Tax Court Considers Taxation of the Golfer Sergio Garcia
March 2013Nearly two years ago, in our July 2011 column, we discussed Goosen v. Commissioner, a case concerning the taxation of endorsement fees paid to professional golfer Retief Goosen, a U.K. tax resident and non-domiciliary. On March 14, 2013 the Tax Court issued an opinion in in a similar case involving another professional golfer, Sergio Garcia, a citizen of the Spain and a Swiss tax resident. The Garcia case is significant because it includes an interpretation of the artistes and sportsmen article (Article 17) of the Convention between the United States of America and the Swiss Confederation for the Avoidance of Double Taxation with Respect to Taxes on Income (the “Swiss Income Tax Treaty”).
In October 2002 Garcia entered into a seven-year contract with TailorMade Golf Co. (“TailorMade”) pursuant to which (i) Garcia was designated as TailorMade's only "Global Icon," (ii) Garcia agreed to exclusively use certain TailorMade products, and (iii) Garcia licensed his name and image rights to TailorMade. In turn, TailorMade agreed to (i) supply Garcia with its products and (ii) pay Garcia certain base remuneration over the term of the contract (e.g., $7 million for years 2003 through 2005) as well as certain performance bonuses.
The contract did not specify the portion of Garcia's remuneration attributable to his personal services and the portion attributable to the license of his name and image rights. However, an allocation was specified when the contract was amended in 2003. That year the parties agreed to reduce TailorMade's payments to Garcia because Garcia would not use TailorMade's Maxfli golf balls. (TailorMade had significantly invested in an advertising campaign centered on Garcia.) The amended contract specified that 15% of Garcia's remuneration was attributable to his personal services, and the balance was attributable to the license of Garcia's image rights.
After entering into the contract with TailorMade, Garcia sold his U.S. image rights to a Swiss entity, Long Drive, which he controlled, in exchange for a promissory note payable over seven years. Long Drive then assigned the U.S. rights to a Delaware LLC, Even Par. Thus, TailorMade paid royalties to Even Par, which paid royalties to Long Drive, which made payments on the promissory note to Garcia.
Garcia filed U.S. Nonresident Alien Income Tax Returns (Forms 1120F) and reported the portion of his remuneration under the contract that was designated as attributable to personal services (i.e. 15% of the total) as U.S. source effectively connected income. Even Par filed tax returns stating that TailorMade's royalty payments were taxable only under Swiss law.
In 2010 the IRS issued Garcia a notice of deficiency for taxable years 2003 and 2004. At trial, the IRS asserted that (i) the “vast majority” of Garcia’s remuneration was for his personal services, (ii) the royalty income was reportable by Garcia, not Even Par, and (iii) Garcia was not exempt from tax under the Swiss Income Tax Treaty.
Opinion of the Tax Court
The allocation issue
The Tax Court first addressed the allocation issue and referred to the Goosen case, in which it had determined a 50-50 split of remuneration between services and royalties. After reviewing the testimony of four expert witnesses and discussing the differences between the facts in Goosen and the facts in Garcia, the Tax Court found a 50-50 allocation was not appropriate in Garcia’s case because he was a Global Icon and so his name and image rights were more significant than Goosen’s relative to the services he provided. The court concluded 35% of Garcia’s remuneration should be allocated to personal services and the remainder (65%) to the license of Garcia’s image rights.
The Swiss income tax treaty issue
Although the IRS argued that the royalties payable to Even Par should have been reported by Garcia (under the assignment of income doctrine), the Tax Court concluded that whether the royalties were income of Even Par or Garcia was not relevant because both taxpayers were eligible for the benefits of the Swiss Income Tax Treaty. The Tax Court then considered the more significant issue: whether the royalties paid by TailorMade were taxable under article 12 (Royalties) or article 17 (Artistes and Sportsmen). If article 12 governed, the royalties were exempt from U.S. federal income tax; however, if article 17 governed, the United States had primary taxing jurisdiction under the treaty.
Both the IRS and Garcia referred to the U.S. Treasury's Technical Explanation to the Swiss income Tax Treaty (the "Technical Explanation") as useful in resolving which article governed the taxation of the royalties. Although some courts have been reluctant to consider such a unilateral statement by the Treasury Department when interpreting an income tax treaty, the Tax Court found the Technical Explanation to be helpful in this case.
With respect to article 17, the Technical Explanation states: “‘In determining whether income falls under article 17 or another article, the controlling factor will be whether the income in question is predominantly attributable to the performance itself or other activities or property rights.’ (Emphasis supplied.)” The Technical Explanation also states that royalty income from the sale of recordings of a live performance is taxable under article 12, even though the income received by the performer for the live performance itself is taxable under article 17. The Tax Court concluded: "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.”
Finally, Garcia argued, in his post-trial opening brief, that he should not be taxed on his U.S. source personal services income, other than the income attributable to wearing TailorMade clothing while golfing. The Tax Court refused to consider this issue because raising it so late in the proceedings prejudiced the IRS.
Although the court did not go into Garcia's argument in any detail, the author believes that Garcia likely argued that such personal services income was business profits (rather than income derived as a sportsman) and so fell within the scope of article 7 rather than article 17. Such income, therefore, would not be taxable in the United States, provided it was not attributable to a U.S. permanent establishment of Garcia. Perhaps one day the Tax Court will resolve whether such endorsement income is taxable under article 7 or article 17.
 136 T.C. No. 27 (2011) (“Goosen”). Garcia v. Commissioner, Docket No. 13649-10.(March 14, 2013) (“Garcia”). Article 17(1) provides: "income derived by a resident of a Contracting State, such as a . . . sportsman, from his personal activities as such exercised in the other Contracting State may be taxed in that other State. The Tax Court stated: “Petitioner agrees with respondent that the Treasury Technical Explanation is useful in interpreting the Swiss Tax Treaty, and we concur. See Kolovrat v. Oregon, 366 U.S. 187, 194 (1961) (‘while courts interpret treaties for themselves, the meaning given them by the departments of government particularly charged with their negotiation and enforcement is given great weight.’). . .”
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