Legal Ruling 1958-133

Income: Source in California

Amounts paid in cancellation of a personal service contract have their source within California when under the contract all of the personal services must be rendered in California.

Taxpayer, a nonresident of California entered into a contract with X Corp., a motion picture company, in July, 1949. Under the terms of the contract all services were to be performed in Hollywood. In July, 1953, X Corp. paid taxpayer a substantial sum, less deductions for State income, Federal withholding, and Social Security Taxes, as a result of a mutual agreement of the parties to cancel the contract. Taxpayer claims a refund of the amount withheld for State Income Taxes. Advice is requested whether the payment had its source in California.

Regulation 17211-17214(b) defines income from sources within this State to include "compensation for personal services performed within this State." The contract in question specifically provided that all services would be performed in Hollywood. Payments of this kind are in substitution of future earnings originally contemplated in the contract rather than in performance of the obligation to pay them. Therefore, this forecloses the contention that the payment was an intangible stemming from the contract itself. It must be noted that similar payments are held to be ordinary income rather than capital gain for Federal tax purposes. George K. Gann, 41 BTA 388.

It is evident X Corp. considered the payment as wages in view of the fact that they made deductions for taxes. Since it was considered as wages for those purposes, and the services could only be performed in California under the contract, the conclusion must be that the payment had its source in California. Further, payment in release of an obligation to perform in California stands on the same footing as payment for actual performance. Therefore, the payment has its source in California and taxpayer is not entitled to a refund.