State aid N 37/ Cyprus Introduction of a tonnage tax scheme in favour of international maritime transport

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1 EUROPEAN COMMISSION Brussels, C (2010) 1727 final PUBLIC VERSION WORKING LANGUAGE This document is made available for information purposes only. Subject: Sir, State aid N 37/ Cyprus Introduction of a tonnage tax scheme in favour of international maritime transport 1. PROCEDURE (1) By letter dated 27 January , the Cypriot authorities notified the Commission, in accordance with Article 108(3) of the TFEU, of their intention to introduce a tonnage tax scheme in favour of international maritime transport. (2) By letters dated 24 February and 12 March the Cypriot authorities send additional information. 2. DESCRIPTION OF THE NOTIFIED SCHEME (3) The Cypriot tonnage tax measure is a tax system whereby legal entities which are liable to corporate tax in Cyprus, engaged in international maritime transport by ship or in an activity directly related thereto, can change the tax base for their operating profits. Qualifying companies may opt for a tax calculated on the net tonnage of the fleet that they operate (tonnage tax) instead of being taxed on the actual profits of their maritime transport activities Registered under Reference SANI Registered under Reference A/3369. Registered under Reference A/4406.

2 (4) The Cypriot authorities intend to adopt a new law entitled "The Merchant Shipping (Fees and Taxing Provisions) Law of 2010" (hereinafter "the Draft Law"). This draft law will repeal and replace the Merchant Shipping (Fees and Taxing Provisions) Laws of and the Merchant Shipping (Taxation of Shipmanagement Services) Regulations" of (5) In addition, in parallel with the Merchant Shipping Law another law has been prepared, entitled "The Income Tax Law (Amendment) (No 3) Law of 2010", which will amend the basic Income Tax Laws of 2002 until , removing the current possibility for ship managers to be taxed for a specific fiscal year with corporate tax instead of tonnage tax at a preferential rate on their net earnings Objectives of the measure (6) The objectives of the Draft Law are to boost the competitiveness of EU ship owners and operators (charterers and ship managers), to maintain jobs and maritime expertise, to support the development of maritime economy, to encourage the employment of seafarers from the EU, the registration of vessels in EU ship registers and to contribute to linking up the maritime economies of EU Member States whilst maintaining the overall competitiveness of the sector. (7) In particular, the Cypriot tonnage tax scheme will encourage the flagging or reflagging of ships to EU registers and promote the maritime cluster, especially in terms of ship management services, thus helping to create a safe, efficient, secure and environmentally friendly maritime transport sector. (8) According to the Cypriot authorities, the Cypriot maritime transport cluster is the 10th largest Ship Registry worldwide, and the 3rd within the EU (a fleet under the Cyprus flag of 1016 vessels, of a gross tonnage of 20 million) and it is the largest third party shipmanagement centre in the EU. Other major third party shipmanagement centres are located in the Far East ship management companies operate in Cyprus, having their headquarters in Limassol and providing shipmanagement services to around ships, under various flags of a gross tonnage of 40 million. According to a study, the fleet under Cypriot management constitutes around 4.5 % of the world fleet in gross tonnage 8. (9) These ship management companies contribute to the employment of EU/EEA citizens in the shipping professions. They offer shore based employment to persons Law 38(I)/1992 as amended. P.I. 395/2000. Law 118(I) 2002 as amended. For example in South Korea, Hong Kong, Philippines, Singapore. Study on Ship Management in Cyprus and in the European Union of 31 May 2008 (271 pages), carried out for the Cypriot government by a consortium under the direction of the Vienna University of Economics and Business Administration.

3 (mainly Cypriots and other EU/EEA nationals), representing 1.2 % of the total gainfully employed population in Cyprus Beneficiaries (10) According to the Draft Law, the following entities are identified as potential beneficiaries of the tonnage tax scheme: i) owners of ships registered under the Cyprus flag (Cyprus ships); ii) owners of EU ships or non-eu ships under any foreign flag (recognised by Cyprus) who are tax residents 9 in Cyprus; iii) charterers of ships under any EU or non-eu flag (recognised by Cyprus) who are tax residents in Cyprus; iv) ship managers providing crew 10 and/or technical 11 ship management services to ships under any EU or non-eu flag (recognised by Cyprus) who are tax residents in Cyprus. Charterers (11) Section 47 of the Draft law stipulates that the total tonnage of ships chartered-in 12 and included in the tonnage tax system may not exceed, for more than three consecutive tax periods, 75 % of the total tonnage of all ships chartered-in or operated 13 by a qualifying charterer and included in the tonnage tax system A tax resident is a person who is resident of Cyprus within the meaning of the Cypriot Income Tax Law. Crew management services are defined as follows: i) selecting and engaging the vessel s crew, including payroll arrangements, and insurances for the crew; ii) ensuring that the applicable requirements of the law of the flag of the vessel as well as any additional requirements imposed by this Law are satisfied in respect of manning levels, rank, qualification and certification of the crew and employment regulations including crew s tax, discipline and other requirements; iii) ensuring that all members of the crew have passed a medical examination with a qualified doctor certifying that they are fit for the duties for which they are engaged and are in possession of valid medical certificates issued in accordance with appropriate flag State requirements; iv) arranging transportation of the crew, including repatriation; v) training of the crew and supervising their efficiency; and may include vi) other relevant functions usually performed by the ship manager as defined by the Baltic and International Maritime Council (hereinafter "BIMCO") Standard Ship Management Agreement. Technical management services are defined as follows: i) the provision of competent personnel to supervise the maintenance and general efficiency of the vessel; ii) the arrangement and supervision of dry dockings, repairs, alterations and the upkeep of the vessel to the standards required by the law of the flag of the vessel and of the places where she trades, and all requirements and recommendations of its classification society; iii) the arrangement of the supply of necessary stores, spares and lubricating oil; and may include; iv) other relevant functions usually performed by the ship manager as defined by the BIMCO Standard Ship Management Agreement. "Chartered-in" vessels are ships chartered-in on a time charter basis or on a voyage charter basis, or on a contract of affreightment. "Operated" vessels are owned ships or chartered-in on a bareboat basis.

