Maritime Transport & Navigation Journal, Vol. 2 (2010), No. 2 Considerations on Introduction of Tonnage Tax Systems in the European Union Ghiorghe Batrinca* Constanta Maritime University Abstract Shipping in a truly international business and for many years, owners were tempted by financial incentives to move ships from national flags to flags of convenience. Many countries in Europe recognised that it is impossible to stop this process unless similar conditions are offered and they started to introduce tonnage tax systems. This paper is written in the context of Romania exploring the possibility of introducing a tonnage tax scheme in an effort to revive its fleet and presents the situation in Europe today together with advantages and disadvantages of such a system. Key words: tonnage tax, shipping, freight, fleet 1 Introduction For many years the number of vessels registered under the flag of convenience has increased and we have today over 50% of the world fleet registered. The reasons for choosing an open register are varied and include protection from taxes, the avoidance of national regulations, labour wage scales or political boycotts. Advantages offered by open registries were a real incentive for many European shipowners to move their ships from national registries to open registries. The lack of competitiveness of European-flagged vessels was recognised at the end of the 1980s and, in the absence of harmonised European measures, several EEA States adopted different arrangements for aiding maritime transport. The strategies adopted and the budgets allocated to support measures were different from one EEA State to the other in reflection of the attitude of those States to public aid or the importance they attach to the maritime sector. In addition, to encourage the re-registering of vessels, EEA States have relaxed rules concerning crews, notably through the creation of second registers. Second registers comprised, firstly, "offshore registers" belonging to territories which have a greater or lesser autonomy in relation to the EEA State, and secondly, "international registers", attached directly to the State which created them. In spite of the efforts made, a large part of the EEA fleet continues to be registered under the flags of third countries. This is because the registers of third countries which apply open registration policies - some of which are called "flags of convenience" - have continued and are still continuing to enjoy a significant competitive edge over the registers of EEA States. In the light of the differences between the aid systems adopted by EC Member States faced with more intense competition from non-community flagged vessels, in 1989 the EC Commission defined its first guidelines on this subject to ensure a certain convergence between the actions of the EC Member States. This method nevertheless proved to be ineffective and the decline of Community fleets continued. The guidelines were accordingly *Constanta Maritime University, gbatrinca@imc.ro Constanta Maritime University. All rights reserved. ISSN: 2065 2909
70 Batrinca reviewed, leading to a 1997 communication defining new Guidelines on State aid to maritime transport. The major development in recent years concerning support measures from the EEA States for maritime transport is the widespread extension in Europe of flat rate tonnage taxation systems ("tonnage tax"). Tonnage tax entered into force very early in Greece and was progressively extended to the Netherlands (1996), to Norway (1996), to Germany (1999), to the United Kingdom (2000), to Denmark, to Spain, to Ireland, to Belgium, to France, to Finland (2002) to Poland (2007). 2. Short Comparative Annalysis of Tonnage Tax Implementation in Various European Countries In Europe basically three different tonnage tax models can be distinguished: - the Dutch model, introduced in 1996 in advance of the EU guidelines; - the Norwegian model, introduced by Norway in 1996 and also based on the EU guidelines in spite of the fact that Norway is not a member of the European Union; - the Greek model, introduced in 1957. 2.1 The Dutch Model The Dutch model, introduced in 1996 in advance of the EU guidelines, is implemented by Belgium, Denmark, France, Germany, Ireland, Italy, The Netherlands, Poland, Spain and the UK. The taxable operating profit of a vessel is based on the tonnage of the vessel, and not on the actual operating results. The amount of deemed taxable profit is subject to ordinary (corporate) income tax rates. The main difference between the Dutch model and the ordinary taxation method is the calculation of the profit related to the shipping activities. Apart from that, the shipping company and its non-qualifying shipping income is subject to regular taxation rules. Calculating the tonnage tax Fixed/deemed profit calculated using 4 tonnage size groups. Based on net tonnage. The calculated profit is taxed against the statutory CIT (corporate income tax) rate, or in case of individual entrepreneurs, with individual income tax. Belgium has 5 tonnage size groups including a special low rate for qualifying large vessels (above 40,000 ton) subject to age conditions. The example below calculates the profit and tax according to the Dutch tonnage tax model for a 5 year old cargo vessel operated by a Dutch resident company operational all year with a gross tonnage of 20,000 and a net tonnage of 18,000. Amount of PROFIT per day Tax per 1000 net ton per day 9.08 up to 1,000 net ton 6.81 for the excess up to 10,000 net ton 4.54 for the excess up to 25,000 net ton 2.27 for the excess over 25,000 net ton Taxable profit: 1 x 9.08 + 9 x 6.81 + 8 x 4.54 = 106,69 per day = 38,941 per year Dutch corporate tax rate for 2007: 25.5% Corporate tax levied amounts to 38,941 x 25.5% = 9,929.
