EUROPEAN COMMISSION Brussels, 02.08.2000 SG(2000) D/ 105768 Subject: State aid No N 790/99 - UNITED KINGDOM UK tonnage tax Sir, Procedure By letter of 19 November 1999, the Commission was notified, in accordance with Article 88(3) of the Treaty, of a proposal for the introduction of a tonnage tax in the United Kingdom. This notification was registered on 24 November 1999. On 23 December 1999 the UK authorities were asked to provide additional information, which was received and registered by the Commission on 24 February 2000. Following a meeting on 17 March 2000, the Commission requested further information by letter dated 14 April 2000, which was received and registered by the Commission on 7 June 2000. The UK authorities submitted further information which was received and registered by the Commission on 7 July 2000. The period within which the Commission must take a decision therefore expires on 7 September 2000. Detailed description of the aid TITLE UK tonnage tax. SCHEME The tonnage tax is a new scheme that the UK authorities intend to introduce in the Finance Bill being put before the UK Parliament. The UK Inland Revenue will administer the scheme. The Right Hon. Robin COOK, MP Secretary of State for Foreign and Commonwealth Affairs Downing Street London SW1A 2AL United Kingdom Rue de la Loi 200, B-1049 Bruxelles/Wetstraat 200, B-1049 Brussel - Belgium Telephone: exchange 32 (0) 2 299.11.11 Telex: COMEU B 21877. Telegraphic address: COMEUR Brussels.
BUDGET After taking into account behavioural changes, it is thought that the annual cost of the scheme will be in the region of GBP 40 million a year in tax foregone. DURATION The regime is not of limited duration, although companies will only have a limited window of opportunity during which to decide whether to opt into the regime. For existing shipping companies, this window is 12 months from the date that the tonnage tax becomes UK law. For a new business, taking up shipping for the first time, it is 12 months from the time it first has qualifying shipping activities. Companies opting into the regime do so by means of a 10-year election, renewable annually on a rolling basis. Companies that have opted into the regime will be subject to tonnage tax rules irrespective of profitability in a particular year. There will be no facility for companies to opt-in and opt-out on an annual basis. If a company exits the regime before the expiry of its 10-year election, the scheme would include measures to recover balancing charges or tax on chargeable gains which the company avoided by being within the tonnage tax. Once a group of companies has left the tonnage tax regime, they could not re-enter unless the Government was to offer a new window of opportunity, which would require new UK legislation. RECIPIENTS The regime would apply only to those companies within the charge to UK corporation tax whose profits are derived from qualifying ships carrying on qualifying activities and which have opted into the regime. Qualifying ships are those which are sea-going and over 100 gross tons 1. Qualifying shipping activities are the transport of goods or passengers, marine assistance or the provision of services necessarily provided at sea. Although it is an optional scheme, election into tonnage tax would be on a group-wide basis. That is to say that all qualifying activities carried out by qualifying ships on the UK tax net within a group of companies under common control would be taxed on the same basis. The regime would include rules to deal with mergers and demergers to ensure the application of the principle of consistency of treatment across groups of companies. Non-qualifying companies or companies that choose not to elect would remain subject to the normal rules for calculating profits chargeable to corporation tax. 1 Gross tonnage is defined in the 1969 International Convention on the Tonnage Measurement of Ships, which has been in force since 1984 and which was made mandatory for all vessels from 18 July 1994 (including both cargo and passenger vessels). The gross tonnage forms the basis for manning regulations, safety rules and registration fees, and is also used to calculate port dues. Gross tonnage is a function of the total volume of all enclosed spaces in a ship. 2
According to the information provided by the UK authorities, it is estimated that three-quarters of eligible companies may elect into the regime between 501 and 1 000 companies. OBJECT OF THE AID The regime is a tax measure aimed at the shipping industry. It is designed to promote the competitiveness of UK shipping in the global shipping market by creating a positive fiscal environment for shipping in line with other major maritime countries, including other EU Member States. EXPECTED EFFECT OF THE MEASURE UK ship registration The UK authorities expect the size of the UK register to double within three years following the introduction of the measure, with sustained growth thereafter in the order of 5% per annum. Such growth would mark a dramatic reversal of the long years of decline of British shipping. According to the information provided by the UK authorities, the UK direct-owned fleet, which is regarded as the critical catalyst for generating employment and skills, has been in long-term decline at the rate of about 4% a year. Tonnage has fallen from a peak of 50 million dead-weight tonnes (dwt) in 1975 to only 9.7 million dwt in 1998. The UK registered fleet has declined even more. Only 20% of the UK-owned trading fleet is registered in the UK, while until the late 1970s it was almost unknown for UK ships to be registered elsewhere. The Chamber of Shipping has forecasted a further decline in ship owning in the present environment. Of current UK-owned shipping: - 20% is registered in the UK; - 54% is registered in UK Overseas Territory and Crown Dependency shipping registers 2 ; - under 1% is registered in other European Community Member States; and - just over 25% is on foreign registers. 2 As noted in point 3 of the Annex to the Guidelines, these registers are not considered to be a Member State s registers even if they serve in practice as a first alternative for shipowners based in that Member State; this is because they are located in and subject to the law of territories where the Treaty does not, in whole or in substantial part, apply. 3