4 (12) Alternatively, the total tonnage of ships chartered-in and included in the tonnage tax system may not exceed, for more than three consecutive tax periods, 90 % of the total tonnage of all ships chartered-in or operated by a qualifying charterer and included in the tonnage tax system, provided that every chartered-in ship is either : (i) registered in an EU or EEA maritime register, or (ii) its crew management and its technical management are carried out from territory of the EU or the EEA. the Ship managers (13) All ship managers of qualifying ships who provide crew and/or technical management services may opt to participate in the tonnage tax system. Α ship manager, who provides commercial management services 14, is not considered as a qualifying ship manager for such services and is liable to corporate taxation. (14) Both crew and technical ship managers must fulfil a set of general conditions as well as a number of specific conditions depending on the type of ship management services offered (crew and/or technical management). The general conditions are, as follows: (15) Eligible ship management companies must have a fully fledged office in Cyprus and employ sufficient personnel in number and qualifications as provided for in Section 32 of the Draft Law. (16) The ship management company should employ ashore EU/EEA citizens at such numbers that they represent at least 51 % of the total number of employees. (17) There must be an economic link between the managed ships and the EU. According to Section 33 of the Draft Law, ship managers may benefit from tonnage tax only with respect to qualifying ships entirely managed (crew and/or technical management) from the territory of the EU/EEA. In order to fulfil this requirement, the ship manager should have at least 2/3 of the total tonnage of its fleet in a given fiscal year managed from the EU. Tonnage in excess of one third of the tonnage which is not entirely managed from the EU is not eligible for tonnage tax 15. (18) Qualifying ship managers providing crew management services and/or technical management services are eligible for the tonnage tax system if all the ships and crews they manage comply with the relevant international standards and EU law According to Section 2 of the Draft Law commercial management services mean: (a) the provision of chartering services in accordance with the instructions of the owner, which includes seeking and negotiating employment of the ship and the conclusion of charter parties or other contracts relating to the employment of the ship; (b) the payment to owners of all hire and freight revenues and any other moneys, to which the owners are entitled and arise out of the employment of the ship; (c) the provision of voyage estimates, accounts, the calculation of hire, freights and demurrage, and/ or dispatch moneys due from or due to the charterers of the ship; (d) and may include other relevant functions usually performed by the ship manager as defined by the BIMCO Standard Ship Management Agreement. Non-eligible ships shall leave the tonnage tax scheme for the particular fiscal year when the excess occurred and the income of the qualifying ship manager derived from the management of those vessels will be subject to corporate taxation.

5 requirements, in particular, those relating to maritime security, safety, training and certification of seafarers, environmental performance and on-board working conditions. These requirements are deemed to be fulfilled by a qualifying ship manager for all the EU/EEA ships under its management. As far as non-eu/eea ships under management are concerned, they should be: a) classed with an inspection and survey organisation (classification society) which is approved by the EU in accordance with the relevant EU legislation in force; and b) duly certificated as appropriate in accordance with the international Conventions regulating maritime safety, security and protection of the environment which are in force and are manned by seafarers who are duly certificated in accordance with STCW , as amended. (19) As far as ship managers carrying out technical management are concerned, they should be certified under the ISM Code (Document of Compliance) by the competent authority of the Flag States of the vessels under their management and must be mentioned as the management company on the relevant Safety Management Certificates (SMC) of those vessels. (20) Non-compliance with these requirements entails a series of fines, and if the noncompliance persists, the ultimate sanction is the exclusion of the ship manager from the tonnage tax system for the next 10 years 17. (21) The tonnage tax scheme also contains the following special conditions for ship managers who perform crew management only or in combination with technical management: (22) All seafarers working onboard of managed ships should be educated, trained and hold a certificate of competency in accordance with STCW 1978, and have successfully completed training for personal safety on board ship. Moreover, crew managers should fulfil STCW 1978 and EU law requirements regarding responsibilities of companies. (23) Crew management companies should comply with the provisions of the Maritime Labour Convention (MLC), Such compliance is ensured by requiring that appropriate private contractual arrangements are concluded between the crew manager and the shipowner, and that such arrangements are expressly reflected in the individual contracts of employment of the seafarers under crew management Convention of the International Maritime Organisation on Standards of Training, Certification and Watchkeeping for Seafarers, Sections 34, 54 and 57 of the Draft Law. MLC has been integrated into EU law by Council Directive 2009/13/EC of 16 February 2009 implementing the Agreement concluded by the European Community Ship-owners' Associations (ECSA) and the European Transport Workers' Federation (ETF) on the Maritime Labour Convention, 2006, and amending Directive 1999/63/EC (OJ L 124, , p. 30).

