Impact of Foreign Tax Credits On Composer's Royalties

There has long been a dispute between songwriters and publishers as to whether songwriters are entitled to a proportional share of a publisher's savings resulting from foreign tax credits. A recent decision of New York's highest court, the Court of Appeals, resolved this issue in favor of the publisher. Under the ruling, absent express contractual language to the contrary, a songwriter is not entitled to share in the benefit of foreign tax credits taken by his or her publisher. Drafters and negotiators should take particular note of this development.

The plaintiffs in Evans v. Famous Music Corp., 2004 WL 330069, 2004 N.Y. LEXIS 261, were well-known composers and songwriters or their successors-in-interest ' including Ray Evans, Henry Mancini, Johnny Mercer and Richard Whiting. The plaintiffs sued their publisher, Famous Music Corp., for refusing to make accommodation for the benefits of foreign tax credits taken by Famous when calculating royalties due to the songwriters under their publishing contracts. The songwriters claimed breach of contract and breach of the implied covenant of good faith and fair dealing.

The songwriters asserted that they should share in the benefits of foreign tax credits taken by the publisher under the contractual provision that entitled the writers to 50% “of all net sums actually received by [the publisher] with respect to such song or musical composition … less all expenses and charges in connection with administering said rights or collecting such sums … and less all deductions for taxes.” In the songwriters' view, this language sets forth an unambiguous contractual scheme under which the parties split net profits evenly. Accordingly, the plaintiffs argued that foreign tax credits must be included because the credits offset tax liabilities that were deducted, but were then effectively reimbursed.

In addition, the writers and their estates argued that they were unaware of the foreign tax credits until shortly before they commenced the action. In particular, the plaintiffs argued that, at the time of the formation of the contracts, neither they nor their predecessors-in-interest had any knowledge concerning the availability of foreign tax credits in the music industry. Moreover, they claimed that the publisher had been evasive about the issue when asked. The songwriters urged the court not to reward the publisher for having concealed, for many years, the breach of its contractual obligations.

For its part, Famous Music claimed that the plain meaning of the contract language didn't support the plaintiffs' claim. Moreover, the publisher argued that, to the degree there is any contractual ambiguity, industry custom and practice don't require the publisher to share the benefits of the foreign tax credits with the writers. Finally, Famous Music made two alternative arguments. First, that it would be impracticable ' if not impossible ' to apportion tax credits among individual songwriters. Second, that foreign tax credits are excluded from standard form contracts such as those at issue because they are, on occasion, specifically included in publishing contracts for certain other songwriters.

The trial court had found the contractual language in question unambiguous and granted partial summary judgment in favor of the plaintiffs. The appellate division reversed and the court of appeals affirmed the reversal. The court of appeals began by explaining the history and nature of the foreign tax credit. Unlike many other countries, the United States imposes taxes on American corporations based on their worldwide income. To relieve corporations that are subject to taxation in multiple jurisdictions from the burden of double-taxation, the tax code has long allowed such corporations to claim a limited credit against their U.S. corporate income taxes for taxes paid by them in other jurisdictions.

The foreign tax credit is subject to many restrictions. For example, the foreign tax credit is capped at the rate of U.S. taxation on that income. The foreign tax credit is also limited by the percentage of income (irrespective of tax rates) that is earned abroad. Moreover, the calculation of this limitation is not simply based on total income; rather, the corporation's income is divided into nine categories (known as “baskets”), eg, passive income, high withholding tax interest, financial services income, shipping income, foreign trade income, and lastly, a catch-all for all other income. In calculating the limit on the foreign tax credit, these income “baskets” are matched against corresponding income in the United States. There also are other rules and restrictions governing the foreign tax credit.

The court of appeals observed in its ruling that application of the foreign tax credit is particularly complicated, “even by tax standards.”

Turning to the legal issue in the case, the state high court found that the contractual language was indeed ambiguous. The court therefore looked to extrinsic evidence to determine the intent of the parties at the time they entered into the contract. The court found several factors that weighed against inclusion of the foreign tax credit in calculating the songwriters' royalties. First, the songwriters had been collecting royalties under the contracts for decades before ever demanding a share of the foreign tax credits. (Noting that foreign credits have been part of the tax code since 1918, the court of appeals dismissed the plaintiffs' assertion that they had been unaware of the tax credits and that the publisher had been evasive when the plaintiffs inquired.)

The court also concluded that industry custom and practice favors the publisher's construction of excluding foreign tax credits from the royalty calculation. The court acknowledged that “industry practice and custom reflects to some extent the generally greater bargaining power of music publishing companies,” as well as “the unlikelihood that a music publisher would assume an onerous obligation 'ie, apportioning the benefit of foreign tax credits among individual songwriters' without explicitly agreeing to do so.”

Thousands of existing industry contracts are governed by contractual language similar to that found in the contracts at issue in the Evans case. If a songwriter has the bargaining power to demand that foreign tax credits be included in the calculation of his or her royalties, a publishing contract governed by New York law must expressly include language to that effect.

The Evans ruling may lead publishers to organize their worldwide businesses so as to maximize their ability to take the foreign tax credit ' possibly even in ways that result in increased total worldwide taxation. Logic would dictate that these factors be taken into consideration when choices are made concerning the location of a music publisher's business operations. This may be particularly true in the growing field of international Internet music sales.

