By Scott Booth and Andrew Appleby

Although states continue to challenge the validity of captive insurance companies, Wendy’s has notched several taxpayer victories. In a win involving Scioto Insurance Company (Scioto), Wendy’s captive insurance company, the Illinois Appellate Court held that Scioto constituted a bona fide insurance company that was properly excluded from Wendy’s combined report. To meet the capitalization requirements under Vermont insurance law, Scioto acquired Oldemark, a Wendy’s affiliate that held trademarks valued at more than $900 million that Oldemark licensed to Wendy’s. The IRS did not challenge Scioto’s status as an insurance company for federal income tax purposes. Even so, the Illinois Department of Revenue concluded that Scioto was not a true insurance company because: (1) there was not actual risk shifting and risk distribution; (2) the majority of Scioto’s income was derived from intercompany royalty income; and (3) it was not regulated in all states in which it wrote premiums. The court gave the Department’s arguments a frosty reception by rejecting them all, holding that the character of Scioto’s business was insurance, and that Scioto engaged in the necessary risk shifting and risk distribution. The court noted that Scioto generated its own business income separate from Oldemark’s intercompany royalty income. Although Scioto’s royalty and interest income dwarfed its insurance premium income, the court recognized that “it is not any percentage of income that determines whether a company is taxable as an insurance company but rather the character of the business actually done by the company.” Wendy’s Int’l v. Hamer, Dkt. No. 4-11-0678 (Ill. App. Ct. Oct. 7, 2013).