6 (24) A qualifying crew manager must submit at the beginning of every fiscal year a written Declaration to the Cypriot authorities, containing an express statement and undertaking that the private contractual arrangements have either been concluded or will be concluded for the specific fiscal year with regard to all vessels and crew members under its management. Sanctions are provided for ship managers noncompliant with this requirement. Furthermore, the non-compliant crew manager commits a criminal offence, liable on conviction to imprisonment for a term not exceeding two years or to a fine not exceeding euro or to both such sentences, and excluded from the tonnage tax system for the next ten years Eligible tonnage tax activities (25) According to the definition, contained in the Draft Law, a qualifying shipping activity" means any commercial business or activity which constitutes maritime transport, or crew or technical management of qualifying ships. In particular, "maritime transport" is defined as the carriage of goods or passengers by sea outside the territorial sea of Cyprus, between a Cyprus port and a foreign port or an off-shore facility, or between foreign ports, or off-shore facilities. (26) A certain number of activities, ancillary to maritime transport, are also considered eligible for tonnage tax: (i) in relation to the carriage of passengers by sea, all hotel, catering, entertainment and retailing activities on board of a qualifying ship, provided that these services are performed as ancillary activities to the activity of carriage of passengers by sea by that ship and are all consumed or used on board that ship; (ii) the provision of loading and unloading of cargo to a qualifying ship operated by the qualifying owner or the qualifying charter, including the moving of containers within a port area immediately before or after the voyage; (iii) (iv) (v) the operation of ticketing facilities and passenger terminals; the operation of office facilities; the sale and distribution of ship supplies. (27) However, the Cypriot authorities committed to modify their Draft Law by deleting point (v) "the sale and distribution of ship supplies" from the law. In addition, they agreed to introduce in points (iii) and (iv) the following wording: "(iii) the operation of ticketing facilities and passenger terminals in connection with shipping activities subject to tonnage tax; (iv) the operation of office facilities in connection with shipping activities subject to tonnage tax". (28) Towage activities and dredging activities are also covered by the tonnage tax scheme, as long as each tugboat or dredger spends each year more than 50% of its operational time in carrying out maritime transport, in which case the tonnage tax applies only for this maritime transport share. Finally, cable laying activities are also considered as eligible for tonnage tax.

7 2.4. Tonnage tax rates (29) Instead of notional profit 19, used in the majority of the Member States, the Cypriot authorities intend to charge for each vessel a lump sum, determined on the basis of its tonnage. (30) The annual tonnage tax rates for ship-owners and charterers are, as follows: Table 1 Net Tonnage > ,50 per 100 NT 31,03 per 100 NT 20,08 per 100 NT 12,78 per 100 NT 7,30 per 100 NT (31) The annual tonnage tax rate for ship managers will be 25 % of the one charged to ship owners and charterers. (32) In the case of lay-up or if rendered inoperative for a period of at least three months due to their judicial arrest, or by act of piracy or armed robbery, or by force majeure 20 Cyprus Ships and EU/EEA ships may have their tonnage tax reduced by 75 % Absence of 'flag-link' (33) The notified tonnage tax scheme has no explicit flag link, that is to say a requirement whereby only vessels listed in EU/EEA maritime registers would be eligible for tonnage tax. (34) Thus, the Cypriot tonnage tax scheme allows for non-eu/eea flagged ships to be eligible for tonnage tax, but only if the following requirements are satisfied by the ship owners: (a) at the time of opting into the tonnage tax system, 60% of their fleet is EU/EEA - flagged; or (b) at the time of opting into the tonnage tax system: i) a share of their fleet is EU/EEA flagged; and ii) this EU flagged share shall remain unchanged or increase within a period of three years from the date of opting in the tonnage tax system. (35) Should the owner of the ships fail at the company/group level to respect the requirement contained in subparagraph (b) ii) above, then any additional non-eu/eea flag ships owned by the company will not be considered as qualifying ships, unless the EU/EEA - flagged share of the global tonnage of all such owners eligible for tonnage The notional profit is based on a lump sum determined on the basis of the net tonnage of each ship, to which is then applied the national corporate tax rate. Sections 11, 12, 14, 22 and 24 of the Draft Law

