U.S. Income Tax Treatment of Personal Service Income or Royalty Income of a Non-resident
Non-residents of the U.S. are subject to U.S. income tax on U.S. source fixed and determinable annual or periodic income, as described in Section 871(a), which income, subject to treaty override, is subject to a flat 30% tax rate without deductions. Such persons are further subject to U.S. income taxation on a “net” basis and at graduated rates with respect to income derived from the carrying on of a U.S. trade or business under Section 864(b). As applied to a non-resident, professional athlete, engaging in a U.S. trade or business includes any business activity in the United States that involves one's own physical presence. Treas. Reg. §1.864-2. It is clear that earnings derived from Goosen’s playing in golf tournaments in the U.S. is income from carrying on a U.S. trade or business. On the other hand, U.S. source income from royalties is generally treated as fixed and determinable annual or period income (“FDAP”). Royalty income paid for the right to use intangible property generally is sourced where the property is used or is granted the privilege of being used. § 861(a)(4). Neither foreign source royalty income nor foreign source personal services income is subject to U.S. tax unless it is related to the conduct of a U.S. trade or business.
Petitioner Retief Goosen
This case involved Retief Goosen, the 2001 & 2004 U.S. Open Champion and considered by many to be one of the leading golfers in the world. His official website, www.retiefgoosen.com, highlights his many achievements in professional and amateur golf.
IRS Issues Notice of Deficiency Issued Against Mr. Goosen for 2002 and 2003
Goosen’s U.S. income tax liability with respect to his U.S. source income for 2002 and 2003 was the subject of a challenge by the IRS and led to a decision by the Tax Court, J. Kroupa, finding for the Petitioner in part and for the Commissioner in part. At the time the Tax Court Petition was filed, Goosen was a citizen of South Africa but a tax resident of the United Kingdom. His wife is a U.K. citizen and resident.
In a summary of the facts set forth in the Official Tax Court Syllabus, Goosen had entered into endorsement agreements with sponsors Acushnet, TaylorMade, Izod, Upper Deck, Electronic Arts and Rolex. He agreed to allow all sponsors to use his name, face, image and likeness in advertising and marketing campaigns worldwide. Goosen also agreed to perform some services for the sponsors. All endorsement agreements paid Mr. Goosen a base endorsement fee. Acushnet, TaylorMade and Izod prorated the base endorsement fee if he did not annually play in a specified number of golf tournaments, i.e., on-course endorsement fees. Moreover, Acushnet, TaylorMade and Izod provided bonuses to Goosen for achieving a specific finish in a PGA or European Tour tournament or a specified ranking on the World Golf Rankings.
Goosen characterized the endorsement fees and bonuses from Acushnet, TaylorMade and Izod as 50% personal services income and 50% royalty income on his nonresident Federal income tax returns (Forms 1040NR) for 2002 and 2003. He treated or characterized the endorsement fees from Upper Deck, Electronic Arts and Rolex as 100% royalty income. He reported approximately 7% of the total endorsement income as U.S.-source income. The Service asserted that Goosen should have characterized the endorsement fees and bonuses from Acushnet, TaylorMade and Izod as 100% from personal services income. It also reallocated a larger percentage of Goosen’s endorsement fees as U.S.-source income. The deficiency proposed by the Service was $20,224 for 2002 and $144, 474 for 2003. Accuracy related penalties were set forth in the deficiency notice but were later conceded prior to trial by the Service.
Tax Court’s Analysis and Decision
First, the Court considered whether the endorsement income was, in whole or in part, personal services income or royalty income. Both parties agreed that endorsement fees under the off-course endorsement agreements that Goosen had received were royalty income. The issue then was whether endorsement income derived solely from the on-course endorsement agreements, which includes the TaylorMade, Izod and Acushnet agreements, was royalty income (or personal service income) as well.