Considerations on Introduction of Tonnage Tax Systems in the European Union 71 Since 2009 Dutch authorities proposed to reduce the tonnage tax rate for larger vessels substantially. From a tonnage of 50,000 net ton, the tonnage rate will be lowered to 0.50 ($0.71) per 1,000 net ton per day. Who qualifies Entrepreneurs, e.g. individual entrepreneurs, foundations, legal entities, partnerships, permanent establishments. Denmark: only legal entities can opt for the tonnage tax system. Qualifying activities Operating vessels in international traffic; also dredging and towing activities can qualify under most systems, under condition that more than 50% of these activities take place at sea. The vessel owner/bareboat charterer must exercise certain management activities with respect to the vessel. Qualifying vessels/ownership Owned vessels (not bareboat chartered out). Vessels in bareboat charter. Vessels in time charter (only applicable if additional ownership requirements are met: Denmark: max 80% of the fleet s tonnage on time chartered vessels without purchase options (if a time charter vessel has a purchase option it is regarded as an owned vessel). Belgium and the UK: max 75% of the fleet s tonnage on time charter. Lock up period A choice must be made in year one and is fixed for 10 years, whether opted for the tonnage tax regime or not. Exceptions are: Belgium: opt at any time; choice fixed for 10 year period. Poland: choice to be made until 20 January of the first year of the tonnage taxation period or, in the case of a shipping company commencing the activities subject to tonnage taxation in the course of the tax year, until the day preceding the day of commencing these activities; the choice is fixed for 5 consecutive years. Capital gains Capital gains are not subject to additional tax. Deferred tax liabilities: valuation at fair market value upon entry into system and claw back rules on hidden reserves realized during lock up period. Deferred tax liabilities disappear after the lock up period: usually 10 years, Poland 5 years. Capital gains derived during the lock up period are part of the tonnage tax tax base (not subject to tax). Exceptions are: France: capital gains are subject to regular statutory tax rate. Poland: capital gains on sale of vessels will be taxed against a flat rate of 15%; a case tax exemption applies when reinvested in a purchase, co-ownership, modernization, renovation or rebuilding of the shipping fleet within 3 years from the moment of sale of that vessel. UK: no deferred tax liabilities. Flag requirement EU/EEA flag requirement (Germany: register requirement instead of flag requirement).
72 Batrinca Ship management companies From 2006 on, the tonnage tax regime has also been available for entrepreneurs conducting ship management activities. Since the fixed tonnage tax rates have shown to be higher that the actual profits, it is now proposed to introduce a 75% discount on the tonnage tax base for ship managers. 2.2 The Norwegian model The Norwegian model, introduced in 1996, is based on the EU guidelines and implemented by Norway (EEA member, not EU member) and Finland. The EEA is also bound by these guidelines. In the Norwegian model the taxation of the operating profits is deferred until profits are distributed, the company exits the tonnage tax system or the company is liquidated. A company subject to this tonnage tax system must pay a tonnage tax based on the net tonnage of the vessels. Calculating the tonnage tax Tax calculated at a degressive tax rate. Finland has 4 degressive size groups, Norway 3. Based on net tonnage. Tonnage tax is not part of the taxable income. Norway applies environment deduction for qualifying environmental friendly vessels. In Finland tonnage tax is calculated and paid on a yearly basis; dividends distributed by the tonnage taxed company are fully taxable for the receiving company. The example below calculates the profit and tax according to the Norwegian tonnage tax model for a 5 year old cargo vessel operated by a Norwegian resident company, with a gross tonnage of 20,000 and a net tonnage of 18,000, which is operational all year. Amount of TAX per day per 1000 net ton per day 0 up to 1,000 net ton NOK 18 for the excess up to 10,000 net ton NOK 12 for the excess up to 25,000 net ton NOK 6 for the excess over 25,000 net to Tax: 9 x NOK 18 + 8 x NOK 12 = NOK 258 per day = NOK 94,784 ( 11,240) Corporate tax levied amounts to NOK 94,784 ( 11,240) Who qualifies Legal entities; in Finland legal entities and permanent establishments, in Norway only Norwegian Limited Liability Companies. Qualifying activities Operating vessels in international traffic. Entrepreneurial activities on non-norwegian continental shelf, leasing out in bareboat, some domestic supply, seismic, anchor handling, tugs and stand-by vessels also qualify. Qualifying vessels/ownership Owned vessels.