8 tax in Cyprus has not decreased on average within the above reporting period, i.e. within a period of three years from the date of opting in the tonnage tax system. (36) According to the draft law, for both conditions (a) and (b), the commercial and strategic management of the fleet was originally to be carried out from within Cyprus and the ships shall comply with the applicable international and EU standards concerning safety, security, training and certification of seafarers, environmental performance and on-board conditions. However, the Cypriot authorities have committed to instead require that the commercial and strategic management of the fleet is carried out from the EU. (37) According to the draft law, conditions (a) and (b) were to be verified at the time of opting into the tonnage tax system. However, the Cypriot authorities have committed to carry out the assessment of both conditions (a) and (b) every three years and not only at the time of opting of the company to the tonnage tax. (38) Instead of calculating the total tonnage of vessels under the Cypriot flag, the scheme provides for separate calculation of the fleet's tonnage for each of the following activities: ship-owners, charterers and shipmanagers. (39) Even though the Cypriot tonnage tax scheme allows for non-eu ships to qualify for tonnage tax under the conditions explained above, such qualifying ships will, however, have their annual tonnage tax increased by 30 % if the flag that they are entitled to fly, appears in the Grey List of the Paris MOU on Port State Control 21 and by 60 % if the flag that they are entitled to fly, appears on the Black List of the Paris MOU on Port State Control 22. (40) In addition to the above described increase of the tonnage tax for non-eu ships operated by either ship owners, charterers or ship managers, the scheme contains an extra provision for ship managers. Ship managers not meeting at a company/group level the EU/EEA-tonnage share requirement, but finally allowed for tax relief on the basis of the EU/EEA-flagged share of the global tonnage of all ship managers providing the same services participating in the tonnage tax scheme in Cyprus, will be subject to an increase of 10 % on the total amount of tonnage tax payable for their non-eu/eea flagged fleet Ring fencing measures (41) The scheme provides for a number of ring-fencing measures to avoid spill-over effects into non-eligible activities in Cyprus or in other countries. These ring-fencing measures are intended to prevent non-qualifying activities from enjoying the benefit of the low tax scheme Memorandum of Understanding on Port State Control, signed in Paris on 26 January The decision whether a flag appears on the Grey List or Black List of the Paris MOU on Port State Control will be taken on the basis of the relevant table contained in the Annual Report of the Paris MOU for the year preceding the tax (fiscal) year.

9 (42) It should be firstly recalled that the tonnage tax scheme will function within the framework of the Cypriot tax system. Verification of intra-group transactions based on the arm s length principle (43) To ensure that profits from other activities are not sheltered within tonnage tax, the legislation applies the arm s length provisions to transactions between the tonnage tax trade and a connected person and to notional transactions between the tonnage tax trade and the non-tonnage tax trade of the shipping company. (44) The provisions of the Cypriot Income Tax Law of 2002 are also applicable to the Draft Law and prevent the transfer of income from non tonnage tax affiliates to tonnage tax ones. (45) The Cypriot authorities have undertaken the commitment that the implementation of the existing legislation will ensure the effective implementation of the Arm's length principle, in particular, to the following three cases : (i) transactions between qualifying for tonnage tax companies and non- qualifying Cypriot companies (in the case of related companies); (ii) transactions between qualifying for tonnage tax companies and non-qualifying non-cypriot companies (in the case of related companies); (iii) transactions between qualifying for tonnage tax activities of a qualifying company and non-qualifying activities of the same company. Separate accounting (46) Section 44 of the Draft Law stipulates that any income of ship-owners, charterers and shipmanagers not deriving from not eligible activities must fall under normal corporate tax. (47) Companies which do not comply with this provision will lose their status as eligible for tonnage tax entities and will be taxed under the corporate tax legislation. In addition, a loss in the activities under tonnage tax cannot be used for reducing the taxable income under the corporate tax legislation. Rules on financial expenditure (48) No tax deduction is permitted in respect of the capital expenditure directly or indirectly attributable to activities under the tonnage tax. Tax deduction on capital expenditure on assets used both in tonnage tax activities and non tonnage tax activities must be divided in proportion of the respective gross income of the two kinds of activities. (49) Only the part of interest expenses, exchange rate differences and any other expenses directly or indirectly attributable to non tonnage tax activities will be tax deductible from income subject to tax under the corporate taxation. Interest expenses, exchange rate differences and any other expenses attributable to both tonnage tax activities and

10 non tonnage tax activities must be divided in proportion of the respective gross income of the two kinds of activities. The "All or nothing" option (50) All qualifying entities, when opting to enter the tonnage tax system, must include in the tonnage tax scheme all qualifying ships. (51) In case the qualifying owners, qualifying charterers and qualifying ship managers are tax resident in Cyprus, and as part of a group of companies tax resident in the Republic, then all such qualifying companies, must enter the tonnage tax system as soon as one company of the group has opted to enter the tonnage tax system. (52) As far as the requirements for opting in for the tonnage tax scheme are concerned, the owners of ships under the Cyprus flag (Cyprus ships) are exempted from income tax and are automatically subjected by law to the annual tonnage tax scheme. Such owners do not have the right to opt for either the tonnage tax or corporate tax, as the other beneficiaries of the schemes. The Cypriot authorities indicated that this would constitute a major administrative burden for the shipowner companies because it would affect around 1000 registered owners operating in the form of single ship companies. (53) Nevertheless, the Cypriot authorities committed to require that owners of Cyprus ships must always remain in the tonnage tax system unless all their ships are sold, lost or broken up. Such owners may re-register one or more of their ships in their ownership under another flag but they cannot opt for the corporate tax system with regard to these ships until a period of ten years has expired from the time of their first entry in the Cypriot tonnage tax scheme. (54) All other eligible beneficiaries (owners of ships under EU (non-cypriot) or non-eu flags, charterers and shipmanagers) should opt explicitly in order to participate in the tonnage tax system. If such beneficiaries opt to participate in the tonnage tax system, they must remain in the tonnage tax system for at least ten years. If they do not opt to participate in the tonnage tax system, their ships will not be considered as qualifying ships. (55) In this respect, if such a beneficiary exits - withdraws from the tonnage tax regime (otherwise than as a result of the disposal or loss of the ship) before the end of the ten year period, it will be liable to pay the difference between the tax due under the standard corporate income tax regime and that payable under the tonnage tax regime for the whole period the beneficiary remained under the tonnage tax regime. In case the amount of standard corporate income tax is less than the corresponding tonnage tax, no refund will be made Tax exemption for salaries and other benefits (56) Section 55 of the Draft Law stipulates that no tax will be charged, levied or collected upon the salary or other benefits from the employment of the master, the officers and other crew members of a qualifying ship, engaged in a qualifying shipping activity.

