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Shipping sector : taxation of US source transportation income |
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US Taxation of International Shipping: New Laws/Opportunities for the Shipping Industry
(Issued December 2004)
Recently, President Bush signed into law (included in the "JOBS Act") four measures that dramatically change the US environment for both US and foreign persons engaged in US-international shipping. This overview explores the details about planning opportunities and business changes bought by this comprehensive US legislation that included significant changes to US tax policy concerning international shipping.
For non-US shippers, the most immediate change is that new US regulations (so called "Freight Tax" Regulations) that require expanded reporting have been deferred by a year. The regulations will now apply to tax years beginning after September 24, 2004, so that they will be broadly applicable for 2005 calendar year filings, rather than 2004. While these regulations don’t change the law, they do reduce the circumstances under which certain exemptions from tax will be available. In the interim, certain ownership structures utilizing bearer shares or tax havens that will preclude US exemptions in the future will remain exempt for one additional year. This reprieve will allow these persons more time to evaluate their options and to rearrange their affairs to reduce US tax. Another new requirement that is deferred is the reporting of income that most people would consider remote from the US, particularly each participant’s share of pool income regardless of whether the participant’s vessel makes voyages to the US. This delay will allow astute pool managers an opportunity to either rearrange pools to reduce this US tax reporting and compliance burden, or to educate participants of their US tax requirements so they can set up their systems to comply efficiently.
For US persons, the remaining three law changes involving international tax policy represent an about-face by US government authorities, which have used the tax code to disfavor shipping in recent decades. Two of the changes relax existing anti-avoidance US income tax rules. First, shipping income derived by foreign subsidiaries of US companies after 2004 will no longer be taxed until the income is brought back to the US. Second, from 2007 any US tax liability from international shipping may be offset with taxes paid on other foreign income. The third, and most dramatic change, is the introduction of a tonnage tax for a small group of qualified persons, generally US business entities and investors who finance their operations. These amendments will combine to favor shipping as an investment option for US persons.
The first two changes are interrelated. US shippers who were required to currently pay full US tax on worldwide shipping income will now be free to leave lightly taxed shipping income offshore, and reinvest gross income without any current US tax cost. When shipping income is returned to the US, corporations with more than one business line will be able to offset potential US taxes on lightly taxed shipping income through the utilization of excess tax credits on highly taxed income from other businesses. Another advantage of this mixing will be that income from the boom and bust shipping cycle may be smoothed by blending shipping income with other income so that, say, shipping income will offset other offshore business losses, decreasing the tax burden on US persons. US multinationals routinely structure cash movements to optimize the benefit of these rules.
A related provision reduces US taxes on banks and financiers that derive offshore income from vessel financing, providing they meet certain tests to show they income is from an active business. This new rule is intended to spur US investment and financing in vessels.
The most radical new rule allows certain US Flag vessels to elect to be taxed on the basis of tonnage. This form of income tax is similar to tonnage taxes in the UK, Norway and Greece, and other countries that promote and encourage development of international shipping operations. It offers the benefits of a tax that will likely be lower than regular income tax calculated under general principals, and will be a predictable amount from year to year. The downside of this tax is that it must be paid even where there would not be taxable income under the regular tax system. We recommend eligible corporations carefully model the benefits and potential burdens of the tonnage tax before electing it.
The Good
With indications of a new and more "shipping friendly" environment, there is hope for a renaissance of the US shipping industry. The biggest long term benefit may be expanded access to US capital markets for financing of US and foreign vessels.
The Bad
Although the tax drag has been removed from US shipping income, without real tort law reform, we expect that the US will not quickly become an attractive location for risk averse shipping operators.
For more information, contact David Lifson at Moore Stephens Hays LLP, New York on + 1 212 572 5500 or Sue Bill at Moore Stephens LLP, London on +44 (0)20 7334 9191.
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