Abeid v. Comm'r of Internal Revenue

• Decision Date: 29 June 2004
• Docket Number: No. 1044109–02.,1044109–02.
• Citation: 122 T.C. No. 24,122 T.C. 404
• Parties: Ismat M. ABEID, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

122 T.C. 404

122 T.C. No. 24

Ismat M. ABEID, Petitioner

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

No. 1044109–02.

United States Tax Court.

June 29, 2004.

Donald L. Feurzeig, for petitioner.

Paul R. Zamolo and Rebecca Duewer, for respondent.

OPINION

GALE, J.

P, a nonresident alien residing in Israel during 1997, 1998, and 1999 (years in issue), became entitled to 20 annual payments of $722,000 each by virtue of a 1992 purchase of a $1 ticket that won a lottery sponsored by the State of California. P received a payment of $722,000 from the California State Lottery in each of the years in issue. P filed U.S. Federal income tax returns for those years in which he took the position that the payments were not subject to U.S. tax.

R determined that the payments were subject to U.S. tax under sec. 871(a)(1)(A), I.R.C., resulting in a deficiency for each year in issue. P contends that the payments constitute “annuities” within the meaning of par. (5) of art. 20 of the Income Tax Convention, Nov. 20, 1975, U.S.-Isr., Hein's No. KAV 971, at xxii (treaty) and are therefore exempt from U.S. tax pursuant to paragraph (2) of Article 20 of the treaty, which provides that “annuities” shall be taxable only in the jurisdiction in which the recipient resides.

Held: The payments at issue are not “annuities” as that term is defined in the treaty, because they were not paid “under an obligation to make the payments in return for adequate and full consideration” as provided in the treaty. Accordingly, the payments are subject to U.S. tax as determined by R.

This case is before us on the parties' cross-motions for summary judgment under Rule 121.¹ The issue for decision is whether certain payments received by petitioner from a lottery operated by the State of California (California State Lottery) are exempt from U .S. taxation pursuant to the Income Tax Convention, Nov. 20, 1975, U.S.-Isr., Hein's No. KAV 971 (U.S.-Israel Income Tax Treaty or treaty).

Summary judgment is intended to expedite litigation and avoid unnecessary and expensive trials. Fla. Peach Corp. v. Commissioner, 90 T.C. 678, 681, 1988 WL 31439 (1988). Summary judgment may be granted with respect to all or any part of the legal issues in controversy “if the pleadings, answers to interrogatories, depositions, admissions, and any other acceptable materials, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that a decision may be rendered as a matter of law.” Rule 121(a) and (b); Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520, 1992 WL 88529 (1992), affd. 17 F.3d 965 (7th Cir.1994). In the instant case, the parties agree that there are no genuine issues of material fact and that judgment may be rendered as a matter of law.

In support of their respective motions, each party has submitted a memorandum of points and authorities. A hearing on the motions was also held.

The parties do not dispute that, at the time of filing of the petition, petitioner was a resident of Israel.²

During 1992, while residing in California, petitioner, an Israeli citizen, purchased a California State Lottery ticket for $1. That ticket won the “Super Lotto” lottery, entitling petitioner to receive annual payments of $722,000 from the California State Lottery for 20 years. Petitioner did not have a choice as to the timing or manner of payment of his lottery winnings.

During 1997, 1998, and 1999 (years in issue), petitioner resided in Israel. For each of the years in issue, petitioner received payments of $722,000 in California State Lottery winnings but did not report these amounts as income on his Federal income tax returns (filed as a nonresident alien). For purposes of computing his Israeli income tax liability for the years in issue, petitioner took the position that the payments were lottery winnings, exempt from Israeli income tax. Petitioner did not pay any Israeli income tax on account of the payments.

In a notice of deficiency, respondent determined that the lottery payments were includible in petitioner's taxable income pursuant to section 871(a)(1)(A), resulting in a deficiency of $216,600 for each year in issue. In his petition, petitioner alleges that the payments are exempt from U.S. taxation pursuant to the U.S.-Israel Income Tax Treaty because they constitute “annuities” within the meaning of paragraphs (2) and (5) of Article 20 of the treaty.