The UK authorities expect that a tonnage tax would result in substantial reflagging to the UK of British-owned ships currently under foreign or other open registries. A major UK shipping company has given a public commitment to reflag to the UK a number of its ships currently registered abroad in the event of a tonnage tax being introduced. [ *] This commitment alone would increase the tonnage on the UK register by 75%. In addition, according to the UK authorities, they have already received advance enquiries from some 60 UK companies about reflagging their vessels to the UK in the event that a tonnage tax is introduced. These companies vary in size from those operating one or two ships to those with fleets of 15 or more ships totalling perhaps 200 000 gross tonnes, and cover all international maritime trading sectors. The UK authorities have informed the Commission that some 22 companies have registered 40 vessels totalling 451 000 gross tonnes since April 1999, including eight newbuilds. Of the reflagged vessels, the main tonnage has come from the Bahamian open register. While some of these UK registrations would have occurred regardless of the UK s new shipping policy, the UK authorities believe that the level of activity is considered to reflect companies confidence in the maritime future of the UK, in anticipation of the proposed tonnage tax regime. Employment of seafarers According to the information provided by the UK authorities, there has been a significant decline in the number of British seafarers between 1980 and 1997. The number of officers fell over this period by 78% while ratings fell by 65%. Projections supplied by the UK authorities indicate that, with an annual recruitment of 500 cadets per annum and a retirement age of 65 years, the number of officers would fall from around 17 000 now to less than 14 000 by 2002 and to about 9 000 by 2012. With the more realistic assumption of a retirement age of 57, the number of officers would fall to near 10 000 by 2002 and to under 6 000 by 2012. 4
An important feature in the UK s proposed tonnage tax scheme is the training link. A company participating in the tonnage tax regime would have to meet a minimum obligation to train one EU cadet for each 15 officer posts in existence on the vessels operated by the company. Where this is not possible, the company would have to make a cash contribution to the Maritime Training Trust in respect of each training place that it is unable to offer. The company s compliance with the training requirement would be monitored by the Maritime Training Trust and the Department for the Environment, Transport and the Regions. The target of the UK authorities is to increase the current annual cadet recruitment of approximately 500 per year by 100 additional cadets each year, thereby doubling the annual intake within five years, and generating 1 500 additional cadets over the period compared to a hypothetical continuation of the status quo. Fixed assets The UK authorities recognise that the retention and development of UK head office strategic and commercial management activities will be a key to the success of the proposed measure. They indicate that, in the event that a tonnage tax is introduced, one major UK shipping company has already undertaken to grow its UK management and that opportunities to acquire or merge with foreign operators would then be considered in terms of bringing them into the UK rather than moving its own operations overseas. The UK authorities expect this pattern of increased domestic activity to be reflected across the industry. Fiscal The UK authorities believe that the competitiveness of British shipping will be increased by: - facilitating the replacement of the current tax-driven investment by investment for sound commercial reasons. It will no longer be necessary for companies to time the purchase of new ships so as to maximise tax deductions; - providing a straightforward regime that is easily understood by global shipping investors; - offering certainty of future tax treatment and reducing artificially created deferred tax liabilities. MODALITY OF TAXATION Election into the regime would mean that participating company s profits from qualifying shipping activities would be calculated by reference to the net tonnage of each of the ships that it operates, whether directly owned or chartered in. The deemed profit thus derived would replace the normal tax measure of UK and foreign income from qualifying activities of companies within the regime. If it has activities other than qualifying activities, profits from these activities would remain subject to the normal rules for calculating taxable profit. 5
The profit from qualifying shipping activities would be calculated by reference to a fixed rate per 100 net tonnage 3 per day, as follows: Net tonnage of ship Fixed profit per day per 100 net tonnage GBP 0-1 000 net tonnage 0.60 For the excess up to 10 000 net tonnage 0.45 For the excess up to 25 000 net tonnage 0.30 For the excess over 25 000 net tonnage 0.15 For example, a ship of 1 500 net tonnage operated for a year would have an associated fixed profit of: 1000/100 x GBP 0.60 x 365 GBP 2 190.00 500/100 x GBP 0.45 x 365 GBP 821.25 Total GBP 3 011.25 This calculation would be done separately for each ship. For instance, a company owning two ships each of 1 500 net tonnage would have total profits chargeable to corporation tax of GBP 3 011.25 x 2 = GBP 6 022.50. The profits thus determined would be subject to corporation tax at the normal rates. RING-FENCING The tonnage tax regime is intended only to apply to qualifying ships carrying on qualifying shipping activities. Such activities would be ring-fenced to prevent a company or group of companies bringing profits from other activities within the tonnage tax regime or relieving losses from qualifying shipping activities against profits from other activities. If a company also has activities other than qualifying activities, profits from these activities would remain subject to the normal rules for calculating taxable profits. The UK authorities specify that the strategic and commercial management of all ships concerned must effectively be carried out from the UK, but that it is not a precondition of entry to the tonnage tax regime that the ships be registered in the UK or other EU Member States. 3 Net tonnage is defined in the 1969 International Convention on the Tonnage Measurement of Ships, which has been in force since 1984 and which was made mandatory for all vessels from 18 July 1994 (including both cargo and passenger vessels). 6
