Offshore vessels and US taxes
Offshore vessels generate income that will be taxed in the United States if the vessels help with oil and gas or recovery of other natural resources on the US outer continental shelf.
This is the area between 12 and 200 nautical miles off the US coast.
However, vessels used to install or maintain offshore wind farms should not fall in this category.
A UK company owned a ship that was used to decommission oil and gas wells in 11 blocks in the Gulf of Mexico on the US outer continental shelf.
It chartered the ship with a crew of 28 during 2009 through 2011 to EPIC Diving & Marine Services, LLC, a US oil services company that specializes in decommissioning oil and gas wells. Decommissioning involves putting deep sea divers on the seabed for extended periods. EPIC had between 40 and 62 people on board, in addition to the crew supplied by the ship owner. Some were its workers and others worked for subcontractors or clients.
EPIC paid the UK ship owner a flat daily rate plus $70 a day for meals for each member of the crew to charter the ship and crew.
The United States taxes foreign corporations on income that is considered “effectively connected” with a trade or business that the foreign corporation conducts in the United States. The foreign corporation must pay taxes on the net income from any such business activity as if it were an American company.
Foreign corporations are also taxed on any income from US sources even if they are not engaged in a US trade or business. US source income includes “[c]ompensation for labor or personal services performed in the United States” and income from renting or leasing “property located in the United States.” Taxes are collected on any such cross-border payments by withholding a percentage of the gross payments.
The ship owner said its income from the ship charter was earned outside the United States.
“United States” is defined for most US income tax purposes as just the US states and the District of Columbia, a federal enclave wedged between Maryland and Virginia that serves as the US capital. The IRS views the United States for this purpose as extending 12 miles offshore.
However, a special tax code section — section 638 — defines “United States” more broadly to include the outer continental shelf for activities “with respect to mines, oil and gas wells, and other natural deposits.”
The UK ship owner argued that its activities were not covered by section 638 because the ship was helping to dismantle wells that were no longer producing.
The US Tax Court disagreed. It said decommissioning is a corollary of oil and gas production.
The ship owner then argued that the United States cannot tax it under the US-UK income tax treaty. The treaty bars the US from taxing the business profits of a UK tax resident unless the UK tax resident has a “permanent establishment,” normally meaning an office or other fixed place of business, in the US.
The ship owner had no office in the United States, unless the ship itself qualified as an office. However, a special provision in the treaty — article 21 — treats any company that carries on “exploration . . . or exploitation . . . of the sea bed and subsoil and their natural resources” as having a permanent establishment for treaty purposes. The court said the ship was involved in exploitation of oil and gas. Decommissioning wells is part of that business.
The case is Adams Challenge (UK) Limited v. Commissioner. The Tax Court released its decision in early February.
EPIC may have been engaged in the oil and gas business on the US outer continental shelf. The court concluded a ship owner who leased a crewed vessel was as well.
The parties will go another round in court over what deductions the ship owner can claim to reduce its US net income.