fede ral law ." ¶ 39 As Scioto has been or g anized as an insura nce c ompany

by the State of Ve rmont and re cog nized as one by the I RS, t he bene fits of confor mity with fede ral a

nd state law e x ist here . Considering the adva ntag es of pr edictability

and ce rtainty , Scioto should be treated a s an insurance company

for I llinois income tax purposes in a similar fashion a s it has been tre ated by Ver mont and the I RS. ¶ 40 D. The Trial Court's O rder ¶ 41 We find Wendy ' s has met its burden in this case. T he fa cts indicate Scioto wa s a bona fide insurance company for pur poses of fe dera l income tax law as it met the require ments duringthe applica

ble y ear s and eng ag ed in the nec essar y risk shifting a

nd risk distribution. No evidenc e indicate s Scioto I nsuranc e Company was for med as a sham business or lac ked a va lid business purpose. Give n all of these f acts, a long w ith the treatment of Scioto by the I RS and the advanta g es of c onformity with fede ral law , Scioto constitut ed an insura nce c ompany

for f eder al income tax purposes and should have been tr eate d in a similar fashion for purposes of the I llinois Income Tax Act. Thus, the tria l court er red in g rantingsummary

judgme nt in favor of

defe ndants and deny ing Wendy ' s motion for summary judgme nt.
- 12 -¶ 42 E. Uniformity Clause ¶ 43 Wendy ' s arg ues the trial c ourt err ed in not holding that the unif ormity clause of the I llinois Constit ution prohibited the Depa rtment from tre atingScioto as any thing other

than an insurance company

for I llinois tax purposes. As we have deter mined that the cour

t erre d in finding Scioto was not an insuranc e compa ny , we ne ed not addr ess Wendy ' s uniformity clause argument. ¶ 44 I I I . CONCL USI ON ¶ 45 For

the re asons stated, we reve rse the tr ial court' s judgme nt gr anting defe ndants' motion for summary

judgme nt and re mand for the issuance of an orde r g rantingWendy ' s motion for summary

judgme nt. ¶ 46 Reverse d and re manded with dire ctions.

- 13 -