Qualifying ships A ship will qualify for the tonnage tax regime provided that it is seagoing, 100 gross registered tonnes or over and is used for one or more of: - the carriage of passengers or cargo by sea; - marine assistance (seagoing towage and salvage); - transport in connection with other services of a kind necessarily provided at sea (vessels such as dredgers would be excluded). Subject to the exclusion of vessels such as dredgers, where a vessel also carries out activities other than those listed above, there will be an apportionment of the company s profit or loss between the two activities upon the basis of the time spent on each activity. The precise rules to be used for determining such profit apportionments will be developed by the Inland Revenue. Vessels such as fishing boats and factory support vessels, pleasure craft, harbour and river ferries, floating supermarkets, restaurants and prisons, fixed and floating oil rigs and platforms, floating production storage and offtake facilities, floating storage units and floating accommodation used in the offshore industry, as well as port service vessels, are specifically excluded from the tonnage tax regime. Qualifying ships may be owned by or time-chartered by the company electing into tonnage tax, but the proportion of ships held on time-charter may not exceed 75% of the total tonnage operated by that company. Qualifying activities Qualifying shipping activities are the transport of goods or passengers, marine assistance or the provision of services necessarily provided at sea. The UK authorities indicate that the only activities to be included under the regime are: - Core activities: consisting of the operation of qualifying ships and such activities that are a necessary and integral part of that operation, excluding any commercial port activity. Commercial port activity is defined as any activity carried out as a discrete function for commercial gain and billed to customers or third parties, giving rise to a revenue stream and potential tax liabilities. - Secondary activities: services or facilities offered which are additional to the core activities but which are part of the total package offered to customers, provided that these would be unlikely to yield a profit were the normal tax rules to be applied. These will consist mainly of shipping related activities which are bought in and recharged to customers at cost. The shipping company therefore would derive no profit as it is effectively delivering the service at cost. 7
Non-qualifying activities No non-shipping-related activity may come within the tonnage tax. The operation of ports and commercial services provided to third parties within the port area are not qualifying activities (these include the loading and unloading of vessels for third parties, activities branched out from self-handling, and the pilotage and towing of vessels in ports). No profits arising from the provision of port services which are not shipping activities would be allowed within the tonnage tax regime. Where such port services are provided to a tonnage tax company by a connected party, the ring-fence rules will apply to ensure that open market prices are used for that provision. Rules The tonnage tax will only apply to genuine shipping operations and rigorous anti-avoidance provisions mean that the benefit of the regime will not be able to leak out to other activities. The UK authorities have given the assurance that other commercial activities, including port activities and commercial activities in other sectors will not be able to benefit from the tonnage tax regime. To ensure that no profits from any activity outside the ring-fence are covered by the regime, the UK authorities have indicated that: - open market values would be used for tax purposes where transactions within a group taking place across the ring fence; - tax relief for the costs of debt finance relating to the qualifying activities would not be available outside the ring-fence; - no expenses or losses derived from qualifying activities could be set against profits arising outside the ring-fence, and no deductions from any source would be available against tonnage tax profits; - the normal rules allowing one member of a group of companies to set off its losses against the profits of another would not apply between qualifying and non-qualifying activities within the group. In addition, there would be a general anti-abuse rule which would expel companies from the tonnage tax regime if they tried to use it to obtain a tax advantage in respect of any activities outside the ring-fence. Where this rule was applied to a company that is part of a group of companies, all other members of the group would also be expelled from the regime. Pre-tonnage tax losses would not be available for relief in any period after a company enters the tonnage tax regime. 8