The taxpayer’s argument for treating on-course endorsement payments as royalty income was that under such agreements he was paid for the right to co-market and co-brand the sponsors' products with petitioner's name and likeness. His counsel relied upon case law that supported the notion that such payments are royalties because the person has an ownership interest in the rights granted. See Cepeda v. Swift & Co., 415 F.2d 1205 (8th Cir. 1969); Haelan Lab., Inc. v. Topps Chewing Gum, Inc., 202 F.2d 866 (2d Cir. 1953). Cf. Boulez v. Commissioner, 83 T.C. 584 (1984) (intellectual property creator receives only personal services income if the creator lacks an ownership interest in the underlying property); Kramer v. Commissioner, 80 T.C. 768 (1983); Uhlaender v. Hendricksen, 316 F. Supp. 1277 (D. Minn. 1970). The taxpayer adduced expert testimony to support the argument that the three companies primarily paid for his name and likeness rather than for the performance of services.
The IRS position as to the on-course endorsement income was that Goosen was primarily paid to perform personal services including playing golf and carrying or wearing the sponsors’ products and logos. The IRS relied upon the fact that the endorsement agreements provided for a proration (partial reduction) of the endorsement fees if Goosen did not play in a minimum number of golf tournaments. Therefore, any income received by Goosen from such on-course endorsements was only marginally for use of his name and likeness (royalty income). After review of the record, the Court found that the income received from the on-course endorsement agreements was part royalty income and part personal services income citing Kramer v. Commissioner, 80 T.C. 584 (1983). The Court allocated 50% of the on-course endorsement income as personal services income and 50% as royalty income.
The next issue was what portion of the on course endorsement income is sourced to the United States and whether any U.S. source royalty income was effectively connected to a U.S. trade or business. §861(a)(4), §862(a)(4). The burden is on the taxpayer to demonstrate that he made a reasonable allocation of the royalty income between U.S. and foreign sources. The sponsors had the right to use Goosen’s name and likeness worldwide and the contracts allocated 25% of the royalty income as sourced to the United Kingdom and 75% to the rest of the world. No provision was contained in the agreement on how to source the royalty to the United States. The Tax Court rejected the contractual sourcing provision for determining U.S. source royalty income. Where the contracting parties fail to make a reasonable allocation, the courts have generally allocated all of the royalty income to the U.S. unless the taxpayer can demonstrate a sufficient basis for making a proper allocation. A sufficient basis is present when a taxpayer establishes that he has property rights outside of the U.S. and furnishes evidence on the value of such rights. The Tax Court made fact findings on each endorsement agreement and the proper allocation of U.S. source royalty income from non-U.S. source royalty income. The allocations determined to be proper by the Court varied with each contract. For example, the Upper Deck endorsement agreement royalty payments were found to be 92% U.S. source income and the Electronic Arts royalty to be 70% U.S. source income.
The next issue was whether the non-U.S. source royalty income is effectively connected to a U.S. trade or business. It was undisputed that Goosen was engaged in the U.S. trade or business of playing golf (“ECI”) when playing in the U.S. and that his tournament earnings were to be taxed at regular graduated rates. The IRS did not assert however, and the Court agreed, that since Goosen did not maintain an office or fixed place of business in the U.S. his non-U.S. source royalty income is not part of his trade or business of playing golf. The succeeding issue was to what extent the U.S. source royalty income should be treated as royalty income or personal services income. Under Treas. Reg. §1.864-4(c)(3)(i), U.S. source royalty income is ECI where the activities of the trade or business are a material factor in realizing the royalty income.
The Court ruled that Goosen’s U.S. source royalty income from on-course endorsement agreements was ECI but that that his U.S. source royalty income from off-course endorsement agreements was not ECI since the payments did not depend on whether he played in any golf tournaments in the U.S. Treas. Reg. §1.864-4(c)(3)(ii), Ex. (2). Thus, such U.S. source royalty income was FDAP and subject to a 30% flat rate.
The final issue was whether, as Goosen had argued, he was entitled to treaty protection in reducing the rate or avoiding the imposition of tax on his U.S. source royalty income by application of the U.S.-U.K. tax conventions. See §894(a)(1). Under the tax conventions, the U.K. will tax a U.K. resident, non-domiciliary on non-U.K. source income only to the extent the income is remitted to or received in the United Kingdom. See U.S.-U.K. tax treaty art. 1(7). The U.S. can not subject the same taxpayer to double taxation. Goosen failed to meet his burden of proof that his non-U.K. endorsement income was remitted to or received in the U.K. Therefore, the Tax Court held that Goosen was not eligible for any treaty benefits.