Today, the US Tax Court looked at the case of a citizen of South Korea, and his gambling. The petitioner argued that the Korea – US Treaty of Friendship, Commerce, and Navigation exempts gambling income; alternatively, that the gambling income was effectively connected with a US trade or business. The IRS argued that there’s nothing in the treaty that states that, and the gambler wasn’t gambling as a professional.
When there’s an argument about a tax treaty, the Court looks at the treaty itself. In this case, it’s not the US-Korea Tax Treaty, but a treaty that granted South Korea Most Favored Nation status. And in that treaty,
Nationals and companies of either Party shall in no case be subject, within the territories of the other Party, to the payment of taxes, fees or other charges imposed upon or applied to income, capital, transactions, activities or any other object, or to requirements with respect to the levy and collection thereof, more burdensome than those borne by nationals, residents and companies of any third country.
But there’s a catch:
Each Party reserves the right to: (a) extend specific tax advantages on the basis of reciprocity; (b) accord special tax advantages by virtue of agreements for the avoidance of double taxation or the mutual protection of revenue; and (c) apply special provisions in allowing, to non-residents, exemptions of a personal nature in connection with income and inheritance taxes.
The petitioner argues that because many countries have Tax Treaties that exempt gambling (even though the Korea-US Tax Treaty does not), this treaty forces that gambling won’t be taxable to Koreans.
The Tax Court disagreed.
FCN treaty article XI, paragraph 5(b), expressly reserved the right to extend specific tax advantages on the basis of reciprocity and accord special tax advantages by virtue of agreements for the avoidance of double taxation or the mutual protection of revenue. This reservation encompasses the more favorable treatment with respect to Federal income tax of U.S. gambling winnings, as extended to Japan and other relevant countries through the bilateral income tax treaties. The most favored-nation provision under article XI, paragraph 3 of the FCN treaty is thus not available when the reservations of paragraph 5(b) apply.
The petitioner’s other argument, that the gambling was effectively connected with a US trade or business, didn’t work. As I tell my professional gambling clients, document, document, and document: Keep good records. This gambler didn’t, and that’s not the sign of a professional.
For the non-resident alien gambler, the Tax Code is miserable. You can’t deduct gambling losses, so it’s effectively a gross receipts tax. This makes gambling a bad bet (especially where there’s withholding), as today’s petitioner from South Korea discovered.