11 2.8. Budget (57) The tonnage tax scheme will result in a reduction of State revenues. The Cypriot authorities estimate that the annual tax foregone by the State will amount to EUR 1.5 million Duration of the scheme (58) The scheme will last 10 years as from 1 January 2010 and any prolongation will be renotified to the Commission before the end of this 10-year period. Therefore, the last date until which entry into tonnage tax may be granted shall be 31 December Cumulation (59) The Cypriot authorities have indicated that no other scheme in favour of Cypriot shipowners exists. 3. ASSESSMENT OF THE AID 3.1. Existence of aid under Article 107(1) of the TFEU (60) Under Article 107(1) of the TFEU, any aid granted by a Member State or through State resources in any form whatsoever which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods shall, in so far as it affects trade between Member States, be incompatible with the internal market. (61) Through the tonnage tax scheme, the Cypriot authorities envisage lowering the corporate income tax that international shipping companies would otherwise have to bear. The comparison between the level of the tonnage tax and the level of the standard corporate tax in Cyprus (which is currently 10 %) is very difficult because they are based on completely different parameters. Nevertheless, as mentioned above, the Cypriot authorities have estimated that the annual cost of the measure would be EUR 1.5 million, which shows that the measure will provide an advantage to the beneficiaries of the scheme. The Commission therefore considers that the notified regime confers a selective economic advantage to undertakings active in the international maritime transport. (62) This fiscal advantage is granted through State resources because the Cypriot authorities are foregoing tax revenues. (63) Such measure threatens to distort competition and could affect trade between Member States, since such shipping activities are essentially carried out on a worldwide market. (64) Similarly, the planned tax exemption for salaries or other benefits derived from the employment of the master, the officers and other crew members of ships also confer a selective economic advantage to the shipping companies employing the staff in question by lowering their labour-related costs. The exemption is granted through State resources because the Cypriot authorities will receive lower tax revenues.

12 Finally, the tax exemption may distort competition and could affect trade between Member States because the crew employing companies operate at a global level. (65) Therefore, the Commission considers that the scheme under examination constitutes State aid within the meaning of Article 107(1) of the TFEU Compatibility assessment (66) Under Article 107(3)(c) of the TFEU, aid to facilitate the development of certain economic activities may be considered compatible with the internal market, where such aid does not adversely affect trading conditions to an extent contrary to the common interest, and thus provides a possible basis for an exemption from the general prohibition of State aid. The Commission considers Article 107(3)(c) of the TFEU to be the appropriate legal basis applicable to the notified scheme. (67) The appropriate legal basis for compatibility assessment is Article 107(3)(c) TFEU, implemented by the Guidelines on State aid to maritime transport 23 (hereinafter "the Maritime Guidelines") as well as the Communication from the Commission providing guidance on State aid to ship management companies 24 (hereinafter "the Shipmanagement Guidelines"). The Maritime Guidelines determine the conditions under which Member States are allowed to set up certain State aid schemes to support their maritime transport industry in the pursuit of general objectives, such as: - improving a safe, efficient, secure and environment friendly maritime transport; - encouraging the flagging or re-flagging to Member States' registers; - contributing to the consolidation of the maritime cluster established in the Member States while maintaining an overall competitive fleet on world markets; - maintaining and improving maritime know-how and protecting and promoting employment for EU/EEA seafarers; and - contributing to the promotion of new services in the field of short sea shipping following the White Paper on Community transport policy. (68) Section 3.1 of the Maritime Guidelines specifically mentions tonnage tax schemes as examples of fiscal measures that "have been shown to safeguard high quality employment in the on-shore maritime sector", and may thus be considered compatible with the internal market. (69) However, the Maritime Guidelines lay down certain criteria, which such schemes must meet to be considered compatible with the internal market. Furthermore, Section 4 of the Shipmanagement Guidelines allow, under certain conditions, for the inclusion of companies carrying out separately or jointly crew and/or technical management as eligible for tonnage tax in accordance with Section 3.1 of the Maritime Guidelines OJ C 13, , p. 3. OJ C 132, , p. 6.

