We know some versions of Windows used BSD code for the TCP/IP stack, and since Windows is pretty widely used on the desktop and in certain server areas I guess that counts as pretty widly used.

Of course that's just one example BSD code finds itself everywhere. e.g. copied into SysV, so quite possibly in Solaris and AIX.  And of course OSX.

BSD code certainly exists in linux (e.g some drivers). I've read in the past (but can't locate now) that the code in Linux which is BSD if it get's modified linus would prefer the modifier to retain the dual licensing, rather than the new code just being GPL, it wasn't an issue which had arisen but he want as far as to suggest he'd probably reject the code it the author didn't do that.

Nonsense.

Right.

US government employees work in many locations overseas.

I guess you think that's supposed to be some kind of revelation.

The US copyright act doesn't have any extraterritorial applicability at all.

That's not what the U.S. Copyright Office says. There have been bilateral copyright agreements in force with Germany in particular since 1887.
http://www.copyright.gov/circs/circ38a.html#2003

Status of forces agreements usually require the US armed forces to observe host nation laws.

Under what conditions? In terms of your service to the US government?
That's not what the NATO SOFA says.

For example German copyright and contract law apply in Germany.

They can apply in the United States as well.

The status of forces agreement even prohibited the Armed Forces from making local purchases over $100,000 except through German government contracting officers,

There are all kinds of provisions to the NATO SOFA as well as other arrangements made directly with governments individually. The notion that that had any bearing on your service to the United States while stationed in Europe or that any Federal regulation or law was negated or superseded doesn't seem to me to have any basis. It might come as a surprise to Congress and the Department of Defense also.

i.e. they are the government there not our Congress.

True enough, but under what conditions and with what jurisdiction? In terms of your service to the US government when stationed in Europe? You're sure you know the terms of the NATO SOFA?

You seem to want to argue about the some hypothetical situation, while I am talking about actual cases.

Let's talk about it.

The US government commissioned me to make a derivative work based upon another work of foreign origin that was merely licensed to the armed forces.

The United States in all its branches respects the copyrights of all nations with which it has treaties to that regard, any licensing terms would naturally be complied with, including gaining license to approve the creation of such derivative work you mention. Furthermore: the US Government "commissioned" you? Were you performing your duties as a member of the armed forces or were you acting as an individual on your own behalf in contract with the US government? Either is possible, the latter has different implications on the nature of the resulting work, but none with respect to your geographic location.

100% of this activity happened in a country where the US copyright law has no bearing on anything at all, i.e. neither copyright nor the law of contracts.

Do you really mean that? You're full of surprises.

The work was used by the US Air Forces in Europe (USAFE) and was never distributed without copyright restrictions and was never placed in the public domain.

So it was a derivative work, your contributions to which did not alter or change the scope or nature of the copyright material on which it was based. That's independent of whether or not your work was performed in your service to the armed forces. The US government in its branches comprises a single entity, so if your work was never distributed outside of USAFE it was never distributed. It would have the same copyright restrictions and licensing terms of the underlying work.