Capital allowances Capital allowances are a horizontal UK fiscal measure which allow the cost of capital assets to be written off against the taxable profits of a business. Under the UK corporation tax system, capital allowances go to the legal owner of the assets. Therefore, if an asset is leased, the capital allowances go to the lessor rather than to the lessee. The UK authorities indicate that capital allowances would have no applicability to capital assets owned by companies whose taxable profits are calculated under tonnage tax rules. It is also proposed to limit the capital allowances available to organisations leasing ships to companies within the tonnage tax regime. Capital gains Capital gains on the sale of assets used wholly and exclusively for the purposes of qualifying shipping activities would be included in the pool of profits which are computed by reference to tonnage. However, capital gains arising on any shares are outside the proposed tonnage tax regime. Also, if a dividend from a foreign company is paid out of profits which include a capital gain on shares of its subsidiary company, that dividend is also outside tonnage tax and subject to the normal UK tax rules. Where the capital gain has accrued during a period partly within the tonnage tax regime and partly outside it, the part of the gain referable to the period outside the tonnage tax would be subject to the normal rules for corporation tax on chargeable gains. FOREIGN DIVIDENDS A crucial element for the success of the proposed tonnage tax regime, according to the UK authorities, is the inclusion within the tonnage tax ring fence of dividends declared out of qualifying shipping profits earned by qualifying foreign shipping companies. Qualifying shipping profits The UK authorities defined qualifying shipping profits as those which would qualify for the tonnage tax were such companies eligible for entry into the tonnage tax regime. If a company has a mixture of activities, then receipt of its dividend will be subject to the normal UK tax treatment. Qualifying foreign shipping companies Dividends to UK tonnage tax companies from foreign companies will only be allowed within the UK tonnage tax regime if a company/companies resident within the EU have the majority of voting power over the affairs of the foreign company and have their head office, which carries out the strategic and commercial management of all ships concerned, also located in the EU. 9
UK legislation will include rules to ensure that dividends may come within the tonnage tax regime only if they are paid out of profits earned after the UK company s entry into the tonnage tax. This will be checked by comparing the level of dividend paid with the level of profit earned during the relevant periods. The only foreign dividends which may come under the tonnage tax are those paid out of profits subject to tax. While dividends from foreign companies are currently minimal, partly because of the long-term depression in the cargo and bulk shipping markets, but more particularly because globalisation within the shipping industry is a relatively recent phenomenon, the UK recognises that the process of international rationalisation is now gathering speed and they are keen to ensure that the UK tax system does not act as a deterrent to national or Community participation in it. OVERLAP WITH OTHER SCHEMES Whilst shipping companies may be able to benefit from some horizontal measures within the UK tax system, the only other form of fiscal aid offered to the shipping industry is rollover relief for balancing charges 4. Whereas under normal accounting rules, depreciation rates are calculated on the useful life of a long-life asset and for tax purposes are assumed to be 6% per year, shipping is permitted for tax purposes a depreciation rate of 25% of the balance at the start of each accounting period. Shipping companies are also granted roll-over relief of capital allowance balancing charges under which they may defer tax arising from the sale of ships (namely the difference between the sale value and the tax depreciated value) and recognise it gradually over the life of the replacement ship. They also have extra flexibility as to when to take benefit of the allowances. Capital allowance balancing charges will only arise within tonnage tax during the first six years of a company s election into it, during which time balancing charges will be phased out. During the phase-out period, a much restricted version of roll-over relief will be available, allowing only a two-year roll-over as opposed to the six years offered under the normal scheme. On the assumption that in the region of three-quarters of eligible shipping companies will elect into the tonnage tax, it is expected that the overall take-up of roll-over relief in the normal corporation tax system will go down to a quarter of its previous level probably to an average of below GBP 5 million per year. 4 Case N 610/94. Notified to the Commission on 24 October 1994. Decision taken by the Commission on 21 February 1996. Letter sent to the UK on 6 March 1996 (SG(96) D/2868). 10
The only other forms of aid currently available to the shipping sector are: - Support for Maritime Training (SmarT) 5, introduced in April 1998 and costing GBP 6.4 million in the current year; - Crew Relief Costs Scheme (CRCS), introduced in 1988 and costing GBP 1.5 million a year. COMMITMENTS BY THE MEMBER STATE Policing The policing of the tonnage tax will be concentrated in four regional Inland Revenue centres of expertise. All but the very smallest companies would be subject to an in-depth review of their tax affairs on an annual basis. This review would ensure that all qualifying companies apply the ring-fence properly and consistently. It would include a scrutiny of foreign dividends to ensure that these originate from qualifying sources. Penalties The UK authorities confirm that the normal rules ensuring compliance with the UK tax system will apply. Any company found submitting false information will have to pay any additional amounts of tax shown to be payable on the basis of the correct facts, plus a penalty of up to 100% of that additional tax. Interest would also be chargeable on the additional tax calculated from the time it should have been paid, had the correct information been submitted at the outset. Reflagging Although the UK tonnage tax has no explicit flag linkage, the UK authorities are committed to encouraging the reflagging onto the UK register of the non-eu flagged ships of those companies benefiting from the tonnage tax regime. The UK has also undertaken to seek information on flag developments in any foreign companies remitting dividends to a UK tonnage tax company. Safety standards The UK authorities confirm that they rigorously enforce all relevant international and Community safety standards, including those relating to on-board working conditions. For the 20% of UK-owned shipping currently registered in the UK, this is carried out directly as the Flag State authority. For the 54% of ships on Red Ensign Group registers (UK Overseas Territory and Crown Dependency registers), the UK Maritime and Coastguard Agency has the responsibility to ensure standards are equivalent to the UK register. For the ships on foreign registers, the UK polices standards through an extensive programme of Port State inspections covering 25-30% of all such vessels visiting UK ports. 5 Case N 78/98. Notified to the Commission on 13 January 1998 and approved. Letter sent to the UK on 20 May 1998 (SG(98) D/4030). 11
