Tax Deal For Illinois Exchanges May Face Legal Challenges

The proposed tax deal hatched to keep Chicago's two big derivatives exchange operators in Illinois could be challenged as discriminatory against out-of-state companies, according to legal experts.

Lawmakers were nearing agreement on a compromise to keep CME Group Inc. (CME) and CBOE Holdings Inc. (CBOE), as well as retailer Sears Holdings Corp. (SHLD), from moving operations out of Illinois, but after months of talks, a pact could be vulnerable to a challenge on constitutional grounds.

The package being voted on this week by Illinois lawmakers would see big state tax cuts for the two Chicago firms, while out-of-state rivals IntercontinentalExchange Inc. (ICE) and NYSE Euronext (NYX) would likely see their own state tax bills unchanged.

"Illinois is potentially benefiting in-state companies at the expense of out-of-state companies," said Eric Tresh, a partner specializing in tax law with Sutherland Asbill & Brennan LLP and an outside counsel for Atlanta-based ICE, which has raised objections to the Illinois proposal.

State lawmakers are making a second attempt this week to pass the package, aimed to soothe outcry from CME and CBOE that their Illinois tax bills are outsized versus other major companies in the state. The protests followed a sharp increase in January in the Illinois corporate tax rate to 7% from 4.8%.

A proposal passed Monday by the Illinois House of Representatives and up for debate Tuesday in the Senate would tax the exchanges on 27.54% of electronic trades, many of which are seen originating beyond Illinois's borders. The Senate is expected to pass the measure Tuesday afternoon.

The prospect is a deal for CME and CBOE, both of which right now pay taxes to Illinois on 100% of such trades. For out-of-state market centers like ICE, NYSE Euronext and Nasdaq OMX Group Inc. (NDAQ), such a shift ultimately could result in a higher Illinois tax bill because currently less than 27.54% of their trading business is seen coming from Illinois, legal experts said.

NYSE Euronext, Nasdaq OMX and ICE in November teamed to lobby Illinois lawmakers for an opt-out provision to the proposal, enabling them to continue paying taxes under their existing regime, in which they pay Illinois taxes only on trades that they identify to have originated in that state. For those exchanges, that level is generally seen below the 27.54% level set out by the pending legislation.

That avoided any constitutional challenge to the package on grounds that Illinois was directly favoring its native exchanges. But providing a break to CME and CBOE while essentially keeping the status quo for other exchanges still leaves the proposal open to a legal attack, said Richard Pomp, a tax law professor at the University of Connecticut.

"This is a pretty blatant attempt to skew the playing field in favor of the home team, although it is done in a less transparent manner than just legislating a lower rate," said Pomp, who isn't directly involved in the matter. "I would think [a challenge on constitutional grounds] would have a pretty good chance of success if [the bill] passes."

Spokesmen for ICE, NYSE Euronext and Nasdaq OMX declined to comment as to whether they would pursue such a challenge, which would come in Illinois state court.

Democratic Sen. Toi Hutchinson, the bill's chief sponsor in the Illinois Senate, said Tuesday that the provision was drafted with an eye toward protecting against challenges. "Our legal staff feels the opt-in clause survives the constitutionality test," she said.

Hutchinson said rival exchange operators hadn't raised the issue with her.

Representatives for CME and CBOE declined to comment. In recent months, CME has fielded offers from states such as Indiana, Florida and Texas to relocate its business.

-By Jacob Bunge, Dow Jones Newswires; 312-750-4117; jacob.bunge@dowjones.com

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