Partial Win For Golfer In Treaty Case

by Charles (Chuck) Rubin

A recent Tax Court case addressed some interesting athlete and treaty issues. The Court ended up siding with the golfer on some, but not all, of the golfer's positions.
Sergio Garcia is a professional golfer. In the tax years at issue, he was a party to an endorsement agreement with TaylorMade Golf Co. Garcia was obligated to use certain TaylorMade products, both on and off the golf course (the "personal services" income). TaylorMade also had the right to use Garcia's name and image in advertising and other promotions (the "royalties" income). The distinction between personal services income and royalties income was important because under the applicable Switzerland - U.S. income tax treaty, royalties income is taxable only in Switzerland. Personal services income could be taxed by the U.S. as to personal services performed in the U.S.
ALLOCATION OF PAYMENTS BETWEEN ROYALTIES INCOME AND PERSONAL SERVICES INCOME. The endorsement agreement allocated 85% of the TaylorMade payments to Garcia as royalties income, and the rest as personal services income. The IRS claimed, at least initially, that all of the payments were for personal services. 
The Tax Court rejected that the contract allocation was binding based on a claim that the parties were adverse to each other in making this allocation. The Court did not believe that TaylorMade was adverse to Garcia simply because it did not want to suffer the bad publicity of the IRS disputing its tax allocation.
The Tax Court determined that 65% of the income was royalty income, thus reducing Garcia's claimed percentage but still allowing him a major allocation to royalties. This was a factual analysis, but the Court borrowed from other cases (including Goosen v. Commissioner) that dealt with similar contracts. The case is instructive for others as to the factors the Court will review in testing such allocations.
WHAT PORTION OF PAYMENT QUALIFIES AS A ROYALTY? The key test employed was what portion of the payments were "for the right to use a person's name and likeness...because the person has an ownership interest in the right."
SUPREMACY OF ROYALTIES ARTICLE OVER ARTISTES AND SPORTSMAN'S ARTICLE OF TREATY. The royalties article of the treaty gives exclusive taxing jurisdiction of royalties to Switzerland  - “Royalties derived and beneficially owned by a resident of a Contracting State shall be taxable only in that State.”  To be able to tax the royalties payment, the IRS argued that as an athlete, the Artistes and Sportsmen article overrides the royalties article and applied to Garcia, thus allowing the U.S. to tax those payments  - "income derived by a resident of a Contracting State as an entertainer, such as a theatre, motion picture, radio, or television artiste, or a musician, or as a sportsman, from his personal activities as such exercised in the other Contracting State may be taxed in that other State.” 
In resolving disputes between the articles, the Treasury Technical Explanation provides that "the controlling factor will be whether the income in question is predominantly attributable to the performance itself or other activities or property rights.”  Applying this test, the Court found that:
we believe that even though petitioner's golf play and personal services performed in the United States has some connection to his U.S. image rights, income from the sale of such image rights is not predominantly attributable to his performance in the United States. Rather, the image rights are a separate intangible that generated royalties (as defined by article 12(2)) for petitioner when TaylorMade paid him for their use. 

Thus, the Court concluded the royalties article prevailed and that the U.S. had no jurisdiction over the royalty portion of the payments.

SERGIO GARCIA V. COMM., 140 TC No. 6 (3/14/2013)

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Charles (Chuck) Rubin, Gutter Chaves Josepher Rubin Forman Fleisher P.A. | Attorney Advertising

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