Rev. Rul. 74-108

Advice has been requested whether a sign on fee, paid to a nonresident alien individual by a domestic corporation pursuant to a "sign on agreement" (agreement), is income from sources within the United States subject to income tax withholding under section 1441(a) of the Internal Revenue Code of 1954.

The taxpayer, a domestic corporation, operates a professional soccer club in the United States. The club is a member of a professional league affiliated with the governing body of world-wide professional soccer. The taxpayer entered into an agreement with a nonresident alien individual during the current taxable year. In order to induce the nonresident alien individual to sign the agreement, the taxpayer paid him a sign on fee. The agreement was executed by the taxpayer and the nonresident alien individual outside the United States.

The sign on fee is paid to induce the player to sign and become bound by the provisions of the agreement. The agreement does not require the player actually to play for the club; it is merely a preliminary agreement that is separate and distinct from a "uniform player" contract which binds a player to play soccer for a salary. When a player enters into an agreement, the taxpayer places him on its reserve list thereby protecting such player from recruiting efforts of any other club and preventing him from negotiating to play or playing for any other professional soccer club. No part of the sign on fee is attributable to future services, but the team anticipates the agreement and fee will induce the player to sign and become bound by the uniform player contract if the club wishes to use his services and a separate employment contract is negotiated for this purpose.

The professional soccer league with which the taxpayer's team is affiliated includes eleven members. Seven of the member teams, including the taxpayer, are located within the United States and the remaining four are located without the United States. The taxpayer's team schedule provides for some of its soccer games to be played in the United States and the remainder to be played in foreign countries.

Section 1441(a) of the Code provides, in part, that except as otherwise provided in section 1441(c), all persons in whatever capacity acting, having control or payment of any of the items of income specified in section 1441(b), to the extent that any of such items constitutes gross income from sources within the United States, of any nonresident alien individual shall deduct and withhold from such items a tax equal to 30 percent thereof.

The items of income described in section 1441(b) of the Code include wages, compensation, and other fixed or determinable annual or periodical income. Section 1.1441-3(a) of the Income Tax Regulations provides that the sources of income shall be determined in accordance with sections 861 to 864 and regulations thereunder.

Rev. Rul. 58-145, 1958-1 C.B. 360, provides that bonuses, which are not predicated on continuing employment, made to new baseball players solely for signing their first contracts, do not represent remuneration for services performed. Such bonuses are taxable to the baseball player as ordinary income in the taxable year received. Accordingly, in the instant case the sign on fee, which is similar to a bonus, paid to the nonresident alien individual is not compensation for labor or personal services for purposes of the source of income rules in section 861(a)(3) or section 862(a)(3) of the Code.

The sign on fee, or bonus, was paid to insure that if the nonresident alien individual did play professional soccer, he would provide his services for the taxpayer only and to no other professional soccer club. See Richard A. Allen, 50 T.C. 466 (1968). The bonus was paid as compensation for the promises made by the nonresident alien individual in the sign on agreement which in essence amounted to a covenant not to compete.

Compensation received for a promise not to compete is taxable as ordinary income and does not constitute income from the sale of property either real or personal. See John D. Beals, Jr., 31 B.T.A. 966, aff'd, 82 F. 2d 268 (2d Cir.), XV-2 C.B. 227 (1936). Such compensation is fixed or determinable annual or periodical income and its source is the place where the promisor forfeited his right to act. Korfund Co., 1 T.C. 1180 (1943). Therefore, amounts paid to a nonresident alien for his promise not to compete in the United States are subject to withholding under section 1441(a) of the Code.

In the instant case the sign on fee is paid for the nonresident alien individual's promise not to compete both within and without the United States. Therefore, the sign on fee is attributable to sources both within and without the United States and the income must be apportioned appropriately. See section 863(b) of the Code pertaining to the reporting of income partly from within and partly from without the United States.

Accordingly, a portion of the sign on fee in the instant case is income from sources within the United States and is subject to withholding under the provisions of section 1441(a) of the Code. The basis upon which the sign on fee is allocated as income from sources within and sources without the United States must be reasonable and based on the facts and circumstances in each case. For example, in some cases it may be reasonable to make the allocation on the basis of the relative value of the taxpayer's services within and without the United States, or on the basis of the portion of the year during which soccer is played within and without the United States. Where a reasonable basis for allocation does not exist, the entire sign on fee is income from sources within the United States and is subject to section 1441(a).