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Karrer v US (1957) Income tax of foreign persons ER:

Karrer was a chemist in Switzerland who discovered how to synthetically produce Vit B2 and E. He made this discoveries with the help of Basle, a chemical manufacturing firm who also provided him with lab equipment, raw materials, and helped him develop the process. They entered into a contract whereby Karrer would share in the profits of the sale of the vitamins Consequently, a similar chemical manufacturing firm in the US (Nutley), became the agent of Basle in the manufacturing and sale of the vitamins of Karrer. Nutley, the US firm, them made payments to Karrer as royalty for his discoveries Nutley withheld and paid United States income taxes on behalf of Karrer in the sum of $92,978.22 Karrer is now asking for a refund representing the total amount of United States taxes paid and withheld from him on account of the payments made by Nutley ISSUE: WON Karrers income was sourced from the US and is thus subjected to tax? NO. It was compensation for services rendered outside the US thus exempted from tax. In the instant case the vitamin B-2 and vitamin E patents, together with the right to use and sell their commercial values were income producing property and thus a "source" of income. o Nutley for such use or for the privilege of such use, would be clearly taxable to the recipient of such payments However, we are of the opinion that the payment made by Nutley to Karrer were not payments for the right of Nutley to use any income producing property or interest therein belonging to Karrer What Nutley paid Karrer were amounts due on an obligation owing to Karrer by Basle for services performed for Basle by Karrer in Switzerland. THUS, they do not represent payments for Karrer's rights or interest in property located in the United States, but rather payments for services performed outside the United States, and are therefore exempt from taxation. Nutley's denomination of the payments as royalties on its books cannot change the true character of these payments.

FACTS: Paul Karrer (KARRER) a chemistry professor at the University of Zurich, Switzerland, winner of Nobel Prize in 1937, Director of the Chemical Institute in the University of Zurich He has not been back to the US since 1933 He researched on the synthesis of Vit B2 and Vit E for commercial production Thus, he contacted F. Hoffmann-LaRoche & Co. Ltd. of Basle (BASLE) for assistance in his research (manufacturing of whey where he extracted the vitamins, use of laboratory equipment, development of the synthesizing process) For this, Basle suggested that Karrer grant Basle the sole right to exploit the manufacturing processes resulting from his investigations if his research proved to be of commercial value. Also, that if the process would lead to a patent, it would grant Karrer participation in the net proceeds. Karrer accepted. Under Swiss law the exchange of letters between plaintiff and Basle constituted a contract which may be designated as a special employment contract under the terms of which all patents resulting from Karrers discoveries belonged to Basle, the employer Eventually, Karrer successfully discovered how synthetically produce vitamin B-2 and vitamin E The parties entered into a formal contract specifying the percentage of net proceeds to be paid by Basle to the plaintiff as 5%. Additionally, Karrer was only allowed to participate in the profits for 12 years. 1941, Basle and Hoffmann-LaRoche, Inc., of Nutley, New Jersey, (NUTLEY) a New Jersey corporation doing business in the United States as a chemical manufacturing firm, entered into a contract whereby Nutley was granted the exclusive enjoyment and use within the United States of all of Basle's secret processes and scientific developments pertaining to certain products, including the vitamins which had been synthesized by Karrer. In return, Nutley agreed to pay Basle 4% of the net proceeds of sales made by Nutley. Karrer, who had no contractual relationship with Nutley, was not a party to the contract between Basle and Nutley

In the United States a patent application can be filed only by a natural person, the inventor, and Basle therefore required Karrer to file the applications on his vitamin B-2 and vitamin E discoveries Also at Basle's request, Karrer assigned the vitamin B-2 and vitamin E United States patent applications to Nutley before the patents were granted. Nutley, produced and marketed vitamin B-2 and vitamin E products and, although Nutley had no contract of any kind with Karrer, it paid him a percentage of all its sales of products containing vitamin B-2 and vitamin E o These payments made to plaintiff by Nutley were characterized on the books of Nutley as royalties. Nutley withheld and paid United States income taxes on behalf of Karrer in the sum of $92,978.22 for the years 1941 through 1945. Karrer timely filed United States income tax returns for the years 1941 through 1946 and paid a balance shown to be due thereon of $108,526.66. o filed claims for refund amounting to $201,504.88, representing the total amount of United States taxes paid and withheld from plaintiff on account of the payments made by Nutley to plaintiff with respect to the sale in the United States of vitamin B-2 and vitamin E products US denied refund US contends: payments from Nutley to Karrer were subject to Federal income tax because they were fixed, periodical income to plaintiff from sources within the United States falling within the provisions of section 211(a) (1) (A) of the Internal Revenue Code of 1939. Karrer: payments made to him by Nutley were for services performed outside of the United States and are therefore not from sources within the United States so as to provide a basis for the imposition of a United States income tax

ISSUE: WON Karrers income was sourced from the US and is thus subjected to tax? NO. It was compensation for services rendered outside the US thus exempted from tax. HELD: It is the opinion of the court that the payments received by Karrer from Nutley were income from sources without the United States and were not taxable under the internal revenue laws in effect during the period in suit. Karrer is entitled to judgment in the amount of $201,504.88, together with interest provided by law. RATIO:

According to the Sec 119 of Revenue Code of the US:

"Income from sources within the United States(a) Gross income from sources in the United States. The following items of gross income shall be treated as income from sources within the United States: ****** "(4) Rentals and royalties. Rentals or royalties from property located in the United States or from any interest in such property, including rentals or royalties for the use of or for the privilege of using in the United States, patents, copyrights, secret processes and formulas, good will, trade-marks, trade brands, franchises, and other like property; and ****** (c) Gross income from sources without the United States. The following items of gross income shall be treated as income from sources without the United States: ****** "(3) Compensation for labor or personal services performed without the United States." The fact that the payments here in question were made by a United States corporation is not determinative of the right to tax the nonresident alien who is the recipient of such payments. The only criterion for imposing the tax is that the "source" of the income to be taxed must be within the United States. The "source" of income in this connection is not necessarily the payor, but may be the property or the services from which the particular income is derived as indicated in section 119 of the Internal Revenue Code. In the instant case the vitamin B-2 and vitamin E patents, together with the right to use and sell their commercial values were income producing property and thus a "source" of income.

Nutley for such use or for the privilege of such use, would be clearly taxable to the recipient of such payments However, we are of the opinion that the payment made by Nutley to Karrer were not payments for the right of Nutley to use any income producing property or interest therein belonging to Karrer. o The right to use and exploit in the United States the patents granted on the discoveries of Karrer was granted to Nutley by Basle pursuant to the terms of the contract of January 27, 1941, and not by Karrer. o Basle was the owner of the commercial rights in Karrer's discoveries and it alone could convey this right to another o Karrers only interest in the sales of the vitamins produced and sold arose out of his contractual relationship with Basle It does not appear that there ever existed between Basle and Karrer any relationship other than that of special employment. o Payments made to such an employee, even though based on a percentage of the proceeds of the sales of the invented process or object, would be compensation for the employee's services rather than royalties, because the employee's right to such payments derives from his services to his employer and not from any rights in inventions owned by the employee. o Thus, it does not come under the above-quoted Sec 119 of the Code o Since Nutley paid Karrer amounts due on an obligation owing to Karrer by Basle for services performed for Basle by Karrer in Switzerland, they do not represent payments for Karrer's rights or interest in property located in the United States, but rather payments for services performed outside the United States, and are therefore exempt from taxation. Nutley's denomination of the payments as royalties on its books cannot change the true character of these payments.