Adams Challenge (UK) Limited v. Commissioner, 154 T.C. No. 3

Background:

Petitioner Adams Challenge (UK) Ltd., a U.K. private company, owned one income-producing asset: the multipurpose support vessel M.V. Adams Challenge (placed in service Jan. 1, 2009).
From 2009–2011 EPIC chartered the vessel on a time-charter (flat daily rate) to support decommissioning and debris‑removal projects on 11 sites located on the U.S. Outer Continental Shelf (OCS) in the Gulf of Mexico; gross charter receipts ≈ $45 million.
The vessel provided specialized surface support (dynamic positioning, saturation‑diving support, heavy crane); most work was post‑production decommissioning of nonproducing or never‑producing wells and removal of installations required by federal offshore‑lease and Interior Department rules.
Petitioner treated the charter income as tax‑exempt; IRS issued deficiency notices treating the income as effectively connected with a U.S. trade or business and taxable; parties filed cross‑motions for summary judgment on taxability and treaty exemption.
Central legal texts: I.R.C. §638 (expands “United States” to include OCS seabed/subsoil for activities “with respect to” oil and gas wells), the Treasury regulation §1.638‑1 (activities “engaged in or related to” exploration/exploitation), and the U.S.–U.K. income tax treaty article 21 (offshore activities “in connection with” exploration/exploitation create a U.S. permanent establishment).

Issues:

Issue	Plaintiff's Argument	Defendant's Argument	Held
1. Was petitioner’s charter income effectively connected/taxable under the Code (§882) via §638?	§638 shouldn’t reach decommissioning on nonproducing wells or surface activities; vessel wasn’t "located in" the U.S.	§638 and reg. §1.638‑1 cover activities "related to" exploitation; decommissioning is integral and legally required post‑production activity on the OCS.	Held: Taxable. §638 expands “United States” to include OCS for these activities; income is U.S.‑sourced and effectively connected.
2. Does the U.S.–U.K. Treaty exempt the income by precluding a U.S. permanent establishment?	Treaty covers only drilling/production activity; post‑production decommissioning is outside article 21.	Article 21 deems offshore activities "in connection with" exploitation to create a PE; that phrase maps to §638/regulatory scope.	Held: No exemption. Article 21 applies; petitioner deemed to have a U.S. permanent establishment; treaty does not exempt the charter income.
3. Are the §1.638‑1 regulations entitled to deference in interpreting the Treaty and statute?	Regs conflict with the Treaty and are not controlling; petitioner hinted at Chevron challenge.	Regs track §638 and contemporaneous treaties; terms "related to"/"in connection with" are synonymous; regs are persuasive and control interpretation.	Held: Court adopts the regulation’s approach; the terms are equivalent and regs appropriately inform treaty meaning.
4. Must income be apportioned (only productive time taxed) or treated as shipping/international‑traffic income under article 8?	Only income allocable to time actively on projects should be taxed; alternatively, income is shipping income taxable only in U.K.	Charter was a flat daily rate covering transit/port/other time integral to the support mission; vessel did not operate in international traffic apart from U.S. places.	Held: 100% attributable to the U.S. permanent establishment; not exempt as international shipping income.

Key Cases Cited

FMC Corp. & Subs. v. Commissioner, 100 T.C. 595 (1993) (broad reading of §638: property or activities need not be directly extracting to be within scope)
Ocean Drilling & Expl. Co. v. United States, 988 F.2d 1135 (Fed. Cir. 1993) (Fed. Cir. held §638 did not convert certain insurance income into U.S. subpart F income; court distinguished that limited holding)
Shell Oil Co. v. Commissioner, 952 F.2d 885 (5th Cir. 1992) (costs at abandoned drilling sites treated as attributable to mining processes—supports including post‑production costs in resource‑related tax analysis)
Tidewater Inc. v. United States, 565 F.3d 299 (5th Cir. 2009) (discusses time‑charter characterization; Court here noted characterization would not change sourcing outcome)
Maximov v. United States, 373 U.S. 49 (1963) (treaty terms not defined are given the meaning they have under the law of the State whose tax is invoked; cited for treaty interpretation principle)
Huntsman v. Commissioner, 905 F.2d 1182 (8th Cir. 1990) (interpreting "in connection with" as equivalent to having an association or relation)