Image rights create royalty payments

The Tax Court held that fees received by foreign professional golfer Sergio Garcia under an endorsement agreement should be treated as 65% royalty compensation and 35% personal service compensation, based on the facts and circumstances of the agreement. The court also held that Garcia’s U.S. image rights payments were royalties and thus exempt from U.S. tax since the U.S.-Switzerland Income Tax Treaty exempts royalty income from U.S. taxation. All of the taxpayer’s U.S. personal service compensation was taxable to the United States, however, since the court held that he had previously conceded the issue to the IRS.

When foreign golfers receive income from endorsement agreements, the court has divided the income between personal service income and royalty income based on the facts and circumstances of the case (see Retief Goosen, 136 T.C. 547 (2011), and Tax Matters coverage, “Golfer Bogies Endorsement Income,” Sept. 2011, page 66). In addition, the United States has tax treaties with numerous countries to coordinate taxation of income. Article 12 of the U.S.-Switzerland Income Tax Treaty exempts royalty income of Swiss residents from U.S. taxation, while Article 17 of the same treaty permits the United States to tax the income of Swiss actors, radio and TV personalities, musicians, and sportsmen from their personal activities conducted in the United States.

Garcia, a well-known professional golfer and a resident of Switzerland, signed a seven-year endorsement agreement starting in 2003 with TaylorMade, a company that sells golf equipment and accessories. TaylorMade paid an annual fee to Garcia who, in turn, was required to exclusively use TaylorMade products, play in a minimum number of golf events, and make a minimum number of personal appearances. TaylorMade also received the right to use Garcia’s image to promote its products worldwide. Garcia sold his image rights to Long Drive, his 99.5%-owned Swiss corporation, in exchange for a promissory note. Long Drive then assigned the note to Even Par, a U.S. corporation owned 99.8% by Garcia. TaylorMade made all image rights payments to Even Par, which transferred the money to Long Drive, which then paid the amount to Garcia in satisfaction of his promissory note.

In 2010, the IRS issued deficiency notices for 2003 and 2004 totaling $1,719,766, arguing all of Garcia’s endorsement income was personal service income. Garcia petitioned the Tax Court for relief.

The court allocated 35% of the endorsement income to personal service income and 65% to royalty income based on the facts and circumstances of the agreement, using an analysis similar to the one it used in Goosen, while acknowledging that a perfect allocation is not possible.

Concerning the image rights payments, the IRS argued they could be taxed by the United States since Article 17 of the U.S.-Switzerland Income Tax Treaty permits the United States to tax a Swiss resident’s income derived from personal activities performed as a sportsman in the United States. Garcia maintained that the payments were royalties and that Article 12 of the same treaty specifically exempts royalties from U.S. taxation. The court agreed with the taxpayer, citing a Treasury Department technical explanation of Article 17 of the treaty. In the technical explanation, an entertainer who conducts a performance in a source country could be taxed by the source country on the income from the performance but would not be taxed on royalties from the sale of recordings of the performance. In a similar manner, the court held, the income from Garcia’s sale of the image rights was not attributable to his performance in the United States. Instead, the image rights were a separate intangible asset that produced royalties.

Since the court held that income from the image rights could not be taxed by the United States under the treaty even if Garcia had received them directly, it did not consider the IRS’s arguments that Garcia’s use of Long Drive had violated the assignment-of-income and economic substance doctrines. The court, however, rejected Garcia’s attempt to reduce the amount of his personal service income subject to U.S. tax since he had not raised the issue in a timely manner.

  Garcia, 140 T.C. No. 6 (2013)

By Charles J. Reichert, CPA, instructor of accounting, University of Minnesota–Duluth.