The Illinois Appellate Court has held that Wendy's International Inc.'s Scioto Insurance Co. captive is an insurance company for purposes of Illinois taxes.

At issue were Dublin, Ohio-based Wendy's exclusion of its Vermont-domiciled Scioto captive and its income from its Illinois unitary business group's combined tax returns from 2001 to 2006 and the Illinois Department of Revenue's contention that the captive was not a true insurance company.

The Illinois department took its position despite the Internal Revenue Service not disputing the captive's insurance company status in multiple audits. In contending the Scioto captive was not a true insurance company, the Illinois department claimed it lacked the actual risk shifting and risk distribution needed to constitute insurance, the majority of its income came from intercompany royalty income and it isn't regulated in all states where it writes coverage.

As a result, the Illinois department claimed Wendy's owed nearly $2.5 million in taxes, penalties and interest for the years in question, which the company paid under protest. In 2011, an Illinois trial court in Sangamon County heard motions for summary judgment from both sides concerning Scioto's status and found in favor of the state, leading to Wendy's appeal.

Last month, the three-judge appellate panel ruled unanimously that the lower court erred in its finding, remanding the case to the trial court for the issuance of an order granting Wendy's summary judgment motion. Last week, the appellate court denied a motion to rehear the case.

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“The facts indicate that Scioto was a bona fide insurance company for purposes of federal income tax law as it met the requirements during the applicable years and engaged in the necessary risk shifting and risk distribution,” the appellate court's opinion said.

“No evidence indicates Scioto Insurance Co. was formed as a sham business or lacked a valid business purpose,” the opinion continued. “Given all of these facts, along with the treatment of Scioto by the IRS and the advantages of conformity with federal law, Scioto constituted an insurance company for federal income tax purposes and should have been treated in a similar fashion for purposes of the Illinois Income Tax Act.”