In general, “interest * * *, dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, and other fixed or determinable annual or periodical gains, profits, and income” received by a nonresident alien from sources within the United States and that are not effectively connected with a U.S. trade or business, are subject to a 30–percent tax. Sec. 871(a)(1)(A). Gambling winnings paid to a nonresident alien fall within this provision, Barba v. United States, 2 Cl.Ct. 674 (1983), with limited exceptions, see sec. 871(j). Annual payments of State lottery winnings are treated as gambling winnings. Rusnak v. Commissioner, T.C. Memo.1987–249; see also sec. 3402(q)(3)(B) (treating certain proceeds from wagers in State-conducted lotteries as gambling winnings). ³

The provisions of the Internal Revenue Code are applied to a taxpayer, however, “with due regard to any treaty obligation of the United States which applies to such taxpayer.” Sec. 894(a)(1). The U.S.-Israel Income Tax Treaty, Hein's No. KAV 971, at xxii, provides:

Article 20—Private Pensions and Annuities

* * *

(2) Alimony and annuities paid to an individual who is a resident of one of the Contracting States shall be taxable only in that Contracting State.

* * *

(5) The term “annuities”, as used in this Article, means a stated sum paid periodically at stated times during life, or during a specified number of years, under an obligation to make the payments in return for adequate and full consideration (other than services rendered).

Petitioner's position is that the payments he received during the years at issue from the California State Lottery were an “annuity” within the meaning of the treaty and therefore exempt from taxation by the United States under Article 20(2) thereof. While respondent does not dispute that petitioner was a resident of Israel, entitled as such to the benefits of the treaty, respondent nonetheless contends that the treaty provides no exemption for the payments at issue because they are not an “annuity” as defined in the treaty. Consequently, the payments are taxable under section 871(a)(1)(A) as U.S.-sourced income of a nonresident alien.⁴

To support his position that the payments constitute an annuity, petitioner relies on our decision in Estate of Gribauskas v. Commissioner, 116 T.C. 142, 2001 WL 227025 (2001), revd. and remanded 342 F.3d 85 (2d Cir.2003),⁵ in which we held that annual payments of a State lottery prize were an annuity for purposes of section 7520.⁶ See also Estate of Cook v. Commissioner, T.C. Memo.2001–170, affd. 349 F.3d 850 (5th Cir.2003). However, we do not believe our holding in Estate of Gribauskas helps petitioner here. Article 2(2) of the U.S.-Israel Income Tax Treaty, Hein's No. KAV 971, at viii, provides that “Any * * * term used in this Convention and not defined in this Convention shall, unless the context otherwise requires, have the meaning which it has under the laws of the Contracting State whose tax is being determined.” (Emphasis added.) As noted, “annuities” as used in the treaty is defined in the treaty. The treaty definition, as pertinent here, provides that “annuities” means a stated sum paid periodically at stated times “under an obligation to make the payments in return for adequate and full consideration (other than services rendered).”

In Estate of Gribauskas, in holding that annual payments of a lottery prize were an “annuity” for purposes of section 7520, we decided that it was the characteristics of the payment stream as fixed and periodic that generally determined whether the arrangement was an annuity. One of the arguments advanced by the taxpayer was that the annual payments of the lottery prize could not constitute an annuity because the consideration provided was only the $1 paid for the lottery ticket, rather than a substantial premium. Estate of Gribauskas v. Commissioner, 116 T.C. at 152. In rejecting that argument, we reasoned that while a substantial premium might be characteristic of a commercial annuity, it need not be present in a private annuity, an arrangement that we concluded also fell within the scope of the term “annuity” as used in section 7520. Id. at 154–155. Thus, the nature of the consideration provided was not determinative of whether an arrangement constituted an annuity for purposes of section 7520.

By contrast, the definition of “annuities” provided in the U.S.-Israel Income Tax Treaty requires that the obligation to make the payments have arisen “in return for adequate and full consideration”. Consequently, the fact that the payments at issue in this case may qualify as an annuity for purposes of section 7520 under the holding in Estate of Gribauskas does not determine whether they constitute an annuity under the U.S.-Israel Income Tax Treaty. The latter depends upon whether the payments were made “in return for adequate and full consideration” within the meaning of Article 20(5) of the treaty.

The term “adequate and full consideration” is not defined in the treaty. Thus, pursuant to Article 2(2) of the treaty, the term “shall, unless the context otherwise requires, have the meaning which it has under the laws of the Contracting State whose tax is being determined”; here, the United States.

The term “adequate and full consideration” appears extensively in the Internal Revenue Code, generally followed by the phrase “in money or money's worth”,⁷ in a multitude of contexts.⁸ The term is generally used to connote a purchase or exchange of property that is bona fide and at an...