There has long been a dispute between songwriters and publishers as to whether songwriters are entitled to a proportional share of a publisher's savings resulting from foreign tax credits. A recent decision of New York's highest court, the Court of Appeals, resolved this issue in favor of the publisher. Under the ruling, absent express contractual language to the contrary, a songwriter is not entitled to share in the benefit of foreign tax credits taken by his or her publisher. Drafters and negotiators should take particular note of this development.

The plaintiffs in Evans v. Famous Music Corp., 2004 WL 330069, 2004 N.Y. LEXIS 261, were well-known composers and songwriters or their successors-in-interest ' including Ray Evans, Henry Mancini, Johnny Mercer and Richard Whiting. The plaintiffs sued their publisher, Famous Music Corp., for refusing to make accommodation for the benefits of foreign tax credits taken by Famous when calculating royalties due to the songwriters under their publishing contracts. The songwriters claimed breach of contract and breach of the implied covenant of good faith and fair dealing.

The songwriters asserted that they should share in the benefits of foreign tax credits taken by the publisher under the contractual provision that entitled the writers to 50% “of all net sums actually received by [the publisher] with respect to such song or musical composition … less all expenses and charges in connection with administering said rights or collecting such sums … and less all deductions for taxes.” In the songwriters' view, this language sets forth an unambiguous contractual scheme under which the parties split net profits evenly. Accordingly, the plaintiffs argued that foreign tax credits must be included because the credits offset tax liabilities that were deducted, but were then effectively reimbursed.

In addition, the writers and their estates argued that they were unaware of the foreign tax credits until shortly before they commenced the action. In particular, the plaintiffs argued that, at the time of the formation of the contracts, neither they nor their predecessors-in-interest had any knowledge concerning the availability of foreign tax credits in the music industry. Moreover, they claimed that the publisher had been evasive about the issue when asked. The songwriters urged the court not to reward the publisher for having concealed, for many years, the breach of its contractual obligations.

For its part, Famous Music claimed that the plain meaning of the contract language didn't support the plaintiffs' claim. Moreover, the publisher argued that, to the degree there is any contractual ambiguity, industry custom and practice don't require the publisher to share the benefits of the foreign tax credits with the writers. Finally, Famous Music made two alternative arguments. First, that it would be impracticable ' if not impossible ' to apportion tax credits among individual songwriters. Second, that foreign tax credits are excluded from standard form contracts such as those at issue because they are, on occasion, specifically included in publishing contracts for certain other songwriters.

The trial court had found the contractual language in question unambiguous and granted partial summary judgment in favor of the plaintiffs. The appellate division reversed and the court of appeals affirmed the reversal. The court of appeals began by explaining the history and nature of the foreign tax credit. Unlike many other countries, the United States imposes taxes on American corporations based on their worldwide income. To relieve corporations that are subject to taxation in multiple jurisdictions from the burden of double-taxation, the tax code has long allowed such corporations to claim a limited credit against their U.S. corporate income taxes for taxes paid by them in other jurisdictions.

The foreign tax credit is subject to many restrictions. For example, the foreign tax credit is capped at the rate of U.S. taxation on that income. The foreign tax credit is also limited by the percentage of income (irrespective of tax rates) that is earned abroad. Moreover, the calculation of this limitation is not simply based on total income; rather, the corporation's income is divided into nine categories (known as “baskets”), eg, passive income, high withholding tax interest, financial services income, shipping income, foreign trade income, and lastly, a catch-all for all other income. In calculating the limit on the foreign tax credit, these income “baskets” are matched against corresponding income in the United States. There also are other rules and restrictions governing the foreign tax credit.

The court of appeals observed in its ruling that application of the foreign tax credit is particularly complicated, “even by tax standards.”

Turning to the legal issue in the case, the state high court found that the contractual language was indeed ambiguous. The court therefore looked to extrinsic evidence to determine the intent of the parties at the time they entered into the contract. The court found several factors that weighed against inclusion of the foreign tax credit in calculating the songwriters' royalties. First, the songwriters had been collecting royalties under the contracts for decades before ever demanding a share of the foreign tax credits. (Noting that foreign credits have been part of the tax code since 1918, the court of appeals dismissed the plaintiffs' assertion that they had been unaware of the tax credits and that the publisher had been evasive when the plaintiffs inquired.)

The court also concluded that industry custom and practice favors the publisher's construction of excluding foreign tax credits from the royalty calculation. The court acknowledged that “industry practice and custom reflects to some extent the generally greater bargaining power of music publishing companies,” as well as “the unlikelihood that a music publisher would assume an onerous obligation 'ie, apportioning the benefit of foreign tax credits among individual songwriters' without explicitly agreeing to do so.”

Thousands of existing industry contracts are governed by contractual language similar to that found in the contracts at issue in the Evans case. If a songwriter has the bargaining power to demand that foreign tax credits be included in the calculation of his or her royalties, a publishing contract governed by New York law must expressly include language to that effect.

The Evans ruling may lead publishers to organize their worldwide businesses so as to maximize their ability to take the foreign tax credit ' possibly even in ways that result in increased total worldwide taxation. Logic would dictate that these factors be taken into consideration when choices are made concerning the location of a music publisher's business operations. This may be particularly true in the growing field of international Internet music sales.