A UK corporation was not entitled to deductions or credits against its U.S. income for 2009 and 2010 because it failed to submit returns for those years before the IRS prepared returns for it. The Tax Court also held that its interpretation of Code Sec. 882(c)(2) did not violate either the business profits article or the nondiscrimination article of the US-U.K. income tax treaty.
Adams Challenge (U.K.) Limited (“Adams”) was a U.K. corporation
whose sole income-producing asset for 2009 and 2010 was a multipurpose support
vessel. The vessel was chartered by a U.S. firm to assist in decommissioning
oil and gas wells and removing debris on portions of the U.S. Outer Continental
Shelf in the Gulf of Mexico.
During 2009 and 2010, Adams derived from the charter gross
income of about $32 million, which the Tax Court determined was effectively
connected with the conduct of a U.S. trade or business. The Court also found
that the US-U.K. bilateral income tax treaty did not exempt that income from US
taxation because the company had a permanent establishment in the US. However,
Adams did not file Federal income tax returns for either 2009 or 2010.
In April 2014, the IRS prepared substitute returns for 2009 and 2010 for Adams that included the charter income but did not include any deductions or credits to offset that income. The IRS then issued Adams a deficiency notice that determined that Adams was not entitled to deductions or credits for 2009 and 2010 because it failed to file returns for those years.
In 2015, Adams timely filed a petition for redetermination, and
in 2017 filed with the IRS its own returns for 2009 and 2010.
The Tax Court held
that Adams was not entitled to deductions or credits to reduce its income tax
for 2009 and 2010 because it didn’t submit returns as required under IRC Section 882(c)(2).
The Tax Court rejected Adams arguments that the IRS’s refusal to allow it to claim deductions and credits in these circumstances violated Articles 7(3) and Article 25 of the Treaty.
(1) Files A Return; and
(2) Files That Return Before The IRS
Has Prepared a Return For it.
Adams argued that Code Sec. 882(c)(2) subjects it
to more burdensome requirements because US companies do not forfeit all their
deductions if they neglect to file returns by an “arbitrary deadline," the
Court found that foreign corporations have more time to submit returns
before the IRS disallows deductions and credits (e.g., foreign corporations
have 23½ months after the close of their tax year to file returns before Code Sec. 882(c)(2) applies but
domestic corporations must file their returns within 3½ month of the close of
their tax year) and may preserve their rights to deductions and credits by
filing protective returns reporting zero income and deductions.
What a foreign taxpayer should do if they believe they are not engaged in a US trade or business, is to file a protective income tax return stating your beliefs as to why you're not engaging a US trade or business in this way where the IRS later disagrees you can file an amended return with all associated deductions and credits.
Remember that where Adams was claiming a tax treaty position for only no US tax, they would still need to file corporate income tax return with a Form 8833 - Treaty – Based Return Position Disclosure.
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