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U.S. Tax Court: UK entity’s income from work on U.S. outer continental shelf held taxable

U.S. Tax Court

The U.S. Tax Court today granted summary judgment for the IRS with regard to whether the taxpayer’s charter income was subject to tax under the Internal Revenue Code or was exempted from tax by provisions of the United States-United Kingdom income tax treaty. The Tax Court concluded that the taxpayer’s charter income from oil and gas-related work conducted on the U.S. outer continental shelf was effectively connected with the conduct of a U.S. trade or business and that it was not exempted by the tax treaty provisions.

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The case is: Adams Challenge (UK) Ltd. v. Commissioner, 154 T.C. No. 3 (January 8, 2020). Read the Tax Court’s opinion [PDF185 KB]

Summary

The taxpayer, a company incorporated under the laws of the United Kingdom (UK), had for the tax years at issue only one income producing asset—a multi-purpose support vessel.

A U.S. firm chartered the taxpayer’s vessel to perform work in decommissioning oil and gas wells and removing hurricane-related debris on portions of the U.S. outer continental shelf in the Gulf of Mexico. From this charter, the taxpayer during 2009-2011 earned income of about $45 million, most of which it treated as exempt from U.S. federal income tax. The IRS, however, disagreed and issued a notice of deficiency.

The Tax Court today concluded that the income received by the taxpayer was subject to U.S. federal income tax.

As the Tax Court explained:

  • Foreign corporations are subject to federal income tax on income “effectively connected with the conduct of a trade or business within the United States.” Section 882(a)(1).
  • Generally, the term “United States” does not include the outer continental shelf. Section 7701(a)(9).
  • However, section 638 provides that, for purposes of applying federal income tax provisions “with respect to mines, oil and gas wells, and other natural deposits,” the term “United States” includes “the seabed and subsoil of those submarine areas” within the outer continental shelf.

At this point, the Tax Court turned to examine whether the income tax treaty between the United States and the United Kingdom provided an exemption from tax for this income. The court noted that under articles of the tax treaty, a UK enterprise is not subject to U.S. federal income tax unless it conducts business in the United States through a U.S. “permanent establishment.” The treaty further provides that an enterprise is deemed to have a U.S. permanent establishment when its activities are conducted offshore in connection with the exploration or exploitation of the sea bed and sub-soil and their natural resources.

In concluding, the Tax Court held the taxpayer’s charter income was subject to federal income tax and because the taxpayer was deemed under the tax treaty to have a U.S. permanent establishment, this income was not exempted from U.S. federal income tax by the tax treaty.

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