Considerations on Introduction of Tonnage Tax Systems in the European Union 73 Vessels in bareboat charter. Vessels in time charter (Finland: max 50% time charter, only EU flagged chartered vessels and only applicable if additional ownership requirements are met). Lock up period Norway: opt every year (exit from the model will result in exit taxation as if all assets were realized at fair market value). Finland: fixed 10 year period. Capital Gains No capital gains taxes need to be paid as long as profits are not distributed. In Norway a participation exemption applies to shareholdings in companies residing in the EEA. This also applies to shareholdings in companies outside the EEA provided that the company is not regarded as resident in a low-tax jurisdiction and certain ownership conditions are met. Gains derived from realisation of shares in companies which do not meet the conditions for the participation exemption are exempt from tax if they constitute a qualifying asset under the tonnage tax model. However, such gains will be taxed upon distribution or upon exit from the tonnage tax model. Other capital gains and financial income are also taxable at a rate of 28% when the company is subject to tonnage tax. Norway: no deferred tax liabilities. Finland: tax deferral. Valuation of fixed assets at fair market value upon entry into the system. Taxation of capital gains at normal tax rate under regular taxation rules through indirect gain recognition method. This may be realised during tonnage taxation period, but the fair market value at the time of the entry limits the taxable amount. Taxes are paid on a yearly basis (if any); tax deferral does not disappear after the lock up period. Profits that were taxed under the tonnage tax regime are subject to 28% tax if distributed. Flag requirement EU/EEA flag requirement. Ship management companies No possibilities. 2.3 The Greek Model The Greek model was introduced in 1957 and implemented by Greece, Cyprus and Malta. The calculation methods applied by Cyprus and Malta differ slightly from the Greek one. The Greek model is mandatory for vessel owners who derive income from shipping. First the taxable gross tonnage must be calculated by multiplying coefficient rates by each scale of gross registered tonnage. This taxable tonnage is multiplied by an age corrected rate. Basically, in this model the shipping activity is taxed. In addition to that, all distributions are exempt from taxation up to the beneficial owner no matter how many intermediate holding companies are imposed. The Greek tonnage tax covers all vessels and all shipping activities. In terms of Maltese law, the tonnage tax regime is mandatory for vessel owners only in the sense that the registration fee and the annual tonnage tax are payable irrespective of whether or not the vessel owner or charterer makes use of the benefits and concessions contained in the Maltese tonnage tax regime. Calculating the tonnage tax
74 Batrinca Taxable tonnage of the vessel calculated based on coefficients using 6 tonnage size groups. Coefficients multiplied by taxable gross tonnage. Tax calculated by using a tax rate that corresponds with the age of the vessel. Cyprus uses 4 size groups and applies 25% deduction for vessels younger than 10 years; an additional 30% deduction can be obtained if the vessel management is performed in Cyprus. No CIT or dividend tax is levied on shipping profits. Malta uses 8 size groups and applies a fixed amount of tax per group + amount of tax for exceeding tonnage. Lock up period Greece/Malta: mandatory system. Cyprus: optional system (mandatory for vessels flying the Cypriot flag). Capital Gains Capital gains on vessels are not taxed. No deferred tax liabilities. Flag requirement Greece/Malta: Greek/Maltese flagged vessels qualify. Cyprus: EU/EEA flag requirement. Ship management companies Greece: not taxed if put under special regime. Only possible in Cyprus. Vessel management companies may choose on an annual basis to either be taxed under the tonnage tax system or have their net profits subjected to Cyprus corporate tax at the flat rate of 4.25% under certain conditions. In Greece tonnage tax extinguishes the tax liability of the owner and if the owner is a company this extends to shareholders. Tonnage tax also extinguishes tax liability in relation to operating profits, capital gains arising out of the vessel sale as well as liquidation proceeds. Who qualifies Greece/Cyprus: entrepreneurs, e.g. individual entrepreneurs, foundations, legal entities, partnerships, permanent establishments. Malta: a legal entity, qualified as a licensed shipping organisation : a limited liability company, a partnership, whether en nom collectif or en commandite, a trust or a foundation, any foreign body corporate or other entity enjoying legal personality, which has established a place of business in Malta. Qualifying activities Greece: ownership qualifies, not activities (the location of the management is of no significance). Cyprus: same as the Dutch model. Malta: a shipping organisation as a whole must qualify by carrying out shipping activities with own or charter vessels in international traffic. Qualifying vessels/ownership Greece/Cyprus: vessels registered here. For non Greek flagged vessels, a special regime applies to the operator. Malta: Malta registered, qualifying tonnage tax vessels (>1000 ton; smaller vessels cannot qualify, unless the Minister of Finance declares such vessels to be tonnage tax vessels ).
