122 T.C. No. 24
UNITED STATES TAX COURT
ISMAT M. ABEID, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 10441-02. Filed June 29, 2004.
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. - 2 -
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.
Donald L. Feurzeig, for petitioner.
Paul R. Zamolo and Rebecca Duewer, for respondent.
OPINION
GALE, Judge: 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). 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,
1 Unless otherwise indicated, all Rule references are to the Tax Court Rules of Practice and Procedure, and all section references are to the Internal Revenue Code for the taxable years in issue. - 3 -
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), 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
2 The parties have stipulated that review of this case shall be by the U.S. Court of Appeals for the D.C. Circuit. - 4 -
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. - 5 -
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
3 We note that whether annual payments of State lottery winnings are categorized under sec. 871(a)(1) as “annuities” (as the term is used in that section) or as “fixed or determinable annual or periodical gains, profits, and income” is immaterial in the instant case, as the tax imposed by sec. 871(a)(1) applies to either category. As discussed hereinafter, the result in this case turns upon the meaning of “annuities” as used in the U.S.- Israel Income Tax Treaty. - 6 -
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), 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
4 Petitioner has not claimed he was in the business of gambling or that the lottery winnings were effectively connected with a U.S. trade or business within the meaning of sec. 871(a)(1)(A). 5 Although the Court of Appeals for the Second Circuit reversed our decision in Estate of Gribauskas insofar as it held that the lottery prize must be valued pursuant to the valuation tables prescribed in sec. 7520, the Court of Appeals left undisturbed our holding that the annual payments of the lottery prize constituted an annuity for purposes of sec. 7520. Estate of Gribauskas v. Commissioner, 342 F.3d 85 (2d Cir. 2003), revg. and remanding 116 T.C. 142 (2001); see also Estate of Shackleford v. United States, 262 F.3d 1028 (9th Cir. 2001)(annual payments of a lottery prize constitute an annuity, valuation of which is made outside tables prescribed by sec. 7520). - 7 -
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
6 Petitioner notes that in Estate of Gribauskas, we described our holding as a conclusion that annual payments of lottery winnings “constitute an annuity for tax purposes and within the meaning of section 7520". Estate of Gribauskas v. Commissioner, 116 T.C. 142, 159 (2001)(emphasis added). As discussed hereinafter, our conclusion in this case is based upon a construction of the term “annuities” as defined in the U.S.- Israel Income Tax Treaty. Accordingly, we express no opinion regarding the extent to which our holding in Estate of Gribauskas may impact the meaning of “annuity” as used elsewhere in the Internal Revenue Code. - 8 -
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 - 9 -
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 arm’s-length
price, as distinguished from a gift or other transfer of property
between persons who do not transact at arm’s length. A
definition of “adequate and full consideration” appearing in the
regulations under section 6323, concerning the validity and
priority of tax liens, provides that “adequate and full
consideration” means consideration that has a “reasonable
relationship to the true value of the interest in property
7 The meaning of the phrase “in money or money’s worth”, when it follows “adequate and full consideration”, has been interpreted to confine the scope of “consideration” to money or its equivalent; i.e., to exclude a mere promise or agreement as consideration. See, e.g., Commissioner v. Wemyss, 324 U.S. 303 (1945). Since the only consideration that petitioner claims is “adequate and full consideration” in this case is money, we do not believe the absence of the “in money or money’s worth” qualifier in the treaty language has any material effect on the analysis herein. 8 See, e.g., secs. 274(e)(8), 675(1), 2035(d), 2036(a), 2037(a), 2038(a), 2040(a), 2043(a), 2043(b), 2053(c)(1)(A), 2055(e)(2), 2056(b)(1)(A), 2106(a)(1), 2512(b), 2522(c)(2), 2523(b)(1), 6019(3)(A)(ii), 6323(h)(6). - 10 -
acquired.” Sec. 301.6323(h)-1(f)(3), Proced. & Admin. Regs.; see
also Estate of Frothingham v. Commissioner, 60 T.C. 211, 215
(1973)(for estate tax purposes, “adequate and full consideration
in money or money’s worth” generally means consideration of
“equivalent amount” to the property transferred for it).
Petitioner contends that the consideration element of the
treaty definition has been met here by virtue of the fact that
the California State Lottery received “adequate and full
consideration” for the payments made to petitioner from all
purchasers of tickets for the lottery he won. According to
petitioner, the terms of the treaty do not require that the
recipient of the lottery payments be the source of the
consideration; rather, it is sufficient if the payor (California
State Lottery) received adequate and full consideration from any
source-–in this case, the other purchasers of lottery tickets.
We do not believe petitioner’s theory comports with the
language of the treaty. The California State Lottery’s
“obligation” to make the payments at issue was not “in return
for” any consideration provided by the nonwinning purchasers of
lottery tickets. The consideration provided by these purchasers
was in return for, and fully expended for, a chance to win the
lottery; i.e., a wager. Cf. Goldman v. Commissioner, 46 T.C.
136, 139 (1966)(purchase price of a lottery ticket is
consideration expended for chance to win, not a contribution to - 11 -
the sponsoring charity), affd. 388 F.2d 476 (6th Cir. 1967). The
other purchasers of tickets in the lottery won by petitioner did
not provide consideration “in return for” the California State
Lottery’s obligation to make the subject payments to petitioner.
Petitioner argues in the alternative that, if the treaty is
construed to require that “adequate and full consideration” come
from the recipient of the lottery payments, then he provided such
consideration because he paid the full, undiscounted price for
the winning lottery ticket; namely, $1. We disagree.
