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By Philip D. Morrison, Esq.
Deloitte Tax LLP, Washington, DC
Since the landmark Boulez1 case, there has been very little guidance regarding the character and source of income earned by a foreign athlete or entertainer from things, such as musical recordings or endorsement contracts, which arguably involve a mix of intangibles and personal services. A 2009 GLAM2 gave us the IRS's view of the character of certain athlete endorsement contract income and the accompanying reasoning. With the Tax Court's recent decision in Goosen v. Comr.,3 a decision rejecting a substantial portion of both the GLAM's reasoning and its conclusions regarding character, as well as providing insight on what the IRS will accept regarding source, we now have a slightly clearer picture.
Petitioner Retief Goosen was, for the years at issue (2002 and 2003), a successful pro golfer. He had won the U.S. Open in 2001 and was, therefore, party to various endorsement contracts in the years at issue. Some endorsements were for products directly related to his golfing (termed "on-course" endorsements). These included TaylorMade (golf clubs), Izod (clothing), and Acushnet (Titleist golf balls). Other endorsements were for products not directly tied to golf ("off-course" endorsements). These included Rolex (watches), Upper Deck (trading cards), and Electronic Arts (video games). Virtually the entire dispute, like the 2009 GLAM, dealt with the on-course endorsement contracts.
Each of the on-course endorsement contracts in Goosen, like the endorsement contracts dealt with in the GLAM, provided the endorsing athlete with an annual fee, plus bonuses for finishing first in a tournament (tournament placement bonus) and/or achieving a specified ranking on the World Golf rankings (ranking bonus). In exchange for the fee and bonuses, the contracts required Mr. Goosen to wear or use the sponsor's product during tournaments, to make a limited number of promotional appearances, to participate in photo or TV filming days, and to permit the sponsor to use Mr. Goosen's "name and likeness rights." The annual fees were prorated if Mr. Goosen failed to play at least two rounds in a stated minimum number of tournaments. The endorsement contracts, both in the GLAM and in Goosen, had "morals clauses" allowing for their termination if the athlete violated public morality or decency, was convicted of a crime, tested positive for drugs, or committed any act that materially reduced the value of the endorsement agreement.4
Unlike the Boulezcase, in Goosen and the GLAM the entertainer/athlete clearly had legal rights in intangible property. In Boulez, the Tax Court concluded, both as a matter of fact and as a matter of law, that Mr. Boulez had no copyrightable property interest in the recordings he helped make. Even for the period following the 1971 amendments to the Copyright Act of 1909, the court held that Mr. Boulez and CBS Records did not rebut the presumption that the employer, CBS Records, owned the copyright in the case of "works made for hire," not the employee/independent contractor, Mr. Boulez.
In Goosenand the GLAM, in contrast, even the IRS admitted that the athlete had a property right in his name and likeness. The question at issue was not whether the athlete owned and licensed a property right. It was how much the license of that property right was the reason for the payments under the endorsement contracts. Mr. Goosen reported on his return that 50% of the endorsement contract payments, both the annual fees as well as the ranking and tournament placement bonuses, were for the license of those property rights and should be characterized as royalties. He and those testifying on his behalf argued that Mr. Goosen was not just a golfer but was a "brand ambassador." The sponsors marketed Mr. Goosen's image globally, year-round. The senior v.p. of marketing for TaylorMade testified that TaylorMade valued its endorsement agreement with Mr. Goosen because it appreciated his image. As the court concluded, "TaylorMade wanted to be associated with his cool and professional persona."5 As a U.K. tax resident, of course, Mr. Goosen hoped to maximize the amount of royalty income to claim a treaty exemption on such income (more on this later).
The IRS, on the other hand, argued that the property rights were of de minimis importance in earning the endorsement fees and bonuses. They argued that the compensation should, therefore, be considered 100% compensation for personal services. The IRS desires personal services treatment because, even though the income would be subject to net tax as ECI (given that it was attributable to a fixed base or PE), there would be no treaty protection.
