SDI Netherlands B.V. v. Commissioner

SDI Netherlands B.V. (SDI Netherlands) (plaintiff) was a member of a group of closely related companies (the SDI Group) that designed, manufactured, and sold computer software. The parent corporation of the SDI Group was a Bermuda-based company, SDI Ltd. The SDI Group included SDI Bermuda Ltd. (SDI Bermuda), a Bermuda-based company, and SDI USA, Inc. (SDI USA), an American company. SDI Netherlands had a licensing agreement with SDI Bermuda that gave SDI Netherlands the rights to use certain technology in exchange for royalty payments to SDI Bermuda. SDI Netherlands also had a licensing agreement with SDI USA in which SDI Netherlands received royalty payments from SDI USA in exchange for the right to use SDI Netherlands’s software in the United States. SDI Netherlands used the royalty payments received from SDI USA to pay the royalty payments owed to SDI Bermuda. Although the royalty that SDI Netherlands received from SDI USA was derived from a United States source, that royalty was exempt from taxes in the United States pursuant to a treaty with the Netherlands. The Internal Revenue Service (IRS) issued deficiency notices to SDI Netherlands. The IRS argued that SDI Netherlands was nevertheless liable for a withholding tax because SDI Netherlands’s royalty payments to SDI Bermuda, which the IRS traced back to the royalty paid by SDI USA to SDI Netherlands, constituted income received from sources within the United States. SDI Netherlands petitioned for judicial review of the deficiency notices.