Annual reports The UK authorities confirm that they will provide annual reports to the Commission on the UK registered fleet as from 2001. The report will also include: a list of the number, tonnage and previous country of registry of ships reflagged to the UK in the prior year; the annual total of certificated UK seafarers and the number of new EU officer recruits recruited each year via the tonnage tax training obligation. The UK will also report on the tax foregone on an annual basis calculated as tonnage tax receipts, less the baseline corporation tax for the year prior to the introduction of the tonnage tax. Assessment of the aid EXISTENCE OF AID UNDER ARTICLE 87(1) OF THE EC TREATY Under Article 87(1) of the EC Treaty 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 common market. Since the tonnage tax scheme outlined above grants aid through State resources in favour of certain undertakings, it threatens to distort competition and could affect trade between Member States. For this reason, this support measure constitutes State aid within the meaning of Article 87(1) of the Treaty. Article 87(2) of the Treaty, which provides for aid having a social character, aid making good the damage caused by natural disasters or exceptional occurrences and aid granted to the economy of certain areas of the Federal Republic of Germany, is not applicable to this sectoral aid case. Article 87(3)(a) which provides for aid to promote the economic development of areas where the standard of living is abnormally low or where there is serious underemployment is not applicable in this particular case as the measure under consideration is one that affects the maritime industry of a Member State and is not focussed on a particular region or regions. Article 87(3)(b) which provides for aid to promote the execution of an important project of common European interest or to remedy a serious disturbance in the economy of a Member State and Article 87(3)(d) which provides for aid to promote cultural and heritage conservation are not applicable for an aid to the transport maritime sector. LEGAL BASIS FOR THE ASSESSMENT Under Article 87(3)(c) of the Treaty, aid to facilitate the development of certain economic activities or of certain economic areas may be considered compatible with the common market, where such aid does not adversely affect trading conditions to an extent contrary to the common interest. 12
The 1997 Community Guidelines on State aid to maritime transport 6 (hereinafter referred to as the Guidelines) give details of aid to shipping companies which may be considered compatible with the common market. These Guidelines define the general objectives of such aid as: - safeguarding EC employment (both on board and on shore); - preserving maritime know-how in the Community and developing maritime skills; and - improving safety. In addition, in paragraph 3 of section 3.1 of the Guidelines, it is explicitly recognised that the issue is not one of competition between Member States but rather one of the lack of competitiveness of the Community fleet with respect to third-country competitors. Flagging out between Member States is a rare phenomenon. Fiscal competition is mainly an issue between EU Member States on the one hand and third countries on the other, since the cost savings available to shipowners through third country registers are considerable, in comparison with the options available within the Community. Furthermore, profits in shipping, which would be subject to tax, have been depressed in recent years so that the differences between effective rates of tax in the Member States have been marginal considerations. The Guidelines note that, in fact, there seems to be an increasing degree of convergence in Member States approaches to shipping aid. The Netherlands and Germany already have approved tonnage tax regimes in operation 7. Fiscal alleviation measures such as the tonnage tax are specifically provided for in paragraph 5 of section 3.1 of the Guidelines and can, in principle, be supported. However, the Guidelines establish certain criteria, in paragraph 8 of section 3.1, which must be met for this purpose. In this respect and as regards the UK tonnage tax, the Guidelines make the following points: The objective of State aid within the common maritime transport policy is to promote the competitiveness of the EC fleets in the global shipping market. Consequently, fiscal alleviation schemes should, as a rule, require a link with a Community flag. However, they may also, exceptionally, be approved where they apply to the entire fleet operated by a shipowner company established within a Member State s territory liable to corporate tax, provided that it is demonstrated that the strategic and commercial management of all ships concerned is effectively carried out from within the territory and that this activity contributes substantially to economic activity and employment within the Community. 6 Community Guidelines on State aid to maritime transport, Official Journal of the European Communities No C 205, 7.7.1997, p. 5. 7 Netherlands: Case NN 89/97 approved by the Commission on 15 July 1997. Germany: Case N396/98 notified by the German authorities on 16 June 1998 and approved by the Commission on 25 November 1998. 13
