Captive finance subsidiary is not financial organization.

The issue of whether a corporation qualifies as a financial organization under Illinois law is an important one. Illinois taxpayers engaged in a unitary business must file a combined report for all members of the unitary group (regardless of nexus), with all members being subject to the same apportionment formula. Financial organizations, on the other hand, are subject to a special apportionment formula and, therefore, cannot be included in a unitary group with nonfinancial organizations. Accordingly, Illinois taxpayers often seek to treat affiliated entities that do not have nexus in Illinois as financial organizations to exclude these entities from an Illinois unitary combined report.

In a recent case, the Illinois Circuit Court for Cook County was forced to interpret the boundaries of Illinois's financial organization statute. In Automatic Data Processing (ADP) & Affiliates v. Dep't of Rev., No. 96 L 50918 (Dec. 23, 1998), the court held that a taxpayer's four wholly owned subsidiaries were not financial organizations for Illinois tax purposes and, thus, could not be excluded from the taxpayer's unitary combined report. The primary issue was whether the subsidiaries qualified as investment companies, one of the categories of entities that qualifies as financial organizations for Illinois tax purposes.

Background

The taxpayer in ADP formed four wholly owned asset management subsidiaries. These subsidiaries performed a variety of functions, such as extending intercompany loans to the taxpayer and licensing intangible assets to the taxpayer and its affiliates. (Such arrangements are typical among large corporate organizations, as they allow for centralization of functions and creation of economies of scale.) The taxpayer sought to classify the subsidiaries as financial organizations for Illinois tax purposes on the grounds that they qualified as investment companies. (Investment companies are included in the definition of a financial organization; however, the statute contains no guidance as to the definition of an investment company.)

The court concluded that the term "investment company" includes only regulated investment companies. The court's narrow decision was based on the fact that all of the other types of entities included in the definition of a financial organization under Illinois law (such as banks) are subject to regulation. However, there was no direct authority for this interpretation. The court's ruling reads into the Illinois statute limitations that will impede taxpayers from excluding captive finance subsidiaries from the Illinois unitary combined report. Accordingly, the court's decision will render it more difficult for corporations to take advantage of the preferential tax treatment associated with the use of financial organizations.

The court asserted that its ruling was based on its earlier decision in Shaklee Corp. v. Dep't of Rev., 93 L 50530 (1996), which was recently upheld on appeal; see Shaklee Corp. v. Dep't of Rev., No. 1-96-3780 (Ill. App. Ct., Aug. 12, 1998). However, the ADP decision goes one step further than Shaklee. In Shaklee, the court ruled that two holding companies that existed for the primary purpose of owning stock in foreign subsidiary corporations were not investment companies. The decision focused on the differences between holding companies (which typically do not diversify their assets and are not considered financial organizations) and investment companies (which have diversified holdings and do qualify as financial organizations). The subsidiaries in ADP were organized to serve an internal financing function and were not holding companies. Thus, the court's decision in ADP narrows the field for companies seeking financial organization status.

Despite ADP and Shaklee, there is still only scant guidance as to how the financial organization statute should be applied. However, these decisions do signal that the provisions will not be interpreted liberally, and, in the aftermath of ADP, it appears that the types of entities that will qualify as investment companies for Illinois tax purposes have been severely limited.

FROM SHARLENE E. AMITAY, J.D., CPA, WASHINGTON, DC