13 (70) The Commission will thus assess below whether the scheme under examination fulfils the criteria established by the Maritime Guidelines and the Shipmanagement Guidelines Objective of the notified scheme (71) The Commission notes that the tonnage tax is a fiscal scheme intended to maintain and foster the EU/EEA flagged maritime fleet, to promote the maritime cluster, especially in terms of ship management services, to preserve the existing Cypriot fleet, to preserve significant employment on-board and on shore in Cyprus and to establish a safe, efficient, secure and environmentally friendly maritime transport. (72) The Commission considers that these objectives are in line with the general objectives set out in the Maritime Guidelines and confirmed by the Shipmanagement guidelines as far as crew and technical management is concerned Qualifying beneficiaries (73) The Commission has no objection with regard to the conditions set out in order to determine qualifying companies. Indeed, since the Draft Law covers companies, liable for corporation income tax in Cyprus, such coverage is explicitly mentioned in the Maritime Guidelines 25. (74) The Commission has no objection either as regards the types of companies, liable to corporate tax in Cyprus, which are identified as beneficiaries of the tonnage tax scheme. Indeed, the Maritime Guidelines explicitly provide for ship owners to be eligible for tonnage tax 26, while the Shipmanagement Guidelines extend the application of Section 3.1. of the Maritime Guidelines to joint or separate crew and technical management of ships (Section 4 of the Shipmanagement Guidelines). (75) As far as chartered-in vessels are concerned, the Commission takes note of the conditions mentioned above 27, namely that the total tonnage of vessels chartered-in can be eligible for tonnage tax as far as their cumulative tonnage for more than three consecutive tax periods does not exceed 75% of the total tonnage of the fleet operated by the tonnage tax company. Alternatively, the tonnage of the chartered-in vessels may reach 90 %, provided that every chartered-in ship is either: (i) registered in an EU or EEA maritime register, or (ii) its crew management and its technical management are carried out from territory of the EU or the EEA. the See for example Section 3.1 of the Guidelines, fourth subparagraph: "the system of replacing the normal corporate tax system by a tonnage tax is a State aid" (emphasis added). See Section 3.1., fourth subparagraph of the Maritime Guidelines. See paragraph (11) of the present decision.

14 (76) Consequently, the Commission concludes that both ratios between owned and chartered-in vessels are in conformity with the Commission's practice and fulfil the conditions contained therein 28. Ship management companies (77) The Commission takes note of the fact that eligible ship management companies must have a fully fledged office in Cyprus and employ sufficient personnel in number and qualifications. In addition, the ship management companies should employ ashore EU/EEA citizens representing at least 51 % of the total number of employees. Therefore, the Commission considers that the condition that the ship management companies should contribute to the EU economy and employment is fulfilled (Section 5.1 of the Shipmanagement Guidelines). (78) Furthermore, the tonnage tax scheme contains explicit requirement that there must be an economic link between the managed ships and the EU/EEA, whereby the qualifying ships must be entirely managed from the territory of the EU/EEA. This requirement will be deemed fulfilled as long as at least 2/3 of the total tonnage of the ship manager's fleet in a given fiscal year is managed from the EU/EEA, in compliance with Section 5.2 of the Shipmanagement Guidelines. (79) The Commission is also of the opinion that the obligations, contained in the tonnage tax scheme, for the ship managers to comply with all relevant international and EU standards relating to security, safety, training and certification of seafarers, environmental performance and on-board working conditions 29 is in conformity with Section 5.3 of the Shipmanagement Guidelines. (80) The Commission considers that the flag link requirement for ship managers, (the same as for ship owners and charterers) is in line with Section 5.4 of the Shipmanagement Guidelines 30. (81) As far as the training requirements and the social conditions for crew managers contained in the tonnage tax scheme 31 are concerned, the Commission is of the view that they fully comply with Section 6 of the Shipmanagement Guidelines. (82) The Commission further welcomes the fact that the scheme provides for strict sanctions against non-compliant shipmanagers (non-compliant crew managers are subject to additional sanctions), the final sanction being their exclusion from the tonnage tax scheme With regard to the 90 % ratio see: State aid C 2/2008 (ex N 572/2007) Ireland on the amendment to the tonnage tax system which Ireland is planning to implement, adopted on , OJ L 228, , p. 20; with regard to the 75 % ratio see for example: State aid N 737/02 - France - Tonnage tax scheme for shipping companies, adopted on , OJ C 38, , p. 5. See paragraphs (18) and (19) of the present decision. See Section below assessing the overall flag link requirements. See paragraphs (22)-(24) of the present decision.

