Article

Illinois court rules PepsiCo subsidiary is not an 80/20 company

March 5, 2025 · Authored by Shannon Bonner, Kristina Stibrich

On Jan. 9, 2025, a circuit court judge in Sangamon County, Illinois, affirmed the Illinois Department of Revenue’s (the Department) position that PepsiCo Inc. (PepsiCo) had created a “shell company” beneath its subsidiary Frito-Lay North America Inc. (FLNA) and the purpose of this shell company, PepsiCo Global Mobility LLC (PGM), was to generate tax benefits by ultimately excluding FNLA’s income from the Illinois combined tax return in 2016 and 2017.

80/20 company rule

For purposes of its unitary combined filing, Illinois excludes 80/20 companies from unitary business groups and defines them as, “members whose business activity outside the United States is 80% or more of any such member’s business activity.” Business activity is measured by the amount of a business’s payroll and property (35 ILCS 5/1501(a)(27)) (herein after referred to as an 80/20 company).

In determining whether the exclusion applies to a particular entity, its United States property and payroll are compared to its worldwide property and payroll. If over 80% of its business activity is outside the United States, the 80/20 exclusion is applicable and as result, the 80/20 company’s income is excluded from the Illinois unitary combined income tax return.

Circuit court decision

In 2010, PepsiCo underwent a global reorganization and, in the restructuring, PGM was formed as a disregarded entity for federal income taxes under FLNA. PGM was set up as a global employment company that held all of the foreign based U.S. expatriates for the purposes of payroll, benefits and general administration. Specifically, expatriates were listed and treated as employees of PGM through the secondment agreements with foreign host companies. As a result, the inclusion of expatriate's foreign payroll in the payroll factor of FLNA through its disregarded subsidiary, PGM, qualified FLNA as an 80/20 company based on the statute. In turn, FLNA’s domestic income was excluded from PepsiCo’s Illinois unitary combined return.

On audit, the Department disallowed the 80/20 treatment, among other items, and issued two notices of deficiency proposing tax deficiencies, penalties and interest in the aggregate amount of approximately $10.9 million. Ultimately, PepsiCo appealed to the circuit court.

PepsiCo argued, among other things, that the Department ignored the plain language of the statute when applying the 80/20 rule. Specifically, “the plain and unambiguous text of the 80/20 Company rule governs whether an entity is excluded from the combined unitary business group.” There is no other statutory requirement and PepsiCo asserted it had met its burden of proving that FLNA qualified as an 80/20 company.

The Department made multiple arguments including that PGM is a shell company, lacking substance and is not the expatriate’s common-law employer and as such PGM’s employees should not have been part of Frito-Lay's 80/20 calculation. The Department asserted that, “PepsiCo created and placed PGM under Frito-Lay only for tax avoidance purposes, to improperly exclude Frito-Lay’s domestic income rather than foreign income, as the 80/20 Test was designed to do.” Additionally, the Department asserted the lack of PGM’s economic substance in stating, “PGM conducted no business, had no management control, no tangible assets, no office, no capital, and no profit potential because it had no income other than reimbursements of expatriate salaries. As a matter of economic reality, PGM could not be the common law employer of anyone, including the expatriates....”

After the bench trial and review of the briefs, the Illinois circuit court judge found that, "the evidence at trial was clear that PGM was created to operate and was, in fact, operating as a “shell” company for purposes of tax benefits for Frito-Lay.” The judge continued to say that PGM was an “entity on paper” and was established for the purpose of creating a tax shield for Frito-Lay (FLNA). The court also found that the majority of FLNA’s profits are generated in the United States, and that the “expatriate compensation charged to PGM does not represent substantive foreign business activities conducted by Frito-Lay.” As a result, the court upheld the Department’s determination that FNLA is not an 80/20 company and should not have been excluded from PepsiCo’s 2016 and 2017 combined Illinois tax returns and provided no abatement of penalties, as requested by PepsiCo.

Notably, in addition to this case, PepsiCo is also in the process of defending FNLA’s 80/20 status for tax years 2011 – 2015 in separate actions in the Illinois Appellate Court and the Tax Tribunal.

What’s next?

At this time, PepsiCo has appealed the decision. It will be important to monitor this case as it works its way through the appeals process as the ultimate outcome will give guidance on what companies should be aware of when attempting to qualify for 80/20 status in Illinois.

In addition to Illinois, many states have 80/20 rules, though recently, some states have started to back away from these rules. Specifically, New Mexico passed legislation in 2024 to narrow its 80/20 rule. As such, it is recommended that taxpayers with an 80/20 company in their structure review its activities to ensure it qualifies for an exclusion from a combined return based on each specific state’s rules.

If you have any questions, please reach out to your Baker Tilly state tax advisor.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.