Rev. Rul. 55-17

Advice has been requested whether payment made by a domestic corporation to a nonresident foreign corporation, for the use of technical knowledge and methods and instruction of its employees in certain techniques in connection with the production of certain chemicals, constitutes income from sources within the United States subject to withholding of tax at source under section 144 of the Internal Revenue Code of 1939.

In the instant case a nonresident foreign corporation, not engaged in trade or business within the United States, possessed certain techniques and methods, commonly referred to as `know-how,' for the recovery and purification of certain chemicals, which a domestic corporation wished to apply to commercial production in the United States. A contract was entered into which licensed the domestic corporation to use the technical `know-how' and processes of the foreign corporation for a specified period of time. The foreign corporation would also provide instruction in certain techniques to the employees of the domestic corporation. The contract provided, among other things, that the domestic corporation would pay a specified amount upon execution of the contract; and, after commencement of production, quarterly installments at a rate based on production would be paid for the use of certain processes until a specified amount had been reached. Additional amounts would be paid for services of chemical engineers and similar experts in the country in which the foreign corporation is located.

Section 144 of the Code, relating to payment of corporation income tax at the source, provides in part as follows:

In the case of foreign corporations subject to taxation under this chapter chapter 1 of the Code not engaged in trade or business within the United States, there shall be deducted and withheld at the source in the same manner and upon the same items of income as is provided in section 143 a tax equal to 30 per centum thereof. * * *

Section 39.143-2 of Regulations 118 provides that only fixed or determinable annual or periodical income is subject to withholding. The Internal Revenue Code specifically includes in such income, interest, dividends, rent, salaries, wages, premiums, annuities, compensations, remunerations, and emoluments. But other kinds of income are included, as, for instance, royalties.

The essence of the contract is the making available to the domestic corporation the technical knowledge, methods, experience, that is, the `know-how' of the foreign corporation. While manufacturing `know-how' is of a nonpatentable nature, it is something that its possessor can grant to another for a consideration. The right to use such `know-how' is not materially different from the right to use trade-marks, secret processes and formulae, and, if the right thereto is granted as part of a licensing agreement, it becomes, in effect, an integral part of the bundle of rights acquired under such agreement.

The payments made under the contract are applicable both to the specific rights therein granted, that is, the right to use the `know-how,' and to services performed abroad in instructing and training the employees or technicians of the domestic corporations. Such payments should therefore be allocated between the license to use the `know-how' and the personal services. Since the personal services have only nominal value apart from the license to use such `know-how,' all but a nominal sum should be allocated to the license.

In view of the above, it is held that the portion of such payments applicable to the rights granted under the contract is in the nature of royalty income, that is, fixed or determinable annual or periodical income from sources within the United States and subject to withholding of tax at source under section 144 of the Code. The portion of such payments applicable to the services performed abroad is not income from sources within the United States and therefore not subject to withholding of tax at source