In this connection, it should be noted that most major European shipping companies are now involved in the operation of ships under various flags, including non-eu flags. This is due, inter alia, to the fact that the entire European fleet suffers from a lack of competitiveness in relation to companies registered in, and vessels flying the flags of, third countries. This competitive difference depends primarily on fiscal costs. ASSESSMENT OF COMPATIBILITY The objective and necessity of the measure The objective defined by the UK authorities, to arrest the decline and then to start to rebuild the UK maritime base, conforms with the specific objective for the fiscal treatment of shipowning companies as defined in paragraph 10 of section 3.1 of the Guidelines, to facilitate the development of the shipping sector and employment in support of the Community interest. The information provided by the UK authorities indicates that the UK direct-owned fleet has been in long-term decline at the rate of about 4% a year and a further decline in ship-owning is expected in the current environment. In addition, only 20% of the UK-owned trading fleet is now registered in the UK, while until the late 1970s it was almost unknown for UK ships to be registered elsewhere. The decline in the UK-owned and registered fleet has been accompanied by a significant decline in the number of seafarers. The UK have indicated that they believe that the current level of around 500 officer cadets entering training each year is much lower than is required to meet the long term needs of, and opportunities for, skilled people in the shipping and shore-based industries. This has potentially serious consequences for the continued strength of these related industries, in which the UK has long had a dynamic and leading role. Increasing the number of seafarers, particularly officers, is considered to be an essential aim for reviving the shipping industry. A June 1999 report from the Environment, Transport and Regional Affairs Select Committee 8 states that The UK shipping industry is in a parlous condition, and radical measures are required to arrest and reverse its decline. The UK Chamber of Shipping describes British shipping as being at a watershed, inter alia due to the ever growing shortage of qualified seafarers and the imminent decisions by companies on location, employment and registration. The UK authorities believe that, without a tonnage tax, new investment and much existing shipping business would be lost to the UK. They have received indications that this process could happen relatively quickly, as those companies which have held investment decisions pending finally jump ship. Without securing a significant UK industry, there would appear to be little prospect of developing the maritime skills base and employment. In short, it is considered that a tonnage tax needs to be an essential part of the UK Government s policy of reviving the shipping industry. 8 The Future of the UK Shipping Industry, quoted in paragraph 12 of the Independent Enquiry into a Tonnage Tax report prepared by Lord Alexander of Weedon, QC. 14
The fiscal disadvantages for UK shipping, as described in paragraph 2 of section 3.1 of the Guidelines, is clearly recognised by the UK authorities as a major reason for the decline in the UK merchant navy. Shipowners have found it too expensive to continue to operate with British seafarers on the UK register and under the UK tax regime. The UK authorities point to the importance of the fiscal environment by indicating that, after the withdrawal of 100% first-year capital allowance against corporation tax in 1984, the tonnage of UK direct-owned ships fell by over 20% in two years. They believe that a more attractive fiscal environment is critical and that the tonnage tax would provide such an environment. The expected effects of the measure While the UK have opted for a system which does not require a strict flag link, it is expected to establish a positive environment in the UK for shipping. The UK authorities have indicated that the current trend to move operations overseas to low tax regimes may not only be halted but also reversed. Following the UK Government s announcement that it had accepted the principle of introducing a tonnage tax regime, P&O, which represents 40% of the UK maritime industry on a gross earnings basis, declared in a press release that The UK will become the base for more of our international strategic and operational management. We will place more purchasing and equipment orders here and carry out more refits in British yards" 9. Such an increased strategic and operational commitment to the UK could be expected to lead to a relatively rapid effect on a company s flag strategy, since they will be able to reflag their ships and operate them in competitive conditions under the UK flag. The P&O chairman, in the same press release, indicated that although there will be no link between tonnage tax and flag, I am committing P&O to bring at least 50 ships onto the UK register. The UK authorities have indicated that they expect the size of the UK register to double within three years following the introduction of the measure and to grow thereafter at the rate of 5% per annum. They point to the fact that the commitment of P&O alone to reflag nearly 50 ships under a tonnage tax regime would increase the tonnage on the UK register by 75%. They also indicate that some 60 other companies of various sizes have been making advance enquiries and significant tonnages have been registered since April 1999, to some extent in anticipation of the proposed tonnage tax regime. Figures recently obtained by the Commission from the Dutch authorities on shipping developments since the introduction of their tonnage tax are very positive and give weight to the expectation of significant reflagging. The number of Dutch-flagged vessels has increased by 46% since the introduction of the tonnage tax scheme, which indicates that the proposed measures would facilitate the development of the shipping sector in support of the Community interest as defined in paragraph 10 of section 3.1 of the Guidelines. The proposed tonnage tax regime has a specific requirement for participating companies to meet a minimum training obligation of one EU cadet for each 15 officer posts in existence on vessels operated by the company, or to make a cash contribution where this is not possible. The target of the UK authorities is to double the existing annual recruitment of 500 cadets over the first five years of the tonnage tax regime, which would be a significant gain given that the total number of UK officers is currently around 17 000. In addition, studies have indicated that the age distribution of the current UK officer population is heavily skewed 9 P&O Welcomes Government Shipping Initiative. P&O Press Release. 12 August 1999. http://www.p-and-o.com/announce/release/120899.htm 15