Considerations on Introduction of Tonnage Tax Systems in the European Union 75 3. Benefits and drawbacks of tonnage tax regimes 3.1 Benefits of a tonnage tax regime The key objective of the tonnage tax regime is to create a business environment which will deliver a number of real advantages for all shipping companies entering the regime. The related domestic business activities, supporting a vibrant shipping industry effectively managed and operated from within the jurisdiction, will constitute further growth in tax base (employment and business income) along with the additional or new tonnage tax income. Key benefits include: Simplicity Straightforward and clear-cut tax calculations are the hallmarks of the system. In case of pure shipping companies, it will minimise administrative and compliance effort regarding the computation of annual tax returns with accompanying cost savings; Increased cash-flow for vessel operators Low effective tax rate will make shipping companies internationally more competitive; Certainty The level of tax will be known, thereby decreasing the need for the company to make provisions in its accounts for deferred taxation; Flexibility Companies will have more freedom to make decisions that are commercially driven and are not primarily informed by taxation considerations; Clarity A company s tax position will be more easily understood, making the company more attractive to investors and potential business partners; Compatibility and competitiveness It levels the playing fields between domestic and international counterparts in cases where at least 15 other important maritime nations have introduced similar notional income tax systems; Employment and training It creates opportunities for local cadets and seafarers; If jurisdictions impose some sort of training requirement It will be accompanied by an increase in the availability of trained seafarers to the shipping industry; and Economic activity not ownership is rewarded Ship management companies must qualify. 3.2 Drawbacks of a tonnage tax regime A tonnage tax regime could have adverse economic consequences for operators if there would be a cyclical downturn in the international shipping industry. Similarly, a start-up firm investing in new vessels may find the standard corporate tax system more attractive due to the available accelerated tax depreciation provisions. Key drawbacks of a tonnage tax are as follows: The incidence of tax could be high In cases of an economic downturn in the shipping business with declining turnovers with subsequent declines of freight rates, high operating cost, especially if the operator owns a significant net registered tonnage; The notional income tax is payable even if operators turn in a loss situation; Once a company has opted for a tonnage tax election, most jurisdictions stipulate a lockin period of ten years, as constant switching in and out of the preferential tax treatment is accompanied by complex transition rules which are difficult to administer. For example, in times of declining world trade companies may suffer in terms of the tonnage tax an excessive tax burden and would be forced to opt out of the tonnage tax dispensation. In such situation, the shipping firm will be in terms of the standard tonnage tax dispensation be debarred from re-entry for ten years; and
76 Batrinca Since most jurisdictions regard a tonnage tax system as a preferential taxation regime, it commonly comes with a host of other government conditions such as the creation of reserves or training requirements for domestic cadet officers and crews. Consequently, any shipping company before opting for the preferential tonnage tax system must judiciously assess its complete financial position before such election can be exercised. References PricewaterhouseCoopers - Choosing a profitable course- European tonnage tax regimes for the shipping industry, 2007 ***Community Guidelines on State aid to maritime transport (97/ C 205/05), OJ C 205 ***Community guidelines on State aid to maritime transport, OJ No C 13, 17.1.2004 ***Communication from the Commission on the training and recruitment of seafarers of 6 April 2001, COM(2001) 188 final