Illinois Appellate Court Respects Characterization of Captive Insurance Company

by Reed Smith

In Wendy’s International, Inc. v. Brian Hamer1, decided earlier this week, the Illinois Appellate Court found that Taxpayer had met its burden and proved that its subsidiary insurance company was a bona fide insurance company for purposes of federal income tax law as it met the statutory requirements during the applicable years, and engaged in the necessary risk shifting and risk distribution. The court found that no evidence was presented that indicated that the insurance company was formed as a sham business or lacked a valid business purpose. Given the facts of the case, the court found that the insurance company was properly treated as such for federal income tax purposes, and should have been treated in a similar fashion for the Illinois Income Tax Act. Thus, the Appellate Court reversed the trial court’s entry of summary judgment in favor of the defendants and denied Taxpayer’s motion for summary judgment.


Wendy’s International, Inc. ("Wendy’s" or "Taxpayer") is an Ohio corporation with commercial domicile in Ohio and the parent company of an affiliated group of corporations operating restaurants throughout the United States, including in Illinois. In 2001, Wendy’s determined it would make financial sense to create a wholly owned insurance company that would also make it possible to obtain insurance for risks for which external coverage could not be obtained, such as protecting against outbreaks of mad cow disease.

Wendy’s formed and licensed Scioto Insurance Company ("Scioto") in the state of Vermont as a captive insurance company that insured affiliated entities. Subsequent to the formation, 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 trademarks in exchange for a royalty of 3 percent of the gross sales of all United States business.2 In October 2001, Scioto was licensed to transact business as an insurance company in the state of Vermont. Scioto issued insurance policies to Wendy’s and Wendy’s affiliates, covering 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, using actuarially determined rates in setting the premiums charged for insurance policies.

Scioto was included in Wendy’s federal consolidated income tax returns. The Internal Revenue Service (the "IRS") audited Wendy’s federal consolidated returns and examined whether Scioto was an insurance company for federal income tax purposes. The IRS did not dispute Scioto’s claimed status as an insurance company in any of the audits of the federal consolidated tax returns for the tax years 2001 through 2006.

Wendy’s excluded Scioto from its Illinois unitary business group and did not include the Scioto income in the Illinois combined income tax returns for the tax years 2001 through 2006. In 2004, the Illinois Department of Revenue (the "IDOR") issued two notices of deficiencies for corporate income taxes against Wendy’s. The IDOR concluded Scioto was not a true insurance company because (1) its transactions with Wendy’s and Wendy’s affiliates did not involve actual risk shifting and risk distribution and, thus, did not constitute insurance for federal income tax purposes, (2) the majority of its income was derived from the intercompany royalty payments received by Oldemark, and (3) it was not regulated as an insurance company in all states in which it wrote premiums.

Wendy’s paid the deficiencies under protest and filed two separate actions pursuant to the State Officers and Employees Money Disposition Act (the "Protest Monies Act")3 alleging (1) Scioto qualified as an insurance company under the Illinois Income Tax Act4 and (2) that the uniformity clause of the Illinois Constitution5 prohibited the IDOR from treating Scioto differently from other insurance companies. Wendy’s filed a motion for summary judgment in May 2011, arguing that it was not required to include Scioto in its Illinois combined tax returns because Scioto is a bona fide insurance company. Furthermore, Wendy’s argued that Scioto met the definition of an insurance company under federal law and, thus, the IDOR should treat it the same as all other insurance companies. Wendy’s claimed that Scioto was engaged in the insurance business because it effectuated both risk shifting and risk distribution. Additionally, Wendy’s argued that the Illinois Constitution prohibits treating an entity that has been determined to be a non-Illinois insurance company as anything other than an insurance company for Illinois tax purposes.

The IDOR filed a cross motion for summary judgment, claiming (1) Scioto did not meet the definition of an insurance company under the Internal Revenue Code and (2) that Scioto’s royalty income was not income from an insurance business. The trial court allowed defendant’s motion for summary judgment, finding Scioto was not an insurance company pursuant to the Illinois Income Tax Act.

Upon appeal, the court looked at Scioto’s income from premiums, royalty income, and interest income, finding that while the income from insurance premiums was dwarfed by its royalty and interest income, it is not the percentage of income that determines whether a company is taxable, but rather the character of the business. Scioto’s only business was to furnish insurance, and the ownership of Oldemark was directly related to Scioto’s ability to satisfy the capitalization requirements under Vermont insurance law.

The court found that the character of Scioto’s business was one of insurance and, under federal income tax law, the arrangements with affiliates met the requirements of risk shifting and risk distribution. The court also found that the conformity with federal and state laws required that Scioto be treated as an insurance company for Illinois income tax purposes, as it was treated as such by Vermont and the IRS. The court did not address the uniformity clause argument.

The court determined that Wendy’s met its burden and should have been treated as an insurance company for Illinois income tax purposes, and reversed the trial court’s judgment granting the defendants’ motion for summary judgment. The court remanded the case back to the trial court for the issuance of an order granting Wendy’s motion for summary judgment.

  1. Wendy’s International, Inc. v. Brian Hamer, 2013 IL App. (4th) 110678 (October 7, 2013).
  2. For more on the Virginia income tax treatment of the royalty payments to Oldemark, see our earlier Alert.
  3. 30 ILCS 230/1 to 6a (West 2008).
  4. 35 ILCS 5/101 to 250 (West 2008).
  5. Ill. Const. 1970, art. IX §2.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Reed Smith | Attorney Advertising

Written by:

Reed Smith

Reed Smith on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at:

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.