Faye was a world-renowned rock star from ABC-Country. A record company located i
ID: 2417408 • Letter: F
Question
Faye was a world-renowned rock star from ABC-Country. A record company located in the USA, named Platinum-USA Records, contracted with Faye to produce records. Platinum-USA Records retained all intellectual property rights in the recordings. The contract granted Faye payments or “royalties” based upon future sales of recordings. Faye paid taxes on the payments in ABC-Country as royalties. A treaty between the USA and ABC-Country exempts royalties from tax in the USA. However, the treaty, did not define royalties or compensation for personal services. The IRS has told Faye, that her contract with Platinum-USA generates personal service income in the United States. Prepare a tax research memo advising Faye on the appropriate tax treatment, given her situation, and with her type of income.
Explanation / Answer
The global income generated for Faye is taxable in ABC country based upon her residential status. Hence, the income received from Platinum-USA records is considered as taxable income in ABC country.
As there is a treaty exists between the USA and ABC country giving exemption for "royalties" from tax in the USA, the treatment of the same in the ABC should be examined. It can be assumed that the treaty will have mutal benefit in both the countries.
It could be seen that the conract terms between Faye and Platinum-USA records have not clearly mentioned that the compensation is in the form of 'roylaties'. There is mention in the contract that "the contract granted Faye payments or royalities based upon future sales of recordings".
This gives room for ambiguity to decide the type of her income. Hence, it is required that the contract terms should clearly speficy that the contract granted roylaties based upon future sales of records and should not contain the term "payments or royalties".
As the treaty did not define royalties or compensation for personal services, this needs further information to come to conclusion.
Based on the above facts, there is an immediate need to change the contract terms with Platinu-USA records to gain the beneift of exemption of royalties under USA and ABC country treaty fofr future sales of recordings.
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