U.S. Inbound Taxation of Operations in the Gulf of Mexico
To support the oil and gas exploration, development and production occurring in the Gulf of Mexico, vessels often travel between the Gulf and U.S. ports. But if these ships are foreign, are they subject to U.S. taxes?
Foreign corporations and individuals are generally taxed by the United States on their U.S. sourced income. Therefore, the source of income is a key component of whether or not a foreign corporation is subject to tax in the United States. Under U.S. tax law, several categories of income are sourced based upon where the activities that give rise to the income are performed. For instance, service income and rental income are sourced according to where the services are performed and where the property is located, respectively.
Source of Income
Foreign corporations operating in the Gulf of Mexico should be aware of what areas off of the U.S. coast are considered to be part of the United States for tax purposes. Under section 638(1) of the Internal Revenue Code, the performance of personal services that relate to the exploration and exploitation of natural resources on the Outer Continental Shelf (“OCS”) are treated as occurring within the United States for federal income tax purposes.
The main IRS guidance issued on this topic is the Industry Director’s Directive #1 – United States Outer Continental Shelf Activity (hereinafter referred to as “OCS Directive”) covering work performed on the OCS. In the OCS Directive, the IRS concluded that the following categories of taxpayers are engaged in activities related to the exploration for, or exploitation of, natural resources on the OCS:
- Contractors that perform services on the OCS,
- Vessel operators that transport supplies and personnel between U.S. ports and locations on the OCS, and
- Owners and/or operators of foreign vessels that bareboat or time charter to persons that perform offshore services.
Thus, a foreign corporation that falls within these three categories is treated as having U.S. sourced income.
U.S. Withholding Tax
Certain forms of U.S. sourced income are subject to a U.S. withholding tax. The IRS contends that this withholding should apply to payments made to foreign vessel operators on the OCS. The rate of withholding tax is 30%, but may be reduced by applicable income tax treaties. If this withholding tax applies, then the corresponding reporting requirements must also be satisfied. For instance, a foreign company may need to provide a Form W-8BEN-E to a U.S. payor to claim a reduced rate or exemption from the withholding tax. Without such documentation, the IRS may assert that the U.S. company should withhold and deposit 30% of the gross payments to the vessel owner. Regardless of the amount of withholding due, Forms 1042 and 1042-S are generally required to be filed by the payor to report the U.S. source income and withholding taxes. If the U.S. company has not satisfied these requirements, then it is at risk for the withholding taxes (if due) and penalties.
U.S. Trade or Business
If the activities give rise to a U.S. trade or business (or a permanent establishment (“PE”) under an applicable income tax treaty), the foreign corporation is subject to U.S. tax on its U.S. sourced net income at graduated rates. Additionally, the foreign corporation is required to file Form 1120-F, U.S. Income Tax Return of a Foreign Corporation. Penalties may be imposed for failure to file the Form 1120-F and for failure to pay the tax due. Each of these penalties may be up to 25% of the unpaid tax.
But what about foreign vessels that are not supporting the oil and gas exploration, development and production activities in the OCS, but only make deliveries in the U.S.: are they still subject to any U.S. taxes? We will address that in our next article on foreign shipping that enters U.S. ports.
For more information on the reporting requirements of foreign corporations operating on the OCS or withholding obligations of U.S. companies that hire them, contact the international tax advisors at Moore Stephens Doeren Mayhew.
Carrie Koshkin, JD
With nearly 15 years of experience in international tax law, Carrie’s international tax services background includes implementing tax-efficient organizations and helping clients enter new jurisdictions. Additionally, she focuses on inbound/outbound tax issues, U.S. tax implications of international restructuring, and more. Contact her at firstname.lastname@example.org or +1.713.860.0219.