Posts Tagged ‘Golf’

Rory McIlroy Dominates in South Carolina

August 12th, 2012 1 comment

Northern Ireland native Rory McIlroy dominated the field this weekend to capture the 2012 PGA Championship, held at Kiawah Island, South Carolina.

McIlroy became the first player to win the Championship by at least eight strokes, breaking Jack Nickalus’ previous record of seven set in 1980.

Finishing first, McIlroy collects a cool $1,445,000. Before taxes, of course.

McIlroy may be considered a U.S. resident and thus subject to U.S. income tax on his worldwide income if he meets the substantial presence test. To have substantial presence, he must (i) spend at least 31 days in the U.S. during 2012 and (ii) have a weighted average of 183 days spent in the U.S. over 2012 and the prior two years. But, if he spends fewer than 122 days in the U.S. during 2012, then he is exempt from substantial presence.

If McIlroy is not a U.S. resident for 2012, he still must pay U.S. tax on income that is “sourced” (earned) in the United States, unless there is treaty relief.

Section 1 of Article 17 of the United States-United Kingdom Income Tax Treaty reads:

Notwithstanding the provisions of Articles 14 (Independent Personal Services) and 15 (Dependent Personal Services), income derived by entertainers, such as theatre, motion picture, radio or television artistes, and musicians, and by athletes, from their personal activities as such may be taxed in the Contracting State in which these activities are exercised, except where the amount of the gross receipts derived by an entertainer or athlete, including expenses reimbursed to him or borne on his behalf, from such activities do not exceed 15,000 United States dollars or its equivalent in pounds sterling in the tax year concerned.

(Emphasis added.)

No treaty relief for the champion. McIlroy’s $1.44 million prize is subject to U.S. income tax.

At 23 years young, McIlroy has a very promising career ahead of him. It’s not far-fetched to speculate he will receive more attention than any other professional golfer from prospective endorsers over the next five to ten years.

The taxation of endorsement winnings of nonresident golfers in the U.S. has been a heavily litigated issue. Retief Goosen took his case to tax court last year, and the parties stipulated to dismiss the appeal of that case this past February.

Another significant case regarding the endorsement earnings of a professional golfer is still pending, however. Sergio Garcia is the taxpayer. I’ll write about that decision after we learn of it.

No Mulligan in Tax Court for Goosen

June 10th, 2011 No comments

In April, I examined the U.S. tax consequences on the winnings earned by South African Charl Schwartzel resulting from capturing the Green Jacket in the 2011 Masters Tournament.  Today we turn to a far more well-known South African native golfer: Retief Goosen.

You will find Retief Goosen’s name listed in the top ten of the Official World Golf Rankings for over 250 out of a total 364 weeks between 2001 and 2007.  He has two U.S. Open titles to his name (2001 and 2004), and is known on the PGA Tour as “The Iceman” because of his strikingly calm demeanor on the golf course.  His popularity has landed him several endorsement deals over the years, including those with sponsors TaylorMade (as pictured to the right) and Electronic Arts, among several others (Izod; Acushnet; Rolex; Upper Deck).  Yesterday, the U.S. Tax Court issued a decision that re-characterized and reallocated substantial portions of his income earned from these endorsement deals in 2002 and 2003, ultimately resulting in a hefty U.S. tax bill.

The opinion is rather confusing to follow.  It’s not because it is poorly written.  It’s because Goosen is a U.K. resident and had several endorsement deals, each with its own terms, during the years in question.  This required the court to closely examine each agreement’s terms and determine whether Goosen properly reported the income therefrom on his U.S. tax returns under IRS examination.

One major reason why international taxation at first glance may seem a daunting subject is because there are two fundamental and critical concepts one must always keep in mind with respect to the income in question: (1) source and (2) character.  Regarding source, the country in which income is earned—also known as the “source” country—has the primary right to tax the income.  International tax issues arise when the source country is not the taxpayer’s country of residence.  The “character” of income (e.g. personal services, royalty, dividend, etc.) is important in order to determine the applicable tax rate, whether or not there is an international tax issue.  When considering (1) and (2) together, one must be very careful and thorough while analyzing U.S. tax consequences.

