Sergio Garcia began playing golf in Spain at the age of three, turned professional in 1999, and won his first PGA Tour event in 2001, at age 21. Garcia has amassed career earnings exceeding $43 million, and had won numerous tournaments. But until this year, Garcia had never won one of golf’s “Major” championships (the Masters Tournament, the U.S. Open, the British Open and the PGA Championship).
That all changed on April 9, 2017 in Augusta, Georgia, when Garcia ended his drought by winning the Masters Tournament in dramatic fashion on the first sudden-death playoff hole.
Not surprisingly, golf fans were electrified by Sergio Garcia’s breakthrough. But it’s unlikely that any of them would have anticipated that the effects of his success at Augusta also merit special attention from those who follow tax law.
In 2013, the fiery Spaniard, who for many years has been a resident of Switzerland, found himself pitted against the Internal Revenue Service in a case involving a seven-year endorsement agreement that began on January 1, 2003, between the golf products company TaylorMade and Garcia, around whom TaylorMade sought to build a “Global Icon” brand.
Although at the time of its deal with Garcia, TaylorMade had endorsements and/or use agreements with nearly 200 professional golfers, Garcia was to be its sole “Global Icon.”
Under the contract with TaylorMade, part of Garcia’s remuneration was for his personal services and appearance days for the company in the U.S., and part was paid to EvenPar, LLC (“EvenPar”), which controlled Garcia’s image rights. These were licensed by TaylorMade in the United States so the company could exploit Garcia’s golf celebrity status to market its products here.
An amendment to the agreement assigned 85% of the payments to EvenPar as royalties for TaylorMade’s use of Garcia’s image rights, and 15% to Garcia for his personal services.
Why does the allocation of payments between royalty and personal service income matter? Because for non-residents, the U.S. tax laws treat these types of income differently.
The income reported by Garcia for personal service payments (15% of the total) was considered U.S.-source income connected with the conduct of a U.S. trade or business within the United States. This income to a non-resident is taxable at the same rates, after allowable deductions, as those applicable to U.S. citizens.
But the 85% portion of the payments attributed on his U.S. tax return to Garcia’s image rights was excluded by Garcia as royalty income. Under the tax treaty between the United States and Switzerland, royalty income was only taxable in Switzerland. (Absent such a treaty provision, the U.S. would have imposed a 30% withholding tax on such royalty income).
The IRS rejected Garcia’s 85%/15% allocation, contending that the vast majority of the payments made to Garcia were for his personal services, and therefore were taxable here.
In Sergio Garcia v. Commissioner, 140 TC 141 (2013), the Tax Court had to decide the proper allocation of the TaylorMade payments between personal services (taxable here) and royalties (excluded from U.S. taxation under the treaty with Switzerland).
The Tax Court evaluated reports from experts submitted by both the IRS and Garcia. It ultimately rejected both Garcia’s 85% royalty/15% personal services allocation and the IRS’ position that the “vast majority” of payments was attributable to personal services.
Finding that both image rights and personal services were crucial elements of Garcia’s agreement with TaylorMade, the Tax Court settled on an allocation of 65% royalty and 35% personal services.
A major reason for this determination was the Tax Court’s observation that Garcia was the centerpiece of TaylorMade’s marketing efforts, which justified a heavier weighting for the image rights.
In its ruling, the Tax Court distinguished this case from its previous decision involving another professional golfer, Retief Goosen, who also had an endorsement/personal services agreement with TaylorMade.
In Goosen’s case, the Tax Court arrived at a 50-50 split between royalty and personal service payments. But that split was not appropriate to Garcia’s case, it said, noting that TaylorMade valued Garcia’s “flashy looks and personality” more than Goosen’s cool, “Iceman” demeanor to sell its products.
Put another way, although Goosen had the better professional golf record, the charismatic Garcia’s “it” factor within the golf world commanded a higher allocation for his royalty payments than for Goosen’s.
When the Tax Court decided Garcia in 2013, it settled on a 65% allocation for royalty income attributable to endorsement fees based on Sergio Garcia’s “star power” during 2003 and 2004, the years the Tax Court was looking at.
Following Garcia’s thrilling Hollywood-ending victory in this year’s Masters Tournament, the value of Garcia’s image rights should certainly be worth considerably more than the Tax Court’s allocation of 65% of the TaylorMade payments to endorsement royalty income.
By ending his years of always being a bridesmaid with a sudden-death exclamation point victory at the Masters Tournament in Augusta, Sergio Garcia may well have given his tax professionals solid grounds to allocate substantially more to royalty income on future endorsement deals than the 65% he got in Tax Court.
So, in addition to the traditional green jacket he received for his tournament win, perhaps Garcia should also qualify for a honorary master’s degree in tax!
By Michael R. Morris, Esq.
