MARITIME STATE AID GUIDELINES REVIEW QUALIFYING FINANCIAL INCOME

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Pamela Walker
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1 D. 3999/12 SF EXECUTIVE SUMMARY MARITIME STATE AID GUIDELINES REVIEW QUALIFYING FINANCIAL INCOME This memrandum addresses the degree t which tnnage tax regimes shuld apply t incme derived frm financial assets, particularly interest incme. Over recent years, it has becme clear that the Eurpean Cmmissin s psitin has nt been sufficiently attuned t shipwners practices, which has harmed the cmpetitive psitin f Eurpean shipwners cmpared t many f their nn-eu cunterparts. ECSA wuld like t cnsider with the Eurpean Cmmissin hw the psitin n this aspect might be clarified. The balance sheets and funding arrangements f tnnage tax cmpanies vary enrmusly between cmpanies. At ne extreme there are large, publicly-wned multinatinal shipping cmpanies managing wrldwide fleets thrugh extensive branch structures; at the ther extreme there are single ship cmpanies in family wnership. Sme cmpanies wn ships, sme lease, sme charter, and then there are ship management cmpanies which have n prperty in their ships at all. ECSA therefre suggests that any guidance shuld be based n general principles which recgnise this diversity and nt n quantitative limits, in rder t accmmdate the circumstances f the very wide range f businesses and situatins invlved. THE ISSUE AT STAKE 1. Outline f the prblem The shipping industry has a number f characteristics that give rise t specific issues regarding the applicatin f the tnnage tax regime: First, the industry s strngly cyclical nature. Successful and prfitable years alternate with pr years, during which ften cnsiderable lsses are made. Whilst this cyclical nature is present in a number f ther industries t, the nature f the assets (ships) invlved and the perid f time between rder and delivery makes the cycles in the shipping industry mre prnunced; Secnd, investments in shipping assets are vast sums fr which substantial (dwn) payments have t be made, bth at the time f rdering a new vessel and during its cnstructin; Third, there can be strng fluctuatins in the incme derived frm freight wing t seasnal influences, even within the space f a calendar year. Examples include the pre- Christmas highs in cntainer traffic frm Asia t the US and Eurpe and t a lesser degree the transprt f bitumen fr the cnstructin f new rads. Because f these characteristics, shipwners need t have access t smetimes cnsiderable cash reserves, t act as a buffer in bad times, during seasnal dwnturns r t be able t finance fleet expansin.

2 Naturally, shipwners will try t make their depsits/reserves earn as much as they can. S far, the Eurpean Cmmissin s 2004 decisin cncerning Belgium is the guiding factr in the questin f whether and, if s, which incme derived frm cash reserves qualifies fr the tnnage tax regime 1. Apart frm the treatment f incme frm buffer reserves, there is the general questin f interest incme arising n nrmal treasury peratins, where there may be incme but n prfit, and intra-grup finance that generates interest incme but similarly invlves n prfit t the grup. In bth these instances a blanket exclusin f interest incme frm tnnage tax, when related interest csts are included within tnnage tax in ttal r in part, will give rise t a tax liability when there is n prfit. Appraches vary frm state t state and sme mre restrictive authrities are taking the view that, apart frm interest arising in cnnectin with wrking capital, the nus is n cmpanies t take whatever steps are necessary t avid the incidence f interest receivable and cnsequent tax n phantm prfits. This apprach flies in the face f nrmal treasury peratins and cmmercial arrangements. The majrity f cmpanies will have external brrwings and the mst efficient use f surplus funds will nearly always be t pay ff external lans; hwever, mst cmpanies will need t hld sme cash reserves, and part f their brrwings will be ther than shrt-term (s nt repayable at will). 2. The Eurpean Cmmissin s psitin The issue f what incme deriving frm cmpany financial assets may qualify fr tnnage tax regimes is addressed in the Cmmissin s ruling f 10 June In this, the Cmmissin states that: A. Shrt-term mnetary investment f regular cash assets is a nrmal activity, directly cnnected t a shipping cmpany s main activities (item , frm 139). This incme qualifies inasmuch as that it is in line with shipping cmpanies regular incme frm said cash assets related t activities cvered by the tnnage tax regime; B. The fllwing incme des nt qualify fr fixed rates (i.e. the tnnage tax regime): Revenue frm shipping cmpanies exceptinal liquidity; Lng-term investments; Incme derived frm activities that d nt qualify fr the tnnage tax regime. ECSA agrees with the exclusin f incme as described under the last bullet, n the basis that all qualifying incme shuld derive frm shipping activities cvered by the tnnage tax regime. Hwever, A. and the first and secnd bullets under B. need further clarificatin, in the light f the shipping industry s specific characteristics and situatin as described abve. 1 2 PB L 150 f See ft nte 1 re the number 2