towards older officers as a result of past under-recruitment. This age distribution would show an immediate improvement as a result of increased recruitment even if, in the short to medium term, the overall numbers of UK officers may still decline due to the net losses arising from the retirement of older officers. This training requirement of the tonnage tax will therefore facilitate the development of employment as defined in paragraph 10 of section 3.1 of the Guidelines. PROPORTIONALITY OF THE MEASURE Aid intensity The aid intensity proposed by the UK authorities is virtually identical to that approved for the German and Dutch tonnage tax schemes 10, while the net tonnage steps specified are identical with the German scheme and comparable with the Dutch. The annual cost of the scheme is anticipated to be in the region of GBP 40 million a year in tax foregone. Ring-fencing The UK authorities have presented a series of ring-fencing definitions and measures to prevent the distortion of competition and to ensure that the benefits of the regime only apply to qualifying shipping activities. The normal UK rules for working out taxable profit will continue to apply to any activity outside the ring-fence, even if that activity is carried on by a tonnage tax company. This is in conformity with the second sentence of paragraph 10 of section 3.1 of the Guidelines, that the fiscal advantages must be restricted to shipping activities; hence in cases where a shipowning company is also engaged in other commercial activities, transparent accounting would be required in order to prevent spill over to non-shipping related activities. Qualifying ships have been restricted to those engaged in the transport of passengers and cargo by sea, marine assistance and transport in connection with other services of a kind necessarily provided at sea. There is a clear objective of restricting the qualifying vessels to those whose primary commercial activity is maritime transport. Therefore, as previously noted by the Commission, vessels such as dredgers and port service vessels are specifically excluded. Qualifying activities have been restricted to the operation of qualifying ships and such activities that are a necessary and integral part of that operation. This would include all activities carried out on board qualifying ships at sea, but would exclude commercial services provided to third parties within the port area, such as the loading and unloading of vessels, activities branched out from self-handling, and the pilotage and towing of vessels in ports. 10 At the annual exchange rate for 1999 of DEM 1 = GBP 0.3368 and HFL 1 = GBP 0.298921. 16
Qualifying secondary activities, as defined by the UK authorities, are mainly shipping-related activities provided at cost as part of the total package offered to customers. These services or facilities would be bought in and recharged to customers at open market prices and would not yield a taxable profit if normal tax rules applied. The UK authorities believe this necessary to avoid an unacceptable regulatory burden on companies which would otherwise have to establish whole new accounting systems and file separate tax computations in respect of activities which would not give rise to any additional tax. In addition, the UK authorities are committed to a rigorous annual review of the tax affairs of all but the very smallest companies. The rules defined by the UK authorities will ensure that the benefits of the tonnage tax regime will not leak out to other activities. This, combined with the general anti-abuse law and the penalty of expulsion from the regime for any company or group of companies found to be trying to obtain a tax advantage for any activity outside the ring-fence, conforms to the provisions of the Guidelines. Non-strict flag link The Guidelines permit, in paragraph 8 of section 3.1, a non-strict flag link for the entire fleet operated by a shipowner company established within a Member State s territory liable to corporate tax, provided that it is demonstrated that the strategic and commercial management of all ships concerned is effectively carried out from within the territory and that this activity contributes substantially to economic activity and employment within the Community. The proposed UK tonnage tax regime does not have an explicit flag link. However, it would only apply to those companies within the charge to UK corporation tax and any company opting into the scheme must itself operate ships which are strategically and commercially managed from the UK. With respect to the evidence required by the Guidelines to demonstrate this economic link, the UK authorities have indicated that they expect the size of the UK register to double within three years following the introduction of the tonnage tax. The experience so far of the Dutch tonnage tax scheme would support this expectation of significant reflagging onto the UK register. The regime has a specific training link, requiring that all companies electing into the scheme must meet a minimum training obligation of one EU cadet for each 15 officer posts in existence on vessels operated by the company, or making a cash contribution where this is not possible. This is expected to lead to a doubling of the existing annual recruitment of cadets and so favours the employment of EU nationals on ships and the preservation of maritime know-how in the Community. The UK acknowledges that the retention and development of UK head office strategic and commercial management activities will be the key to the success of the tonnage tax, indicating that a major UK shipping company has already undertaken to grow its UK management and, more importantly, has stated that opportunities to acquire or merge with foreign operators would be considered in terms of bringing them into the UK rather than moving its own operations overseas. This will promote the repatriation of the strategic and commercial management of all ships concerned in the EU. In addition, this pattern of increased domestic activity in the UK could be expected to be reflected across the industry, with associated new investment in management systems and facilities in the context of a more positive fiscal environment for shipping. 17
