The Tax Court also held that any royalty income was exempt from taxation in the United States under provisions of the United States-Switzerland income tax treaty, but that none of the taxpayer’s U.S. source personal service income was exempt from tax in the United States.
Read the opinion: Garcia [PDF 53 KB]
The taxpayer (a professional golfer and a resident of Switzerland) entered into a seven-year endorsement agreement with a corporate sponsor, under which the taxpayer agreed that his image, name, and voice (i.e., his image rights) could be used in advertising and marketing campaigns worldwide.
The taxpayer also agreed to perform personal services for the corporate sponsor—including using its products in all golf events, posing and acting for advertisements, and making personal appearances for the company.
In return for his services and use of his image rights, the corporation agreed to pay the taxpayer certain compensation which they allocated 85% of the compensation to royalties (i.e., for use of his image rights) and 15% to personal services.
The taxpayer established a limited liability company (LLC) in Delaware, to receive the royalty payments and then pay a portion of the royalty payments (attributable to use of the image rights in the United States) to a second LLC that was established in Switzerland. The result was that the taxpayer paid no U.S. tax on the royalty payments, but did pay U.S. tax on the U.S. source personal service payments.
IRS deficiency determination, contentions
The IRS determined deficiencies of approximately $930,000 and $790,000 in the taxpayer’s income for 2003 and 2004, respectively. The IRS disputed the 85%-15% allocation between royalty and personal service payments, and asserted that—
- A larger portion was attributable to the taxpayer’s personal services.
- The U.S. source royalty payments were made directly to the taxpayer and that the form of the transactions involving the two LLCs was to be disregarded.
- The royalty income (as well as all U.S. source personal service income) was taxable in the United States and not exempted from U.S. taxation under the United States-Switzerland income tax treaty.
Tax Court’s opinion
The Tax Court today concluded that the payments were to be allocated 65% to royalties and 35% to personal services.
The Tax Court also held that any royalty income was exempt from taxation in the United States under the United States-Switzerland income tax treaty, but that none of the taxpayer’s U.S. source personal service income was exempt from tax in the United States.