In support of this argument, the IRS pointed to the contract provisions mentioned above. The bonuses were dependent on the level of performance in playing golf (either over a single tournament or, for ranking purposes, over many tournaments) so they must have been for performing personal services—i.e., for playing golf—the argument goes. The annual endorsement fees were prorated if Mr. Goosen failed to play in a specified minimum number of tournaments. That also, the IRS argued, made the fee clearly one for playing golf—providing services—not for the use of Mr. Goosen's image. In the GLAM, the IRS states:
The inference to be drawn from this [the reduction of fees for failure to compete enough] is that the player's value to the sponsor is as a walking billboard, and that the sponsor relies on the broadcast of the live event in conjunction with the publicity the event generates (before, during, and after it takes place) to promote the sale of its products.
In a footnote, the IRS quotes various commentators who give numbers for the walking (or running) billboard values. In the 2008 Wimbledon men's final (the longest in history up to that point), for example, both Roger Federer and Rafael Nadal wore multiple Nike "swooshes" (Federer wore seven gold ones, Nadal 11 black ones). Between the two players, Nike's logo was featured for 35 minutes and 23 seconds, "equaling $10,615,000 worth of equivalent advertising time," a figure that does not include the value from replays, the internet, and local sports news coverage, according to a CNBC commentator. This, the IRS thought, clearly justifies their conclusion that the endorsement fees should be treated as 100% for personal services. In essence, the argued that Goosen's name and "image" were far less important to getting his TaylorMade cap on TV than his golfing. He could wear the cap 24/7 off the course and his image wouldn't be worth a dime. (Who even remembers what Retief Goosen looks like?) What the sponsor wants is TV exposure and that is only available on the course and when the player is successful.
On this character question, the court sided with Mr. Goosen, allowing 50% of the endorsement fees (annual fees plus bonuses) to be treated as royalties. The expert report and the testimony of the TaylorMade executive were given considerable weight. While there was moderate discussion in the opinion as to why some portion of the fees should be considered royalties, there was almost no discussion of why a 50/50 split between royalties and personal service income was appropriate. All the court said was, "The record shows that the performance of services and the use of name and likeness were equally important." Still, the result and the discussion regarding why some portion of the fees were royalties is instructive.
The source conclusions in Goosen are less instructive. Mr. Goosen reported a portion of the personal services 50% of his endorsement fees as U.S.-source, based on a fraction the numerator of which was days of golf in the United States and the denominator of which was total days of golf. For reasons not noted in the opinion (perhaps it was based on Mr. Goosen's formula?), the parties stipulated that a fixed percentage (just slightly above 40%) of the personal services half of the annual fees should be U.S. For the ranking bonuses, the source was determined using a fraction the numerator of which was U.S. prize winnings and the denominator of which was total winnings. For the tournament placement bonuses, the parties agreed to use Mr. Goosen's formula.
There was greater disagreement regarding the source of the royalty portion of the endorsement fees. The endorsement contracts simply allocated this 25/75 between the United Kingdom and the rest of the world. They did not provide what portion was U.S.-source. Mr. Goosen reported less than 7% as U.S.-source. The court noted that other courts allocated all royalty income to the United States if the contracts failed to allocate and the taxpayer did not show a sufficient basis for allocating. That sufficient basis, however, was a fairly low hurdle. Because Mr. Goosen showed that sponsors paid for the right to use his name and likeness outside the United States, and because he demonstrated that he had a global image and was, in fact, marketed all over the world, the court held it was unreasonable to source all royalties (or at least all of the 75% that the sponsors and Mr. Goosen allocated to sources outside the United Kingdom) to the United States. The court then, without any detail other than "taking into account all of the evidence," concluded that 50% of the royalty income was U.S.-source.
