The Internal Revenue Service (IRS) continues to pursue diligently foreign companies and the US companies that hire them to perform offshore services for the oil and gas industry on the outer continental shelf in the Gulf of Mexico. The IRS is using sophisticated monitoring and vessel tracking systems (eg, Sea-Web, Vessel Tracking Services and satellites) to track the daily movement of certain vessels. The IRS contends that these foreign companies and their foreign workers have US source income and should have filed US income and employment tax returns and paid US taxes on amounts earned from these offshore activities. Moreover, the IRS contends that the US companies that hired and paid these foreign companies should have withheld taxes out of the amounts paid.(1)
Following the announcement of this enforcement effort, the IRS sent a number of 'soft' letters to foreign companies during 2009 that requested the company either to file US tax returns and pay any tax and interest due, or to provide a reason why it believed that it was not required to file US tax returns. The IRS is now aggressively following up on those soft letters by:
- preparing 'substitute' returns for these foreign companies;
- issuing statutory notices of deficiency; and
- assessing the taxes, interest and penalties that are purportedly due.
The IRS has even issued jeopardy assessments against these foreign companies and served levies on the US companies that hire them. The IRS has more than 50 people working on this initiative and is pursuing both income and employment taxes. Moreover, it is pursuing substantial penalties and denying income tax deductions for foreign companies that have not previously filed US tax returns.
The linchpin of the IRS's position is that the services performed by these foreign companies are in the United States. The Internal Revenue Code's definition of 'the United States' is extremely broad for personal services that relate to the exploration and exploitation of natural resources under Section 638. Under this broad definition, those performing personal services on the outer continental shelf that relate to the exploration and exploitation of natural resources are considered to be within the United States for federal tax purposes.
The IRS has broadly defined the services that relate to the exploration and exploitation of natural resources in its industry directives and in a 2008 private letter ruling. At present, it is unknown whether the IRS's expansive view of 'exploration and exploitation' set forth in the directives and private letter ruling would survive a court challenge. The only reported case in this area, Ocean Drilling & Exploration Co v United States,(2) held that the IRS had overreached in defining 'exploration and exploitation' activities.
The IRS is currently reviewing information on vessels operating on the outer continental shelf. It can determine what vessels have been operating on the outer continental shelf through US Coast Guard and US State Department records. Extensive information must be submitted to the US Coast Guard to obtain approval for foreign vessels to be operated in US waters by foreign nationals. The necessary information includes:
- the names and nationalities of crew members;
- the bareboat charter agreements (including amounts paid); and
- information and documents about the owners of the vessels and their officers and directors.
Moreover, the IRS is monitoring vessel operations on the outer continental shelf through Lloyd's Register Fairplay, vessel automatic tracking systems and satellites.
In light of the IRS's enhanced enforcement efforts, both foreign vessel owners and the US companies that hire them should be prepared to respond to potential IRS inquiries and tax enforcement proceedings. Responding to such IRS actions would include:
- analysing the specific facts involved in light of the US tax laws;
- making any necessary challenges to the IRS's sometimes overly broad definition of what constitutes 'exploration and exploitation' of natural resources;
- raising any available exceptions to or exemptions from US tax return filing or withholding requirements;
- asserting available tax treaty exemptions or reductions; and
- raising any applicable defences to the IRS's collection efforts.
Foreign vessel owners may also consider making a voluntary disclosure of their activities to the IRS and then seeking the waiver or reduction of any penalties that the IRS may assert. Foreign vessel owners and the US companies that hire them may also consider reviewing the provisions of their charter agreements relating to US taxes and adjusting their tax compliance procedures going forward.
For further information on this topic please contact Andrius R Kontrimas or Robert C Morris at Fulbright & Jaworski LLP by telephone (+1 713 651 5151), fax (+1 713 651 5246) or email (email@example.com or firstname.lastname@example.org). The Fulbright & Jaworski LLP website can be accessed at www.nortonrosefulbright.com.
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