Rev. Rul. 80-15

1980-1 C.B. 365, 1980-2 I.R.B. 16.

                       Internal Revenue Service
                                 Revenue Ruling

       ITALY; FOREIGN CORPORATION'S DOMESTIC TRUST; SUIT TO RECOVER U.S.
                                   ROYALTIES

                          Published: January 14, 1980

United States-Italy Income Tax Convention, 1956-2 C.B. 1096

(Also Part I, Sections 671, 676, 1.671-1, 1.676(a)-1.)

  Italy; foreign corporation's domestic trust; suit to recover U.S. royalties. An Italian corporation set up a domestic trust to commence and conduct a civil suit against a domestic corporation to recover patent royalties payable by the domestic corporation. The trust agreement limits the authority of the trustee, a U.S. citizen and resident, to commencing and maintaining the legal action, settling the claim, and receiving all sums of money due as a result of the claim. The trustee received and remitted to the Intalian corporation a sum of money in settlement of the claim. The trust in not a permanent establishment under Article II(1)(c) of the United States-Italy Income Tax Convention, and the payment to the trust is treated as royalties within the meaning of Article VIII.

ISSUES

  (1) Whether a domestic trust set up to commence and conduct a civil suit is a 'permanent establishment' under Article II(1)(c) of the United States-Italy Income Tax Convention (the Convention), 1956-2 C.B. 1096.

  (2) Whether an amount received in a settlement agreement involving a contract suit to recover patent royalties is treated as the payment of 'royalties' within the meaning of Article VIII of the Convention.

FACTS

  A is a citizen and resident of the United States. X is an Italian corporation that has its principal place of business in Italy.  Y is a domestic corporation engaged in manufacturing. In 1970 X and Y entered into a written agreement that described the procedure to be used for the payment by Y to X of patent royalties as they accrue.

  At the request of X, A, acting as trustee, and X, acting as settlor, executed a trust agreement to institute a legal claim by X against Y for certain patent royalties.  The trust agreement provides that the settlor may revoke, modify or amend the trust in whole or in part. The authority of A as trustee is limited to (1) commencing and maintaining a legal action against Y on behalf of X; (2) settling the claim of X against Y; and (3) receiving all sums of money due as a result of such claim.

  Subsequent to the execution of the trust, A, as trustee, instituted a civil action against Y for recovery of the patent royalties that were subject to the trust.  Later, X and Y entered into a settlement agreement and A, as trustee, received a check from Y for the sum of 12x dollars.  A remitted the 12x dollars to X.

LAW AND ANALYSIS

  Section 676 of the Code provides that a grantor of a trust shall be treated as owner of any portion of a trust, where at any time the power to revest title in the trust to the grantor is exercisable by the grantor.

  Section 671 of the Code provides that when the grantor of a trust is treated as the owner of the trust, items of taxable income of the trust are included in computing the taxable income of the grantor.

  Article VIII of the Convention provides that royalties and other amounts received as consideration for the right to use copyrights, patents and other like property from sources within the United States by an Italian corporation not having a permanent establishment in the United States shall be exempt from taxation within the United States.

  Article II(1)(g) of the Convention defines the term 'Italian corporation' to mean a corporation created or organized in Italy or under Italian laws.

  Article II(1)(c) of the Convention defines the term 'permanent establishment' to mean a branch, office, factory, warehouse or other fixed place of business. The term 'permanent establishment' does not include an agency unless the agent has and exercises a general authority to negotiate and conclude contracts on behalf of an enterprise.

  In Rev. Rul. 64-206, 1964-2 C.B. 591, a citizen and a resident of Switzerland, who did not maintain a place of business in the United State or conduct any business through a 'permanent establishment' situated in the United States, owned a United State patent.  That citizen was awarded a judgment for damages and interest for the infringement of this patent within the United States.  Rev. Rul. 64-206 holds that the damages awarded were amounts received as consideration for the right to use the patent, and thus

were exempt as royalties from United States income tax under Article VIII of the United States--Swiss Confederation Income Tax Convention.

  Under Article II(1)(c) of the Convention, an agency will not constitute a  'permanent establishment' in the United States unless the agent has and exercises a general authority to negotiate and conclude contracts.  In this revenue ruling, A, as trustee for X, does not have the general authority to negotiate or conclude contracts on behalf of X.  Rather, A's authority is limited by the terms of the trust agreement.

  Because X is treated as owner of the trust under section 676 of the Code, any income paid to the trust is taxable to X under section 671 unless otherwise excluded by law or treaty provision.

  The amount paid to the trust under the settlement agreement between X and Y was in lieu of the amount X would have realized under the patent agreement between X and Y.

HOLDINGS

  (1) The domestic trust established by an Italian corporation (X) for the limited purpose of conducting a breach of contract suit to recover patent royalties is not a 'permanent establishment' within the United States under Article II(1)(c) of the Convention.

  (2) The amount paid to the trust on X's behalf under the settlement agreement between X and Y is treated as the payment of royalties within the meaning of Article VIII of the Convention and therefore is exempt from United States income tax.

Rev. Rul. 80-15, 1980-1 C.B. 365, 1980-2 I.R.B. 16.