15 (83) In view of the above, the Commission concludes that the requirements contained in the tonnage tax scheme in relation to the ship management companies are in line with the Shipmanagement Guidelines Qualifying shipping activities (84) The Commission notes that the shipping activities identified as eligible for tonnage tax correspond to the relevant definitions in the Maritime Guidelines. In particular, "maritime transport", defined as "the carriage of goods or passengers by sea outside the territorial sea of Cyprus, between a Cyprus port and a foreign port or an off-shore facility, or between foreign ports, or off-shore facilities" is per se eligible for tonnage tax pursuant to Section 2, third subparagraph of the Maritime Guidelines. (85) The Commission considers that the activities described in paragraph (26), points (i) and (ii) of the present decision, namely the carriage of passengers by sea, all hotel, catering, entertainment and retailing activities on board of a qualifying ship as well as the provision of loading and unloading of cargo to a qualifying ship operated by the qualifying owner or the qualifying charter, including the moving of containers within a port area immediately before or after the voyage, are indeed closely related, ancillary to maritime transport and are not exercised as main activities by the shipping companies. (86) With respect to the operation of ticketing facilities and passenger terminals as well as the operation of office facilities, the Commission takes note of the commitment undertaken by the Cypriot authorities to allow the eligibility of these ancillary to maritime transport activities only as long as they are carried out in relation to eligible shipping activities included in the tonnage tax. (87) As far as the activities of sale and distribution of shipping supplies are concerned, the Commission is of the opinion that they cannot be considered as eligible ancillary activities. Therefore, it welcomes the commitment undertaken by the Cypriot authorities to remove these activities from the Draft Law. (88) Consequently, the Commission considers that the remaining types of ancillary activities included in the Draft Law should be eligible for tonnage tax. (89) As far as the eligibility of towage and dredging activities is concerned, the Commission acknowledges that their activities will be included as eligible as long as they fulfil the requirements contained in the Maritime Guidelines with respect to the time spent on maritime transport activities. In addition, they will be eligible for tonnage tax only with respect to the share of their time spent carrying out maritime transport. Consequently, the Commission concludes that the conditions contained in Section 3.1 fourteenth, fifteenth and sixteenth subparagraphs of the Maritime Guidelines are fulfilled. (90) Regarding the inclusion of cable-laying activities as eligible for tonnage tax, the Commission considers that this is in line with a recent Commission decision 32, in 32 Commission Decision C 22/07 (ex N 43/07) as regards the extension to dredging and cable-laying activities of the regime exempting maritime transport companies from the payment of the income tax and social

16 which State aid to cable-laying activities was found compatible with the internal market on the basis that these activities should be associated by analogy with maritime transport. Despite the fact that this decision concerned Section 3.2 of the Maritime Guidelines, the Commission is of the view that the other State aid measures provided for in the various sections of the Maritime Guidelines (such as tonnage tax) should be also applicable to cable-layers Calculation of the tonnage tax rate (91) The Commission notes that the method of calculation of the Cypriot tonnage tax rate differs from the one applied by the majority of the Member States (most of the Member States establish the so-called "notional profit" for the different categories of ships based on their tonnage, on which then they apply the national corporate tax). Nevertheless, the Commission notes that the ultimate level of taxation for Cypriot companies equals the average rate applied in the rest of the EU. (92) The tonnage tax rates applicable in Cyprus compared to the rates applicable in other Member States are as follows: Table 2 CYPRUS* THE NETHERLANDS* DENMARK* LITHUANIA * *All the Up to 1000 NT EUR 1 per 100 NT From 1001 until NT EUR 0.85 per 100 NT From to NT EUR 0.55 per 100 NT From to NT EUR 0.35 per 100 NT Above NT EUR 0.2 per 100 NT Up to 1000 NT EUR per 100 NT From 1001 until NT EUR 0.68 per 100 NT From to NT EUR 0.45 per 100 NT From to NT EUR 0.22 per 100 NT Above NT EUR 0.05 per 100 NT Up to 1000 NT EUR 0.90 per 100 NT From 1001 until NT EUR 0.70 per 100 NT From to NT EUR 0.40 per 100 NT Above NT EUR 0.30 per 100 NT N/A Up to 1000 NT EUR 0.93 per 100 NT From 1001 until NT EUR 0.67 per 100 NT From to NT EUR 0.43 per 100 NT Above NT EUR 0.27 NT per 100 NT N/A values are given per day (93) The rates above for the Netherlands, Denmark and Lithuania are notional profit rates. These rates are multiplied with the actual tonnage to establish the notional profit. This contributions of seafarers in Denmark, adopted on , OJ L 119, , p. 23, see, in particular, paragraphs thereof.

17 notional profit is then subject to the standard corporate tax rate in the country in question. The notional profit rate for Cyprus can be calculated by dividing the annual rate by 365 (in order to establish the daily rate) and then by dividing again with the Cypriot corporate tax rate (10 % = 0.10). For example, for the brackets up to 1000 NT the rate is calculated as follows: 36.50/365 days = 0.1; 0.1/0.10 = EUR 1. (94) Consequently, the Commission considers that the tonnage tax rates applicable in Cyprus keep an equitable balance in line with the tonnage tax regimes in other EU/EEA States. In addition, the Shipmanagement Guidelines explicitly note that the method of calculation of the tonnage tax is irrelevant 33. (95) As far as the reduced tonnage tax rate to shipmanagers (25 % of the one charged to ship owners and charterers) is concerned, the Commission notes that it is in line with Section 7 of the Shipmanagement Guidelines. (96) With regard to the possibility for reduction of the tonnage tax rate by 75 % for Cypriot and EU/EEA ships in case they are laid-up or inoperative for a period of at least three months 34, the Commission is of the view that such a reduction is in line with other tonnage tax schemes, whereby ships may have full exemption from payment of tonnage tax for the time during which they are not operational 35. (97) The Commission therefore concludes that the tonnage tax rate complies with the provisions of Section 3.1., eighteenth subparagraph of the Maritime Guidelines Flag link (98) The Commission considers that the flag link requirements contained in the Cypriot tonnage tax are in line with the provisions of Section 3.1, eighth subparagraph of the Maritime Guidelines as well as with Section 5.4 of the Ship management guidelines as far as ship management companies are concerned. (99) In particular, the Commission takes note of the fact that in line with Section 3.1, eighth subparagraph of the Maritime Guidelines, the Cypriot authorities committed to carry out every three years a verification of the companies' compliance with the flag share requirements in order to determine their eligibility for tonnage tax and not only at the companies' entry into the tonnage tax scheme. (100) The Commission further considers that the fact that the calculation of the flag ratio will be carried out separately for each of the eligible activities (ship-owners, charterers and shipmanagers) imposes additional constraints for non-eu/eea flagged ships to become eligible for tonnage tax since the changes in the flag share in any of the three See footnote 1 on page 9 of the Shipmanagement Guidelines. See paragraph (32) of the present decision. See for example Commission Decision State aid N 325/2007 Slovenia - Introduction of a tonnage tax scheme in favour of international maritime transport, adopted on , OJ C 53, , p.1., paragraph 17 thereof, where it is indicated that for the purpose of the calculation of the tonnage tax rate only the days when the vessel is operational will be taken into account.