Petitioner’s contention mischaracterizes the transaction which
gave rise to his right to the lottery payments. The $1 paid by
petitioner was not “adequate and full consideration” for the
right to 20 annual payments of $722,000. One dollar bears no
“reasonable relationship” to the value of such a right, nor was
the right transferred to him “in return for” the $1 of
consideration he provided. The $1 paid by petitioner was the
consideration for the ticket itself; i.e., for the wager. This
$1 consideration was fully expended for, and secured only, a
chance to win the right to the payments at issue herein.9 Cf.
9 The conclusion that the $1 consideration was expended for the wager itself is consistent with the definition of “wager” for purposes of sec. 3402(q), governing withholding from certain gambling winnings, including those from State-conducted lotteries, that are “proceeds from a wager”. The regulations under that section provide that, in order for a transaction, in which a chance to win a prize is acquired, to be treated as a wager, consideration must have been provided to obtain such (continued...) - 12 -
Goldman v. Commissioner, supra. Petitioner became entitled to
the stream of payments not by reason of any exchange of
consideration, but by virtue of winning a wager, a separate
taxable event under U.S. tax law constituting an accession to
wealth. See, e.g., McClanahan v. United States, 292 F.2d 630,
631-632 (5th Cir. 1961); Solomon v. Commissioner, 25 T.C. 936,
938-939 (1956); Lutz v. Commissioner, T.C. Memo. 2002-89;
Lyszkowski v. Commissioner, T.C. Memo. 1995-235, affd. without
published opinion 79 F.3d 1138 (3d Cir. 1996). Thus, the
payments petitioner received from the California State Lottery
were neither “in return for” the $1 consideration he cites, nor
was this consideration “adequate and full” with respect to those
payments. The payments were the proceeds of a winning wager;
i.e., gambling winnings.
Petitioner also relies upon Estate of Shackleford v. United
States, 82 AFTR 2d 98-5538, 98-2 USTC par. 60,320 (E.D. Cal.
1998), affd. 262 F.3d 1028 (9th Cir. 2001), to support his claim
that the $1 purchase price of the lottery ticket was adequate and
full consideration for the lottery payments. In that case, a
decedent lottery winner’s estate argued that the decedent’s right
to California lottery payments, if deemed an annuity, should not
be included in the gross estate by virtue of section 2039(b).
9 (...continued) chance. See sec. 31.3402(q)-1(d), Example (10), Employment Tax Regs. - 13 -
Section 2039(b) limits the inclusion in the gross estate of the
value of certain annuities to “only such part of the value of the
annuity * * * as is proportionate to that part of the purchase
price therefor contributed by the decedent.” Accordingly, the
estate argued, since the decedent had provided only $1 towards
the purchase price of the annuity represented by the lottery
payments, which was an infinitesimal percentage of the purchase
price contributed by the other purchasers of tickets in the same
lottery, the portion of the annuity includible in the gross
estate should be zero. The District Court rejected this
argument, concluding that no portion of the annuity qualified for
exclusion under section 2039(b) because the interest in the
lottery payments “represents the accumulated wealth of the
decedent.” Estate of Shackleford v. United States, 82 AFTR 2d at
98-5542, 98-2 USTC par. 60320 at 86,530. Consequently, the
entire annuity was includible in the gross estate.
Petitioner here reasons that, since the District Court in
Estate of Shackleford rejected the argument that a $1 lottery
ticket constituted only “part of the purchase price” (within the
meaning of section 2039(b)) of the annuity resulting from the
lottery win, and instead required that the entire annuity be
included in the gross estate, it follows that the decedent’s $1
payment for the lottery ticket constituted the entire purchase
price for the annuity. Thus, petitioner reasons, if the $1 price - 14 -
of the lottery ticket was the entire purchase price of the
resulting annuity for purposes of section 2039(b), it must by
extension also constitute “adequate and full consideration” for
the annuity.
Petitioner’s reliance on Estate of Shackleford is misplaced.
The District Court therein did not conclude that the entire
annuity was includible in the gross estate because the annuity
was acquired solely through decedent’s purchase of a $1 lottery
ticket. Instead, the court reasoned that full inclusion was
required because the taxpayer had not shown that any part of the
lottery payments was “‘attributable to contributions by the
surviving beneficiary or contributions from another as a gift.’”
Estate of Shackleford v. United States, 82 AFTR 2d at 98-5542,
98-2 USTC at 86,530 (quoting Neely v. United States, 222 Ct. Cl.
250, 613 F.2d 802 (1980)). The District Court’s conclusion that
the annuity “represents the accumulated wealth of the decedent”,
id., comports with our view that the obligation to pay out
lottery winnings arises from the lottery participant’s winning a
wager, not from his providing adequate and full consideration.
We therefore hold that the payments petitioner received from
the California State Lottery were not an annuity within the
meaning of the U.S.-Israel Income Tax Treaty because the payments
did not arise from the exchange of adequate and full
consideration; rather, they were the result of winning a wager. - 15 -
Thus, the sums were not paid “under an obligation to make the
payments in return for adequate and full consideration” (emphasis
added) within the meaning of Article 20(5) of the treaty.
As the treaty is silent with respect to gambling winnings,
and petitioner has failed to establish that the payments at issue
were an “annuity” within the treaty’s meaning, the treaty does
not prevent the United States from imposing a tax under section
871(a)(1)(A) upon such payments. Accordingly, respondent is
entitled to judgment as a matter of law. We shall therefore
grant respondent’s cross-motion for summary judgment and deny
petitioner’s motion. To reflect the foregoing,
An appropriate order and
decision will be entered.