Rev. Rul. 80-64

1980-1 C.B. 158, 1980-10 I.R.B. 9.

                       Internal Revenue Service
                                 Revenue Ruling

        INCOME SOURCE; U.S. OUTER CONTINENTAL SHLF; EXPLORATORY DRILLING

                           Published: March 10, 1980

Section 861.--Income from Sources within the United States, 26 CFR 1.861-1: Income from sources within the United States.

(Also Sections 638, 883; 1.638-1, 1.883-1.)

  Income source; U.S. outer continental shelf; exploratory drilling. Income derived by a foreign corporation from exploratory drilling in the outer continental shelf of the U.S. is income from sources within the U.S. for purposes of section 861 of the Code and is not excludable from gross income under section 883(a).

ISSUES

  (1) Is income derived from exploratory drilling in the outer continental shelf of the United States income from sources within the United States for purposes of section 861 of the Internal Revenue Code?

  (2) Is this income excludable from gross income under section 883(a) of the Code?

FACTS

  X, a corporation organized under the laws of foreign country M, was hired to perform a Continental Offshore Stratigraphic Test (COST) project in the outer continental shelf of the United States.

  A COST project drills to get information about the soil conditions before an offshore lease transaction is entered into. The drilling is done to obtain core samples of the subsoil and not to develop or remove oil or gas.

  X used a dynamic positioning drill ship to perform the COST project. The ship, which is documented under the laws of foreign country M, was chartered by X from Z corporation, and was operated by X's employees.  This type of ship does not anchor while on location.  It floats above the seabed or subsoil except for the drill pipe and bit that penetrates the seabed and subsoil in drilling.

  Foreign country M grants an exemption to United States citizens and corporations that is equivalent to the exemption provided by section 883(a) of the Code.

LAW AND ANALYSIS--ISSUE 1

  Section 861(a)(3) of the Code provides that compensation for labor or personal services performed in the United States is treated as gross income from sources within the United States.

  Under sections 638 of the Code and 1.638-1(a)(1) of the Income Tax Regulations, for purposes of provisions dealing with the performance of personal services, including section 861(a)(3), with respect to mines, oil and gas wells, and other natural deposits the term 'United States,' when used in a geographical sense, includes the seabed and subsoil of the submarine areas adjacent to the territorial waters of the United States over which the United States has exclusive rights, in accordance with international law, with respect to the exploration for and exploitation of natural resources.

  Section 1.638-1(c)(1) of the regulations provides that persons, property, or activities that are engaged in or related to the exploration for or exploitation of mines, oil and gas wells, or other natural deposits need not be physically upon, connected, or attached to the seabed or subsoil to be deemed to be within the United States.

  In Example (5) of section 1.638-1(f) of the regulations, a ship chartered from a domestic corporation and operated by the domestic corporation's personnel, explored for oil in the continental shelf of foreign country Y.  Foreign country Y exercises taxing jurisdiction with respect to the exploration for or exploitation of natural resources as provided in section 1.638-1(b).  The ship is treated as being within foreign country Y under section 638 of the Code for the period it was exploring for oil in the foreign continental shelf.

  Example (5) of section 1.638-1(f) of the regulations illustrates by analogy that section 638 of the Code extends United States taxing jurisdiction to a drill ship operating in the United States continental shelf even though the ship does not rest on, or is not anchored to, the seabed and does not penetrate the subsoil except to remove core samples.

LAW AND ANALYSIS--ISSUE 2

  Section 883(a)(1) of the Code provides that earnings derived from the operation of a ship documented under the laws of a foreign country that grants an equivalent exemption to United States citizens and corporations is not included in the gross income of a

foreign corporation.  Section 883(a)(2) and (a)(3) grant this same exemption to earnings derived from the operation of aircraft and railroad rolling stock.

  Although section 883(a) of the Code excludes from gross income earnings derived from several types of transportation activities, it does not extend to nontransportation activities such as those undertaken by X.  In the present situation, X's earnings were not derived from the 'operation of a ship,' as that phrase is used in section 883(a)(1), but rather from X's exploratory drilling activities.  See Rev. Rul. 74-170, 1974-1 C.B. 175, which concerns whether a taxpayer has earnings derived from the operation of a ship in four specific situations.

HOLDINGS

  (1) Income derived from exploratory drilling in the outer continental shelf of the United States is income from sources within the United States for purposes of section 861 of the Code.

  (2) This income is not excludable from gross income under section 883(a) of the Code.

Rev. Rul. 80-64, 1980-1 C.B. 158, 1980-10 I.R.B. 9.