18 types of eligible activities would not have an impact on the inclusion of non-eu/eea ships in the other two categories of activities. Similarly, the Commission is of the opinion that the fact that non-eu/eea ships, allowed to qualify for tonnage tax, will be charged an increased rate of tonnage tax (with 30 % or 60 % 36 ) and that non- EU/EEA ship managers will have an additional increase by 10 % of their tonnage tax rate will also encourage non-eu/eea ships to register in the EU/EEA registers. The Commission acknowledges that these measures are clearly in line with the EU objective of encouraging re-flagging to the EU/EEA flags (and not simply benefiting from the tonnage tax scheme without leaving the third countries' flags) Ring-fencing measures (101) Pursuant to Section 3.1., nineteenth subparagraph of the Maritime Guidelines, a tonnage tax scheme must be accompanied by a series of appropriate ring-fencing measures, in order to prevent spill-over into non-shipping activities and tax evasion 37. (102) To that end, the Commission has reviewed the different ring-fencing mechanisms put in place under the Draft Law. Verification of intra-group transactions based on the arm's length principle (103) The Commission considers that Cyprus must ensure that its own tonnage tax scheme will not lead to distortion of competition in other sectors through transfer prices and/or to tax evasion to the detriment of the country where the second affiliate is tax liable. (104) In the case at hand, the Commission notes that, in order to ensure that profits from other activities are not sheltered within tonnage tax, the legislation applies the arm s length provisions to transactions between the tonnage tax trade and a connected person and to notional transactions between the tonnage tax trade and the non-tonnage tax trade of the shipping company. (105) Moreover, the Cypriot authorities will verify intra-group transactions across the ringfence. (106) Therefore, the Commission considers that the scheme under examination is satisfactorily equipped in order to verify that intra-group transactions are based on the arm's length principle See paragraph (39) of the present decision. Section 3.1 of the Guidelines, nineteenth subparagraph stipulates the following: "In all cases, the benefits of schemes must facilitate the development of the shipping sector and employment in the Community interest. Consequently, the fiscal advantages mentioned above must be restricted to shipping activities; hence, in cases where a ship-owning company is also engaged in other commercial activities, transparent accounting will be required in order to prevent "spill-over" into non-shipping activities. This approach would help Community shipping to be competitive, with tax liabilities comparable to levels applying elsewhere in the world, but would preserve a Member State's normal tax levels for other activities and personal remuneration of shareholders and directors."

19 Separate accounting (107) The Commission notes that Section 44 of the Draft Law clearly requires that tonnage tax companies put in place separate accounting between eligible and non eligible activities. Rules on financial expenditure (108) The Commission takes note of the fact that the tax deduction on capital expenditure on assets used both in tonnage tax activities and non tonnage tax activities, as well as interest expenses, exchange rate differences and other expenses attributable to both tonnage tax activities and non tonnage tax activities will be divided proportionally between the tonnage tax and non tonnage tax activities, based on the share of the respective gross income of the two kinds of activities. The Commission is of the opinion that the use of such method is in line with the aim of excluding all noneligible expenditures from benefiting from the tonnage tax scheme. The all or nothing option (109) The tonnage tax legislation provides that the choice of entering the notified scheme must be made jointly by all companies being part of a group of undertakings for all their eligible activities. (110) In addition, the Commission notes that the commitment to maintain vessels under tonnage tax for a period of 10 years, irrespective of whether the ships are operated by ship owners, charterers or ship managers, is consistent with the existing tonnage tax schemes already approved by the Commission. (111) To conclude, the Commission considers that the tonnage tax scheme under examination satisfies the criterion of the 'all or nothing' option applicable to eligible activities Tax exemption for salaries or other benefits (112) With regard to the planned tax exemption for salaries or other benefits derived from the employment of the master, the officers and the crew members of ships such reduced (up to zero) rates of income tax for EU/EEA seafarers on board ships are explicitly allowed in Section 3.2 of the Maritime Guidelines. Moreover, the beneficiaries of this tax exemption will be exclusively qualifying ships engaged in qualifying shipping activities. Therefore, the Commission considers that the tax exemption in question is in line with the Maritime Guidelines Compliance with aid ceiling (113) Section 11 of the Maritime Guidelines indicate that "the total amount of aid granted under Chapters 3 to 6 [that is to say tonnage tax, exemption from the payment of income tax and social contributions for seafarers, aid to crew relief, investment and regional aid] should not exceed the total amount of taxes and social contributions collected from shipping activities and seafarers".