U.K. Chartered Vessel Income Not Exempt From U.S. Tax Under Treaty

U.K. Chartered Vessel Income Not Exempt From U.S. Tax Under Treaty

U.S. Tax Court

The Tax Court held that income that a U.K. company received for a chartered vessel used by a U.S. firm to decommission oil and gas wells and remove debris on the U.S. Outer Continental Shelf (OCS) was effectively connected with the conduct of a U.S. trade or business and wasn’t exempt from federal income taxes under the U.K.-U.S. tax treaty. Adams Challenge (U.K.) Ltd. was incorporated in the United Kingdom, and its only income-producing asset was a multipurpose support vessel that was chartered by a U.S. company to decommission oil and gas wells and remove debris on the OCS in the Gulf of Mexico. The IRS determined that the U.K. company was liable for federal income tax deficiencies for 2009-2011. The company petitioned the Tax Court for a redetermination and filed a motion for summary judgment that none of the income it earned from the charter was subject to federal income tax. The IRS filed a cross-motion arguing that all the income was taxable. Judge Albert G. Lauber, writing for the Tax Court, first considered whether the income received by the U.K. company was effectively connected with the conduct of a trade or business within the United States under section 882. The court found that section 638 expands the term "United States" to include the OCS “with respect to mines, oil and gas wells, and other natural deposits.” Lauber explained that decommissioning was integral to, and legally required to be undertaken in connection with, the exploitation of oil and gas resources on the OCS, and therefore that the U.K. company was engaged in a trade or business within the United States. Lauber concluded that “because petitioner’s charter income was derived from the use of property and the performance of services in the United States, its income was sourced in the United States and was ‘effectively connected’ to a trade or business within the United States,” and therefore it was taxable. After concluding that the income was effectively connected, Lauber addressed the question whether the income was exempt from federal income tax under the U.K.-U.S. tax treaty. According to the court, article 7(1) of the treaty provides that profits are only taxable if the U.K. company carries on business through a permanent establishment in the United States, which the company didn’t have. However, article 21 provides that a company is deemed to have a PE when activities are conducted offshore in connection with the exploration or exploitation of the sea bed and sub-soil and their natural resources situated in the United States. Lauber noted the similarity between the text of section 638, the section 638 regulation, and the tax treaty regarding the extension of tax jurisdictions for offshore activities. As a result, the court determined that the vessel’s decommissioning activities were in connection with the exploration or exploitation of the sea bed and sub-soil and their natural resources, and that the U.K. company conducted its U.S. trade or business through a PE in the United States. The court concluded that no portion of the company’s income was attributable to any location other than its U.S. PE and granted the IRS summary judgment.

The Tax Court held that income that a U.K. company received for a chartered vessel used by a U.S. firm to decommission oil and gas wells and remove debris on the U.S. Outer Continental Shelf was effectively connected with the conduct of a U.S. trade or business and wasn’t exempt from federal income taxes under the U.K.-U.S. tax treaty.

The Tax Court held that income that a U.K. company received for a chartered vessel used by a U.S. firm to decommission oil and gas wells and remove debris on the U.S. Outer Continental Shelf (OCS) was effectively connected with the conduct of a U.S. trade or business and wasn’t exempt from federal income taxes under the U.K.-U.S. tax treaty. Adams Challenge (U.K.) Ltd. was incorporated in the United Kingdom, and its only income-producing asset was a multipurpose support vessel that was chartered by a U.S. company to decommission oil and gas wells and remove debris on the OCS in the Gulf of Mexico. The IRS determined that the U.K. company was liable for federal income tax deficiencies for 2009-2011. The company petitioned the Tax Court for a redetermination and filed a motion for summary judgment that none of the income it earned from the charter was subject to federal income tax. The IRS filed a cross-motion arguing that all the income was taxable. Judge Albert G. Lauber, writing for the Tax Court, first considered whether the income received by the U.K. company was effectively connected with the conduct of a trade or business within the United States under section 882. The court found that section 638 expands the term "United States" to include the OCS “with respect to mines, oil and gas wells, and other natural deposits.” Lauber explained that decommissioning was integral to, and legally required to be undertaken in connection with, the exploitation of oil and gas resources on the OCS, and therefore that the U.K. company was engaged in a trade or business within the United States. Lauber concluded that “because petitioner’s charter income was derived from the use of property and the performance of services in the United States, its income was sourced in the United States and was ‘effectively connected’ to a trade or business within the United States,” and therefore it was taxable. After concluding that the income was effectively connected, Lauber addressed the question whether the income was exempt from federal income tax under the U.K.-U.S. tax treaty. According to the court, article 7(1) of the treaty provides that profits are only taxable if the U.K. company carries on business through a permanent establishment in the United States, which the company didn’t have. However, article 21 provides that a company is deemed to have a PE when activities are conducted offshore in connection with the exploration or exploitation of the sea bed and sub-soil and their natural resources situated in the United States. Lauber noted the similarity between the text of section 638, the section 638 regulation, and the tax treaty regarding the extension of tax jurisdictions for offshore activities. As a result, the court determined that the vessel’s decommissioning activities were in connection with the exploration or exploitation of the sea bed and sub-soil and their natural resources, and that the U.K. company conducted its U.S. trade or business through a PE in the United States. The court concluded that no portion of the company’s income was attributable to any location other than its U.S. PE and granted the IRS summary judgment.

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U.K. Chartered Vessel Income Not Exempt From U.S. Tax Under Treaty