Illinois' "wheel of unity" doctrine.

In Envirodyne Industries, Inc., 7th Cir., 1/6/04, the court addressed the Illinois "unitary business group" concept. An Illinois corporate parent, Envirodyne, owned a Wisconsin steel subsidiary that operated at a loss, and several profitable Illinois food-pack aging businesses. The taxpayer attempted to offset the steel subsidiary's loss against the profits of the food-packaging subsidiaries by filing a combined Illinois corporate return.

The Concept

The parent provided some central office functions for its subsidiaries (e.g., legal and accounting services), but Illinois requires that "a group of persons related through common ownership whose business activities art" integrated with, dependent upon and contribute to each other," constitute a unitary business group. Further, functional integration evidenced by the exercise of strong centralized management authority over purchasing, financing, tax compliance, product line, personnel, marketing and capital investment, must also be present.

Dissimilar businesses may be a unitary business group if they are sufficiently linked together by common managerial resources that generate economies of scale and transfers of value that collectively benefit the corporate affiliates.

The taxpayer believed that only the parent's common management control over each of the individual subsidiaries was required to establish a unitary business group. The court analogized the relationship between the parent and each subsidiary as constituting individual unitary spokes in a wheel, with the parent at the wheel's center. However, it failed to find sufficient integration between the Wisconsin steel and the Illinois food-packaging subsidiaries, which would have been evidenced by centralized departments that generate economies of scale and value for the corporate group members.

Thus, the taxpayer failed to demonstrate the contribution and dependency that must exist between commonly controlled subsidiaries to constitute a unitary business group. Because no common links existed, the individual subsidiary spokes were not sufficiently linked together by the contribution and dependency rim to create a single, integrated wheel of unity.

Abernathy Specialties

The unitary business group principle bad previously been reviewed in an administrative hearing decision, Abernathy Specialties, Inc. v. Dep't of Rev., Office of Administrative Hearings Decision No. IT 02-9, 4/29/02. This case involved an S corporation with three manufacturing divisions--locomotive components, automobile accessories and door hinges--located in different states--Illinois, Georgia and Michigan. Only the locomotive division conducted business in Illinois. There were no common customers, suppliers, warehousing, raw material purchases, pension plans, employee benefit plans, research and development functions, employees (with one minor exception), marketing strategies, sales force, legal services or accounting functions provided by central departments. There were no intracompany sales or purchases among the divisions.

A common bank account existed, but not a centralized cash management system. An insurance broker purchased all divisional workers' compensation and property insurance, and charged the premiums separately to each division. Each division obtained separate employee health and benefit insurance coverage, and had its own president, fully responsible for financial and operational performance. Two S shareholders were not involved in division management, but they were apprised quarterly of divisional financial performance.

The Georgia automobile accessory division's assets were sold for a $20 million gain. During an Illinois income tax audit, the taxpayer's tax adviser raised an affirmative adjustment that fully excluded that gain from the Illinois tax base. This adjustment was supported by the Illinois regulations and the lack of dependency between the three manufacturing divisions. Strong centralized management (usually evidenced by centralized departments that create mutual economies of scale) was not present.

The administrative law judge agreed that the three manufacturing divisions were not sufficiently connected by mutual contribution and dependency (the rim) required to link the individual division spokes together into a single integrated unitary wheel.

Conclusion

Both Envirodyne and Abernathy riffled to satisfy the Constitutional requirement that the out-of-state activities of the purported unitary business be related in some concrete way to its in-state activities. There must be some sharing or exchange of value not capable of precise identification or measurement that renders formulary apportionment reasonable. In each case, the out-of-state income or loss was not sufficiently linked to the in-state activity, thereby rendering unitary apportionment inapplicable.

The income or loss of each individual spoke (i.e., division or subsidiary) was found to be "separately" ascertainable, because the group of companies lacked the contribution and dependency rim required to establish a single, integrated wheel of unity.

L.JAMES MARGNER

CPA 

CHICAGO, IL