Introduction
The IRS continues to diligently pursue the 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, such as 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. The IRS's Industry Directives on this initiative can be found below.
- Industry Director's Directive #1 - United States Outer Continental Shelf Activity
- Industry Director's Directive # 2 - Employment Tax and the Employees on the U.S. Outer Continental Shelf
IRS enforcement efforts
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 file US tax returns and pay any tax and interest due, or provide a reason why the company 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 gone so far as to issue Jeopardy Assessments against these foreign companies and serve 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, the IRS is pursuing substantial penalties and denying income tax deductions for foreign companies that have not previously filed US tax returns.
The IRS's position
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.
IRS broadly defines "exploration and exploitation"
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. Our previous briefing sets forth the IRS's expansive view of section 638 and is available by clicking here. It is currently unknown whether the IRS's expansive view of "exploration and exploitation" set forth in the Industry Directives and private letter ruling would survive a court challenge. The only reported case in this area, Ocean Drilling & Exploration Co. v. United States, 24 Cl. Ct. 714 (1991), aff'd, 988 F.2d 1135 (Fed. Cir. 1993), 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
The IRS 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 the members of the crew, 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.
US companies and foreign vessel owners should be ready
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 analyzing 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 defenses to the IRS's collection efforts. Foreign vessel owners may also consider making a voluntary disclosure of their activities to the IRS and seek the waiver or reduction of any penalties 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 adjust their tax compliance procedures going forward.
IRS Circular 230 Disclosure
To ensure compliance with requirements imposed by the IRS, we inform you that any US federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or tax-related matter[s].