3 3. The need fr further clarificatin Frm practical experience, there is a real need t clarify bth the general principles t be applied and a number f terms which the Cmmissin is treating as pivtal t the questin as t what financial incme can qualify fr tnnage tax regimes. The fllwing paragraphs ffer suggestins fr clarificatin and cncern interest incme derived frm all activities related t the business f perating tnnage tax ships. Our cmments n the Cmmissin statement f 10 June 2004 are as fllw. Paragraph A. This begs the questin f what mnetary investments f regular cash assets are cnsidered t be shrt-term and whether this categry is restricted t what is typically described as wrking capital. In all cmpanies, including shipping cmpanies, incme and expenditure related t day-tday business may shw varying patterns. Many utgings fllw a fixed pattern, like seafarers wages, interest and payments n ships mrtgages, ships mandatry technical survey fees, as well as the cntinuus csts f fuel and lubricatin il. Incme n the ther hand is less reliable and can be mre irregular and subject t seasnal influences within a year. Because f all this, shipwners need t have access t cash reserves that are tailred t their specific situatin cncerning incme and expenditure. This is ften referred t as wrking capital. Wrking capital depsits may accrue interest. In the view f ECSA and the Eurpean Cmmissin, incme derived frm said interest qualifies fr the tnnage tax regime. Beynd wrking capital depsits, there are a variety f shrt-term depsits that arise frm nrmal shipping treasury peratins, such as the depsit f funds drawn dwn n lans in advance f investment in ships. In the view f ECSA all such interest incme shuld qualify fr the tnnage regime. Paragraph B. The first bullet raises the questin f what is cnsidered t be shipping cmpanies exceptinal liquidity, and the secnd bullet f what is meant by lng-term investments. ECSA assumes that cash depsits wuld nt be categrised as lng-term investments and certainly accepts that incme frm investments in nn-shipping shares wuld fall utside the tnnage regime. During the bm perid f recent years (up t 2008) shipwners faced very lng intervals between rdering new vessels and actually taking delivery f them. Tw t three years r smetimes even mre was nt an unusual perid f time. Nevertheless, shipwners were bliged t make dwn payments and/r prvide ther cllateral. At the same time, reserves had t be maintained t make peridic payments t shipyards during ships cnstructin. Reserves are als frmed fr the repayment f lan terms. Funds derived frm the sale f ne r mre vessels are cmmnly used as capital t meet these bligatins. Buying and selling ships are part f the nrmal activities f a shipping cmpany invlved in ship peratin 3. Any prfits accrued frm this kind f transactin wuld qualify fr the tnnage tax regime. In a significant number f cmpanies, especially the smaller and medium sized cmpanies, this capital is set aside in a different accunt and 3 Cmpanies that nly trade ships and that are nt invlved in ship peratin in accrdance with the tnnage tax regime s requirements are excluded frm the categry f shipping cmpany referred t in this paragraph. Therefre they are nt entitled t the applicatin f the tnnage tax regime s regulatins pertaining t incme, as prpsed in this memrandum. 3

4 clearly earmarked fr this purpse; the accunt is then als used fr actual payments 4. In the view f ECSA this capital shuld nt be regarded as exceptinal liquidity and therefre interest incme n these depsits shuld qualify fr the tnnage tax regime. As well as reserving financial assets fr financing the acquisitin f new r existing vessels, maritime mrtgagers may have their wn requirements cncerning the financial reserves that are t be available thrughut a ship s peratinal life during the perid f the mrtgage. Banking terms and cnditins will ften require shipwners t have a separate accunt fr reserves fr financing their shipping activities. These reserves, t, may generate incme and, in ECSA s view, the same principle shuld apply and the interest incme n these shuld als qualify fr the tnnage tax regime. ECSA RECOMMENDATION ECSA suggests that as a general rule designed t accmmdate all shipwners management practices and the industry s specific characteristics the fllwing categries f interest incme shuld qualify fr tnnage tax: 1. Interest incme frm shrt-term cash depsits frming part f, r relating t, wrking capital. 2. Interest incme frm cash depsits which are nt part f, r d nt relate t, wrking capital but arise frm nrmal treasury peratins relating t the business f perating tnnage tax ships, including (1) The maintenance f cash reserves t cver cyclical r seasnal dwnturns in the shipping business (2) The maintenance f cash depsits required by prviders f lan and lease finance (3) The depsit f prceeds frm the sale f ships pending either re-investment r utilisatin fr the repayment f lans (4) The depsit f funds drawn dwn in advance f investment in ships. There shuld be suitable safeguards t ensure that the interest is nt substantially cnnected t nn-qualifying activities. Hwever, as already mentined, the needs and circumstances f different cmpanies vary greatly and there are substantial differences in the balance sheets and funding f shipping cmpanies. Clearly, the detailed prvisins will be fr determinatin by the natinal taxatin authrities in the light f the particular circumstances f their natinal tax regime. Nevertheless, if apprpriate fr a natinal regime, the fllwing sets ut a framewrk f hw specific aspects culd be defined mre clsely fr small and medium sized cmpanies: Shrt-term cash depsits culd be defined as the cash ut (such as payments fr wages, insurance, fuel, interest, lan repayments) during a perid f 12 mnths; and Cnditins culd be set fr the depsits mentined in pints 2.(2), 2.(3) and 2.(4) abve alng the fllwing lines: 4 There may be ther ways f raising capital fr ships financing, like insurance payments received. 4

5 the depsit shuld be separately identified frm inceptin frm inceptin, the depsit shuld be either (a) clearly earmarked fr future investment in cmpany tnnage tax assets/ships (newbuildings r secndhand ships); r (b) built up in accrdance with banking terms and cnditins related t the financing f shipping fr the investment depsits referred t in (3), part r all f the depsit is subsequently used fr the intended purpse incme arising n the investment depsits referred t in (3) shuld cease t qualify fr tnnage tax after a number f years frm inceptin. Such an apprach wuld preclude benefits under tnnage tax regimes attaching t interest incme under ther circumstances (e.g. frm nn-shipping shares), which wuld nt qualify

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