Taxing Times in the U.S. Gulf
Dozens of foreign shipowners have received letters from the U.S. Internal Revenue Service, asking them to clarify their status vis-à-vis the taxability of their income for work performed on the U.S. Outer Continental Shelf in the Gulf of Mexico.
The IRS expects to issue further guidance by the end of June, which would clarify—and quite possibly expand—the scope of its pursuit of such owners and their foreign crews.
The guidance is expected to address employment taxes, and the withholding of social security and other dues from foreign employees’ paychecks.
The upshot for foreign shipping businesses, at the very least, is that they must start factoring in potential U.S. taxes while negotiating time charters or bareboat charters on ships that might work on the OCS, by including tax gross-up clauses, for example. This would raise their price.
If a foreign charterer is engaged in OCS business taxable in the U.S., the IRS requires this taxpayer to pay a 30% withholding on the identified income to cover taxes that should have been paid.
However, legal experts said the IRS letters could not be wished away with such simple tactics as making time charters 30% more expensive. What was needed in most such cases, said Blank Rome partner Jonathan Waldron, was a frank personal meeting between a party engaged in OCS operations using foreign-flagged vessels and its tax adviser.
The IRS’ promise of clarifying its position on withholding was likely to make companies focus on this issue even more, Mr. Waldron said. This is because many foreign crew members do not have U.S. social security numbers or tax identification numbers.
“Foreign employers may need to go through the procedure for obtaining these numbers for all foreign workers, even temporary ones,” Mr. Waldron added.
His point about seeking professional advice is well taken. The IRS letter gives the recipient 30 days from the date of receipt to file a U.S. tax return, along with taxes due plus interest on the delay.
“This letter is not an audit of your tax return,” says the document, reassuringly and ominously.
Lloyd’s List understands there are at least dozens of such recipients.Blank Rome partner and business tax practice group leader Joseph Gulant confirmed there is strong anecdotal evidence to corroborate this, but could not provide names due to confidentiality.
Mr. Gulant agreed that the letters had caused confusion, not to mention consternation, among the vast community of foreign shipowners engaged in some capacity or another on the OCS.
“These letters are a bolt out of the blue. The IRS has fired a shot across the bow of these foreign-owned businesses in an attempt to eliminate perceived competitive advantages over US-owned businesses,” he said. These advantages often derived from the fact that foreign vessels offered lower rates because they were held by entities enshrined in low-tax or no-tax jurisdictions, Mr. Gulant added.
The IRS letters attach a two-and-a-half page industry directive issued in October last year, which invokes the agency’s authority over “foreign taxpayers engaged in activities related to the exploration for, or exploitation of, natural resources on the OCS.”
According to the directive, an IRS analysis has indicated that a “significant number of foreign vessels permitted to work on the OCS do not comply with U.S. filing requirements.” The focus of the directive appears to be on corporate filers, and it is quite generic on how employees and their tax withholding are to be treated.
The directive states that the IRS’ natural resources and construction industry group has established an issue management team to determine the compliance impact of OCS activities.
It names four technical advisers to whom potential taxpayers may address questions related to shipping, natural resources, withholding and employment tax.
William Pfeil, the adviser designated for shipping, told Lloyd’s List that he had since left this position, but confirmed that a “lot of delinquent returns” were filed after the letters went out, and there was “more voluntary compliance” in the aftermath of the directive.
The consensus, said Mr. Pfeil, was that many of these taxpayers simply had no knowledge that they were subject to tax for activity on the OCS, and the IRS’ outreach helped them to understand that they owed taxes.
Some of these filers have paid taxes, while others have claimed exemptions under tax treaties which the agency was reviewing, he said.
The IRS did not reveal how much was raised from these filers in back taxes and interest.
Mr. Pfeil said the guidance expected by end-June would cover income tax, employment and withholding. It is expected to be issued in the form of a follow-up directive from IRS industry director for natural resources and construction Keith Jones.
The Offshore Marine Service Association (OMSA), which represents owners and operators of U.S.-flagged offshore service vessels and champions U.S.-citizen crews operating this tonnage, voiced strong support for the IRS on this issue.
OMSA said: “This confirms something we have suspected for a long time, that many foreign vessels that work off leases granted by the U.S. government and reap the benefits of America’s oil and gas sector do not pay U.S. taxes. Clearly, if the foreign boats start out with a 30% beneficial cost differential, that makes it hard for Americans to compete.”
OMSA president Ken Wells told Lloyd’s List that the IRS action was not to be construed as a blow against international commerce. He described work on the OCS as similar to a construction contractor being engaged to do business on the U.S. mainland, and so being subject to U.S. tax jurisdiction.
“The IRS is not changing fundamental rules here, but is simply addressing what, quite frankly, has been a black hole in the form of companies not paying taxes,” Mr. Wells said.
He cited the example of one foreign company, which publicly reported that it had to pay the IRS $3.2m because foreign vessels it chartered had not paid U.S. taxes.
Mr. Wells also welcomed the prospect of a follow-up directive that might provide clarity on income tax withholding for foreign laborers who work on the OCS. He said keeping track of vessels on the OCS was an easier task for the IRS, thanks to U.S. Customs and Border Protection arrival and departure records and Automatic Identification System data.
“It is dicier to determine who exactly is working on these boats and how U.S. tax law applies to these workers. We hope the IRS’ second guidance leads to employers taking steps to address this aspect,” Mr. Wells said.
Mr. Waldron agreed with Mr. Pfeil’s comment about foreign employers and individuals unwittingly facing possible U.S. tax liability.
However, in the context of the upcoming guidance, Mr. Waldron observed: “This appears to confirm that the IRS would be very aggressive. It fits with the agency’s recent sabre-rattling on its tax enforcement, and the uptick in U.S. protectionist tax policies. The onerous and counter-intuitive tax rules raised by the directive are no longer a theoretical concern—we now are seeing them in action.”
OMSA is separately spearheading an effort to get the U.S. regulatory system to revoke the agreement that allows foreign ships to transport specialist equipment for construction or modification of offshore installations in the U.S. Gulf.
Mr. Wells said: “We see this issue and the IRS directive as linked. Not only do we believe these vessels have been carrying substantial amounts of cargoes that only U.S. vessels should carry, but we now find out that they are cheating our country out of tax revenue as well.” He added that the Jones Act was an integral part of the fabric of U.S. society, not just for job creation, but also for the government’s tax revenues.
Mr. Waldron and other experts downplayed the possibility that the spotlight on BP in the aftermath of the Deepwater Horizon oil spill, as well as the increased distrust of foreign corporations, would make the IRS’ next steps on recovering back taxes on the OCS any more aggressive.
Still, it is hard to resist recycling a comment Mr. Wells made last autumn: “This is a bad time for anyone to be seen as a tax cheat in America, let alone a foreign corporation.”
"Taxing Times in the U.S. Gulf, "by Rajesh Joshi first appeared in Lloyd's List on May 4, 2010. To learn more about Lloyd's List, please visit www.lloydslist.com.
Reprinted with permission from Lloyd's List.