September 16, 2013
Tax Court Characterized a Golfer’s Endorsement Income
By Adam Wachler, Senior, Alternative Investment Group
Foreign athletes working in the United States must deal with certain income inclusion and taxation issues. Sergio Garcia, a professional golfer from Switzerland, entered into an agreement with Taylor Made/Maxfli related to his personal services and image rights. The agreement did not specify which percentage of the remuneration was attributable for services or attributable to the rights. Sergio later sold his image rights and only reported the personal service income as U.S. source income. Sergio received a deficiency notice from the IRS for $930,248 and $789,518 for 2003 and 2004, respectively, because the IRS did not agree with the allocation of service income reported to the U.S. Garcia’s contract entailed that 15 percent of his salary was attributable to his personal services and 85 percent was attributable to royalties. Garcia’s U.S. Nonresident Alien Income Tax return, only reported a small portion of the amount he was receiving from Taylor Made.
The Switzerland/ United States tax treaty that states, “royalties derived and beneficially owned by a resident of a Switzerland shall be taxable only in Switzerland.” Therefore, any royalties Garcia was paid can only be taxed by his home country and he should not be subject to U.S. income tax for amounts relating to royalties. According to the contract with Taylor Made, 15 percent of the contract income should have been allocated to the U.S. According to Tax Court documents, Garcia’s return did not accurately allocate the amount of income derived from his personal services based on the agreement or the economic reality as it pertained to his services. The Court also argued, that even though the contract called for a 15/85 split, the golfer’s services truly extended beyond the 15% allocation for personal services.
In a former Tax Court case involving Retief Goosen, another professional golfer, Goosen was held to a 50% personal services and 50% royalties standard in 2003. The current court realized that Garcia could not be held to the same standard as Goosen since Garcia was used in most of the Taylor Made advertisements and was considered the “centerpiece” of their marketing. This meant that Garcia generated more revenue from royalties than personal services. The court then ruled that for a split of 35% personal services and 65% royalty would be a more logical ratio for Garcia.
The Court’s biggest challenge in this case was deciding how to fully distinguish personal services from royalties since much of the income derived from Taylor Made related to use of Garcia’s image using products during professional events. To solve this problem, the Tax Court referred to the treaty between United States and Switzerland which states, “income derived by a resident of Switzerland as an entertainer or as a sportsman, from his personal activities as such exercised in the U.S. may be taxed in the U.S.” Further, the treaty states that royalty income is exempt from source country tax. To support this statement, Garcia’s representatives referenced a case involving an entertainer who received royalties from the sale of a live recording that took place in the United States. The entertainer could not be taxed by the U.S. on royalties related to that recording.
It was therefore concluded that even though Garcia’s golf play and personal services performed in the U.S. helped boost his image in the U.S., income from the use of his image could not be subject to U.S. taxation because it was not entirely based on his performance. The income from the image was deemed to be derived from a separate intangible which solely generated royalties for Garcia.
Even though Garcia made several attempts at protesting the decision, the Court concluded that he would be subject to taxation on all deemed personal service income.