With that framework in mind, let’s proceed to the heart of Goosen’s case.  Each of his agreements was considered one of the following:

  • A.  On-Course Agreements: These required Goosen to wear or use the sponsor’s products during golf tournaments; and
  • B.  Off-Course Agreements: These did not have the on-course requirement.

For purposes of relative brevity, let’s look at how the court treated Goosen’s income earned from two endorsement agreements: (i) The TaylorMade on-course agreement, and (ii) The Electronic Arts off-course agreement.

The TaylorMade On-Course Endorsement Agreement

TaylorMade agreed to pay a $400,000 annual endorsement fee so long as Goosen completed certain golf tournament playing requirements, wore required clothing, and made certain appearances.  In addition, TaylorMade agreed to pay a tournament bonus if he won a specified tournament, and pay a ranking bonus if he achieved a specified ranking on the World Golf Rankings.

On his nonresident U.S. tax returns, Goosen characterized the annual fee and bonuses as 50 percent royalty income and 50 percent personal services income.  For the “source” component, Goosen attributed the royalty income as 3.4 percent U.S. source; for the personal services, he sourced endorsement fees and tournament bonuses based upon the number of days he played golf inside the U.S. over the total days he played golf for the year, and sourced ranking bonuses based on a ratio of his U.S. prize winnings to his worldwide winnings.

After taking five pages to analyze the issue, the court held Goosen’s characterization as accurate.  Payments for the right to use a person’s name and likeness has been repeatedly held as royalties because the person has an ownership interest in that right.  Goosen asserted that TaylorMade paid him, in part, to co-market and co-brand the company’s products with his name and likeness.  So, on the one hand, the court observed TaylorMade’s desire to be associated with Goosen’s “cool and professional persona,” which cast in public view internationally.  On the other hand, the court highlighted the value of Goosen’s participation at tournaments to promote TaylorMade products; in fact, the full endorsement fee was conditioned upon Goosen’s participation in a specified number of golf tournaments.

For sourcing, Goosen and the IRS agreed to his approach for sourcing the personal services income, but disagreed as to what portion of the royalty income was U.S. source.  Generally, royalty income paid for the right to use intangible property is sourced where the property is used or to given the privilege to use.  To make this determination, the court considered where Goosen’s name and likeness were used, and held that 50 percent of the royalty income as U.S. source.  This represents an increase of over forty percentage points for U.S. source from how Goosen sourced the royalty income.

Finally, the court had to determine whether the U.S. source income was effectively connected to a trade or business.  That’s because in the case of U.S. source income effectively connected to a trade or business, a nonresident alien is essentially treated like a U.S. resident for tax purposes with respect to that income: graduated rates apply. If not effectively connected and the income consists of rents, royalties, or other similar types of income, the nonresident instead is subject to a thirty percent withholding tax.

In this case, the parties agreed that the income from personal services was effectively connected, but disagreed to the royalty income.  The court held that the royalty income was effectively connected, because Goosen’s participation in golf tournaments was material to receiving income for the use of his likeness.

The Electronic Arts Off-Course Endorsement Agreement

Electronic Arts develops video games, including Tiger Woods PGA Tour.  Pursuant to the agreement, EA obtained the right to use Goosen’s name and likeness in the game, and EA agreed to pay $45,000.  Goosen characterized his endorsement fees as 100 percent royalty income, and attributed the income as 6.8 percent U.S. source.

The parties in the case agreed with the 100 percent royalty characterization, but disagreed as to source.  After evaluating where EA’s video games were sold and marketed and the extent to which Goosen’s name and likeness was tied to those sales, the court held that this income as 70 percent U.S. source.  That’s an increase of over 60 percentage points from how Goosen sourced the income in the U.S., ultimately subjecting far more of his EA royalty income to U.S. taxation.  For the effectively connected analysis, the court held that the royalty income from the EA agreement was not, because the income therefrom did not depend on whether Goosen participated in any golf tournaments.

