Moore Stephens Outlines Tax Regimes Available to Industry

The OGSR team found the article, "Will shipowners come under more pressure following Amazon and Google?" from Moore Stephens accountant Philip Parr well outlined the tax regimes adopted in the industry today. Following are selected excerpts from the article. To read the full story, click here.

Most of the developed world’s governments are running a deficit, and have tried to close the gap by increasing taxes, mainly income tax and value added tax, and cutting public expenditure. 

Where does this leave shipping? Will shipowners feel the pressure of public opinion to force up taxes? Or will existing exemptions come under review and cease to apply. 

Most of the developed world taxes on the basis of a water’s-edge approach. That is to say it taxes income earned in a country rather than income earned from overseas activities by bona fide trading subsidiaries, but with anti-avoidance rules to protect tax take.

Shipping is the most international of businesses, even more so than Google or Amazon. Deep-sea ships trade globally and at first glance their only interaction with countries charging tax is when they call at ports in those countries. Hence the proliferation of freight taxes, especially in the Indian Ocean region, and in the Americas. 

Prior to World War II, most shipping was registered in the country in which it was owned. It was only after World War II that flags of convenience became popular, at the same time as Greek shipowners expanded dramatically. They were assisted by a benevolent Greek tax regime that exempted qualifying shipping activities from Greek tax. This resulted in the decline of mainstream flags as flags of convenience became more popular. Thus, instead of being owned by British, French, German and US companies with British, French, German and US flags, ships were owned and flagged offshore. Their profits were not taxable in the high-tax countries. How was this possible? 

Modern ships are quite difficult to trade on their own, with the master managing everything. They generally require the owning company to be managed, and they need offshore management, including shipbroking services, technical management, and crewing and manning services. 

A company is generally resident for tax purposes in the country where it is incorporated or where it is managed and controlled from.  In the UK a company is resident in the UK if incorporated there or, if not incorporated in the UK, managed and controlled from the UK. The key issue here, and the potential focus of taxing authorities, is the location of the shipowning company’s corporate residence.  It is vital that the shipowning company is not managed and controlled from the UK and this means ensuring that the principal business decisions are taken by the directors outside the UK.  Once this is achieved it is important that the offshore companies are not trading through a permanent establishment in the UK, or elsewhere, and that all services provided by companies under common control are on an arm’s-length basis. 

It was therefore possible, with careful planning, for international shipping groups to structure matters so that comparatively little tax was payable. 

High-tax countries, in particular in Europe, reacted with tonnage tax schemes designed to compete with countries operating flags of convenience. In north-west Europe, that is the Dutch/German tonnage tax model, ships are required to be owned by companies resident in the relevant country and vessels to be strategically and commercially managed from that country.  The ships owned within the European tonnage tax regimes are owned in the most part by companies subject to normal (high corporate) taxes but with special rules governing the calculation of taxable profit.  This means that, generally, they pay a flat rate of tax depending upon the net rate of tonnage of the vessels operated. This deemed profit is substituted for the actual shipping profits. Since they are operated and owned by a company resident in a high-tax country, it means that they can generally take advantage of tax treaties with countries charging freight tax, which reduces the overall tax charge. 

International shipping therefore now falls into three categories: 

1) ships owned and operated by a high-tax country but without any tonnage tax regime to exempt profits.  This is becoming less and less popular. 

2) ships owned in low-tax areas flying flags of convenience. 

3) ships owned and operated in the EU or similar taxable location but with a tonnage tax exemption. 

Shipping’s profile is lower and the end-customers are companies. Shipping companies do not sell directly to the public (with the exception of ferries/cruise lines). Amazon and Google appear to the public to be businesses headquartered in the US, a high-tax country, and earn their revenues from the US and other countries with large populations and large GDPs, and with mostly high-tax regimes.  It appears that the US IRS does not agree with Amazon’s tax analysis, as last year Amazon revealed that the IRS wants $1.5 billion in back taxes. The claim, which Amazon said it would vigorously contest, is linked to its foreign subsidiaries and associated payments. This contrasts with shipping, which is not selling or interacting directly with consumers in high-tax countries.

Deep-sea ships trade with – rather than in – high-tax countries. The ships owned in high tonnage tax locations are complying with the spirit and intent of the tax law, rather than circumventing the law to achieve a tax result that was not intended.  It is the circumvention of the tax law that David Cameron was referring to when he called for global action on tax avoidance at the World Economic Forum in Davos.  When making such comments as, “Those that avoid tax need to wake up and smell the coffee,” it is clear that Mr Cameron is referring to consumer groups rather than to international shipping companies taking advantage of legislation designed to attract them. 

Any further pressure will therefore come from high-tax areas increasing the impact of their anti-avoidance rules so that profits made by low-tax subsidiaries are imputed through to the parent company unless there is a conscious decision by the relevant high-tax country to exempt certain types of income. Therefore, going forward, it should continue to be possible for shipping companies to be located in low-tax areas, provided those companies are fully managed and controlled from those countries by real - as opposed to nominee - directors. Where companies are resident for corporate tax purposes in low-tax areas, but use services provided from higher tax countries, it will be important to analyse the transfer pricing position and, if necessary, to have this fully documented rather than waiting for an enquiry from either the IRS or UK HMRC or similar tax authorities in France or Germany. 

To conclude, it seems unlikely that shipowners will come under significant pressure regarding their low tax position, as more and more countries are introducing tonnage tax regimes or similar, rather than reducing them. It is accepted that shipping is a special case that needs to be encouraged. Shipping can therefore easily distinguish itself from Amazon and Google. It is taking advantage of existing tax rules rather than circumventing them. 

Does your organization prefer one tax system over another? Leave your thoughts in the comments below.