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)