## Facts

- Korfund Co., a New York corporation, manufactured and sold vibration- and noise-isolation materials and operated from New York City.
- Hugo Stoessel, a German citizen and nonresident alien, owned 925 of Korfund’s 1,000 shares.
- Emil Zorn Aktiengesellschaft (Zorn), a German corporation in the same line of business, was also connected to Stoessel’s ownership and control.
- In 1926, Korfund and Zorn executed a written contract in the United States under which Zorn agreed (i) not to compete in the United States and Canada or assist competitors there through 1945, and (ii) to provide technical and business advice on request.
- Korfund agreed to pay Zorn royalties based on sales of specified products, with minimum annual payments through 1940, and also agreed to reciprocal exchanges of certain technical information and patent-related matters.
- In a separate agreement, Stoessel agreed to act as a consultant/adviser for Korfund through 1939 and to refrain from acting for competing concerns; he was to receive compensation equal to 10% of Korfund’s net earnings.
- Wartime conditions disrupted performance and produced disputes over the parties’ obligations under the contracts.
- The disputes were resolved by a settlement under which Korfund made lump-sum payments to Stoessel and Zorn, withholding only a small amount of U.S. tax.
- The Commissioner determined a 1938 income tax deficiency against Korfund for failure to withhold the proper tax, asserting the payments were U.S.-source income to a nonresident alien and a foreign corporation.

## Issues

1. Whether settlement payments made to a nonresident alien and a foreign corporation for contractual rights including U.S./Canada noncompetition covenants and advisory services constituted “income from sources within the United States” under § 119 of the Revenue Act of 1938.
2. If the payments were U.S.-source income, whether Korfund was required to withhold tax under §§ 143(b) and 144 of the Revenue Act of 1938.

## Decision

- The Tax Court sustained the Commissioner’s deficiency determination.
- The court held the payments to Stoessel and Zorn were income from sources within the United States under § 119.
- Because the payees were a nonresident alien and a foreign corporation receiving U.S.-source income, Korfund was required to withhold under §§ 143(b) and 144 and was liable for the underwithholding.

## Legal Principles

- For sourcing purposes under § 119, the source of income from payments for contractual rights is determined by the situs of the rights and the place where the economic benefit is realized.
- Payments for covenants restricting competition in the United States (and related advice supporting a U.S. business) are treated as U.S.-source income because the protected business interest and market are located in the United States.
- Characterizing a covenant not to compete as “negative conduct” by foreign persons abroad does not change the sourcing analysis when the restraint’s commercial effect and the protected right are tied to U.S. territory.
- When a domestic corporation pays U.S.-source income to a nonresident alien individual or a foreign corporation, withholding obligations apply under the Revenue Act’s withholding provisions.

## Conclusion

The Tax Court ruled that settlement payments to foreign payees resolving noncompetition and advisory contracts aimed at protecting a U.S. business constituted U.S.-source income, so the domestic payor was required to withhold tax and was liable for the resulting deficiency.


Korfund Co. v. Commissioner, 1 T.C. 1180 (Tax Ct. 1943)