For taxpayers who, unlike Mr. Goosen (as will be seen below), can take advantage of favorable treaty exemptions (or reductions) for royalties, most of the practical benefit of the court's conclusion that 50% of the on-course endorsement fees were royalties was taken away by the court's ECI conclusion. For royalties that are not ECI, of course, many treaties eliminate U.S. withholding tax and almost all reduce it. For royalties that are ECI, or are attributable to a PE, however, virtually all treaties allow taxation of such royalties as business profits—i.e., under normal graduated rates on a net income basis. The Tax Court in Goosendetermined that all of Mr. Goosen's U.S.-source royalty income from on-course endorsement contracts was effectively connected to Mr. Goosen's U.S. trade or business.6
U.K. Treaty Benefits
As mentioned above, Mr. Goosen was a U.K. tax resident. Under the U.K. tax system, however, as a non-domiciliary he was taxed in the United Kingdom only on remitted income. Article 1(7) of the U.S.-U.K. Income Tax Treaty, recognizing this regime, prevents treaty benefits for U.K. residents with respect to their unremitted and therefore untaxed (in the United Kingdom) income. Mr. Goosen's endorsement income was paid into Liechtenstein bank accounts of two companies that Mr. Goosen used to enter into his endorsement contracts and which paid him salary and bonuses. All of Mr. Goosen's endorsement earnings and prize winnings "inside the United Kingdom" were paid to one company; those "outside the United Kingdom" were paid to the other. The Tax Court opinion does not provide any clear definition of what earnings "inside" versus "outside" the United Kingdom means. I guess, given the 25/75 split in each of the endorsement contracts described in the opinion, as well as the court's statement that this arrangement assured that Mr. Goosen's non-U.K.-source income would remain outside the United Kingdom, that this means 25% of endorsement fees went to the "earnings inside the United Kingdom" company and 75% to the "earnings outside the United Kingdom" company. It is not clear, however, what the court thought regarding the source, under U.S. rules, of these respective allocations.
The "earnings inside the United Kingdom" company remitted salary and bonus to Mr. Goosen in the United Kingdom of the total amount deposited into that company's account from Mr. Goosen's winnings and endorsements, after deducting expenses. Presumably this included 25% of all endorsement fees less a pro-rata share of expenses. According to the opinion, Mr. Goosen argued "that he should benefit from the U.S.-U.K. tax treaties to the extent [the "earnings inside the United Kingdom" company] remitted his salary and bonus to his U.K. bank account."
Given that the premise for the 25/75 split of endorsement fees appears to have been source (U.K. vs. non-U.K.), and that only the "earnings inside the United Kingdom" company remitted anything to Mr. Goosen's account in the United Kingdom, it seems odd that he would claim that some or all of that income should be treated as U.S.-source income eligible for benefits under the treaty. The court apparently concluded that it did not need to comment on this, however, because it found, simply, that Mr. Goosen failed to establish that his U.K.-remitted salary and bonus payments constituted endorsement income. Because he failed to show that endorsement income was remitted to the United Kingdom, the court held that he was not eligible for U.S.-U.K. treaty benefits on the endorsement income.
The court's finding that Mr. Goosen failed to establish that his U.K.-remitted salary and bonus payments constituted endorsement income also seems odd, however, given that it was in evidence that 25% of all endorsement income went into the "earnings inside the United Kingdom" company and that that company paid all such income (after deducting expenses) to Mr. Goosen's U.K. bank account. In any event, given that the endorsement income that was remitted to the United Kingdom appears to have been, by the terms of the endorsement contracts, identified as non-U.S.-source, the result the court reached seems correct.
This commentary also will appear in the August 2011 issue of the Tax Management International Journal. For more information, in the Tax Management Portfolios, see Blessing and Lubkin, 905 T.M., Source of Income Rules, and Bissell, 907 T.M., U.S. Income Taxation of Nonresident Alien Individuals, and in Tax Practice Series, see ¶7120, Foreign Persons—Gross Basis Taxation, and ¶7130, Foreign Persons—Effectively Connected Income.
4 One of the experts testifying for petitioner (a former president of Wilson Sporting Goods) cited these clauses and their invocation to terminate endorsement contract obligations between Tiger Woods and certain of his sponsors as evidence that Mr. Goosen was being paid for his name and likeness or "image."
5 The court noted no irony and did not discount this testimony despite relying heavily on Mr. Goosen's expert's report regarding the high value of "image," a report which noted that Sergio Garcia, a lower-ranked golfer than Mr. Goosen, received substantially higher endorsement payments from TaylorMade because "TaylorMade valued Mr. Garcia's flash, looks and maverick personality more than petitioner's cool, `Iceman' demeanor."
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