Possible Treaty Relief

When the source country is not the taxpayer’s country of residence, the resident country only has residual taxing rights on the income.  Sometimes, the source country relaxes its primary taxing rights on the income by law or treaty.

Retief Goosen is a resident of the U.K., so the court considered whether Goosen would receive any benefits offered by the U.S.-U.K Tax treaty.  The court held that he did not, because payments from Goosen’s sponsors were made to entities controlled by the company he hired to manage his career and finances; Goosen couldn’t prove the payments he received from these entities constituted endorsement income or another type of income.  To me, losing on that point sounds like the result of poor tax planning and/or record keeping.

(Hat tip: TaxProf Blog)

Congratulations Charl Schwartzel: You Owe Uncle Sam

April 10th, 2011 No comments

Congratulations to South African Charl Schwartzel for rising above the rest of the competitive field and capturing the Green Jacket in the 2011 Masters Tournament.  Of the $8 million total prize purse, Charl takes home $1.44 million for his first place finish.  Before taxes, of course.

A fundamental principle of international taxation is that the country in which income is earned—also known as the “source” country—has the primary right to tax the income.  If the taxpayer is a resident of the source country, then the source country and resident country are the same.  When the source country is not the taxpayer’s country of residence, however, the resident country only has residual taxing rights on the income.  Sometimes, the source country relaxes its primary taxing rights on the income by law or treaty.

As noted, Mr. Schwartzel is a resident of South Africa.  Can he also be considered a U.S. resident?  Under the Internal Revenue Code, a non-U.S. citizen is considered a U.S. resident for tax purposes under the “substantial presence” doctrine if the taxpayer (i) spends at least 31 days in the U.S. during the tax year in question and (ii) has a weighted average of 183 days spent in the U.S. over the present year and prior two years.  But, if the non-U.S. citizen spends fewer than 122 days in the U.S. during the tax year, the taxpayer is exempt from substantial presence.

We don’t know how many days Mr. Schwartzel will spend in the U.S. in 2011.  Now that he’s recently joined the PGA Tour and plans to play in about 18 U.S. events, it’s very possible he will satisfy the substantial presence test.  In that case, the analysis is simple:  Uncle Sam has no limitations on taxing the $1.44 million in winnings.  If Mr. Schwartzel is not a U.S. resident in 2011, however, the analysis is different.

In general, income of foreign persons that is effectively connected to a U.S. trade or business is taxed on a net income basis.  In other words, like a U.S. resident, the foreign person may deduct operating costs from gross income and pay tax on the resulting net income.  Certainly, if Mr. Schwartzel participates in 18 U.S. golf events in 2011, he will have effectively connected income to a trade or business.  Accordingly, Uncle Sam taxes the Masters Tournament income as if Charl was a U.S. resident, unless a tax treaty applies to change the result.

The purpose of tax treaties is to reduce source country taxation that would otherwise be imposed on residents of a treaty partner under the source country’s tax law.  Treaties may only reduce tax imposed on nonresidents; they never increase it.

Under most tax treaties, the business profits in the source country of a foreign taxpayer are subject to tax in the source country only if the profits arise through a permanent establishment in the source country.  Many treaties, however, have specific provisions that address the business profits of athletes and entertainers.  The United States-South Africa Tax Treaty is no exception.

Specifically, Article 17, “Entertainers and Sportsmen,” governs the tax treatment of Mr. Schwartzel’s winnings from the 2011 Masters Tournament.  The first paragraph states if the income is not taxable in the source country under other articles in the treaty, then the source country may tax the income unless the gross profits are less than $7,500.  For Mr. Schwartzel, this means Uncle Sam gets paid in full.

If you’ve made it this far, you can easily see that the issues regarding the taxation of income earned by foreign athletes are not straightforward.  As fellow tax blogger Kay Bell recently discussed, professional and non-U.S. resident golfers Retief Goosen and Sergio Garcia are currently in dispute with the IRS regarding the U.S. income tax treatment of endorsement earnings.

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