The Illinois Tax Tribunal issued an order denying PepsiCo Inc. and Affiliates’ (“PepsiCo”) motion for summary judgment and found that PepsiCo’s subsidiary, Frito-Lay North America, Inc. (“FLNA”), was not an excluded 80/20 company and must be include in the PepsiCo Illinois unitary group corporate income tax return.[1] As originally filed, PepsiCo excluded FNLA from its returns for 2011-2013 based on the state’s 80/20 rules. The Department issued audit adjustments that denied this treatment, included Frito-Lay in the unitary return, and included approximately $2.5B of additional income in the return for each year.

Illinois adopts the water’s edge combined apportionment method and allows exclusion of unitary members if the taxpayer can demonstrate that 80% of the business of such member fall outside the United States. Illinois determines whether 80% of the business is outside the US based on the worldwide property and payroll factors of the member. The member shall be excluded if the average of its worldwide payroll and property factors is 80% or more outside the US.[2] While PepsiCo argued that the 80/20 determination is a straightforward mechanical calculation, the Tribunal reasoned that the Department may analyze the underlying facts that go into the calculation. In calculating the 80/20 property factor, PepsiCo included the payroll costs reported by PepsiCo Global Mobility, LLC (PGM), a disregarded single member limited liability company owned by FLNA, as compensation paid to expatriate employees. PepsiCo argued that the expatriate employees who were transferred to related foreign host companies through secondment agreements should be considered employees of  FLNA through PGM.

The court determined that as part of its global reorganization, PepsiCo created PGM in 2011 to reduce its overall tax liability. PGM had no assets, no capitalization, no management or supervisory employees, and no offices. When PepsiCo created PGM, it swapped PGM’s name on the expatriates’ secondment documents. The Tribunal determined that PGM was nothing but a “shell corporation” and that “it must be disregarded for having no economic substance or valid business purpose.” The Department also argued that the expatriates should not be considered the employees of PGM. The Tribunal considered common law factors in determining whether the expatriates were employees of PGM including that PGM did not provide work tools to expatriates, PGM had no investment in foreign work facilities, had no ability to assign projects to expatriates, had no ability to dictate the timing and length of work assignments, and that PGM did not pay the expatriates because the foreign host companies reimbursed PGM. The Tribunal determined that PepsiCo failed in its burden to show that PGM was the true employer of the expatriates and thus PGM’s tax regarded owner, FLNA, was not he true employer of the expatriates. This changed the payroll apportionment calculation of FLNA for the 80/20 test. As a result, the Tribunal concluded that FLNA could not be considered an 80/20 company and must be considered a company conducting business within the United States and included in the PepsiCo Illinois unitary combined corporate income tax return.

Eversheds Sutherland observation: Many states employ an 80/20 test that can result in the exclusion of domestic entities from the return or the inclusion of foreign entities into the return. Many of these states determine exclusion or inclusion based on the member’s property and payroll ratios. For example, if the ratio of US property and payroll to worldwide property and payroll falls below 20% for a domestic entity, that entity will be removed from the unitary combined group. While the 80/20 test is a mechanical calculation, the calculation of the property and payroll ratio for purposes of the 80/20 test is subject to audit and adjustment just as apportionment factors are. Based on a company’s business operations and structure it may have a domestic entity with sufficient amounts of foreign property and payroll to meet the 80/20 test and exclusion from the combined return. However, taxpayers should ensure that they have the proper information and documentation to substantiate the determination of foreign property and payroll amounts for those entities excluded under the 80/20 rules.

[1] Pepsico Inc. and Affiliates v. Illinois Department of Revenue, Ill. Tax. Trib., 16 TT 82; 17 TT 16 (2021)

[2] 35 ILCS 5/1501(a)(27); 86 Ill. Adm. Code 100.9700(c)