The proposed tonnage tax regime, with the significant reflagging anticipated, its integral training requirement for EU nationals and the increased domestic activity in the UK, is therefore consistent with the requirement for the economic link defined in paragraph 8 of section 3.1 of the Guidelines. In addition, in conformity with paragraph 9 of section 3.1 of the Guidelines, the UK have committed to submitting regular reports on the UK-registered fleet, including the annual total of certificated UK seafarers. Foreign dividends The UK indicates that the tonnage tax regime is designed to secure within the Community the head offices and strategic and commercial management of the fleets of international shipping companies/groups. For this to be achieved, UK tonnage tax company head offices need to be able to receive dividends from foreign shipping companies without incurring UK Corporation Tax. The foreign companies themselves would not be tonnage tax companies, would not derive any benefit from the proposed UK tonnage tax and would be taxed according to the rules of the State where they are resident. The UK believes that the inclusion of qualifying foreign profits within the tonnage tax regime is crucial to its success. To require payment of UK corporation tax on remittances would make the basic regime less attractive, with the result that parent companies might well move offshore, probably outside the Community. With the growing consolidation and restructuring in the international shipping industry expected to result in the emergence of a very few global operators, the UK argues that it is essential for the development of shipping in the Community that the European identity and management of the present UK/European global companies and joint ventures is retained, and that future ventures are secured through the location of their corporate head offices and other ship management functions within the Community. Therefore EU tonnage tax regimes need to provide broadly equivalent fiscal environments for international shipping companies to those available in other centres of international shipping. The UK highlights, in particular, the situation of joint ventures between EU and non-eu partners, where there is considerable pressure for management functions to be located away from the Community. This issue is specifically acknowledged in paragraph 7 of section 3.1 of the Guidelines: It is also recognised that the incentive for expatriation of management and ancillary activities would continue if the shipowner obtained a significant benefit from maintaining different establishments and accounting separately for Community flag earnings and other earnings. This would be the case, for example, if the non-community flag earnings were liable either to the full rate of corporate taxation in a Member State or a low rate of tax overseas if overseas management could be demonstrated. The inclusion of qualifying foreign profits within the tonnage tax regime would be an exception to the general taxation regime in the UK. This would not be the case in a number of Member States where, subject to certain conditions such as minimum shareholding requirements, foreign dividends paid by a subsidiary company to its parent company are entirely exonerated from normal corporate taxation. This is on the basis that the profits generating these dividends have already been subject to taxation in the country of origin. Other Member States apply exemptions of between 60% and 95%. In contrast to this participation exemption system, a minority of Member States, including the United Kingdom, 18
systematically tax all overseas dividends upon receipt, with the possibility of a tax credit being given for any tax already paid. Special rules to deal with foreign profits are therefore necessary to deliver a UK tonnage tax regime of equivalent worth to shipping companies as delivered by tonnage tax regimes in other Member States and elsewhere. For the dividends from the foreign company to fall within the tonnage tax regime, the UK requires that the company or companies resident within the EU must have the majority of voting power over the affairs of the foreign company. This both ensures that the beneficiaries of the schemes must be liable to corporation tax in the Community and that strategic and commercial management of all ships is effectively carried out from within the EU, as required in paragraph 8 of section 3.1 of the Guidelines. Ensuring that the strategic and management functions are retained within the EU during a period of industry concentration will promote continued, even increased, economic activity and employment within the Community. This appears confirmed by the commitment of a major UK shipping company to grow its UK management and that opportunities to acquire or merge with foreign companies would be considered in terms of bringing them into the UK rather than moving its own operations overseas. This is consistent with the requirement in paragraph 8 of section 3.1 of the Guidelines that the aid must be necessary to promote the repatriation of the strategic and commercial management of all ships concerned in the EU. Thus, the conditions for a non-strict flag link, that is to say that the shipowner is established within a Member State s territory liable to corporate tax, that the strategic and commercial management of all ships concerned is effectively carried out from within the territory and that this activity contributes substantially to economic activity and employment within the Community, are fulfilled, since the management of the whole group, including the ships owned by the foreign companies which are part of this group, must be carried out from within the EU. The Commission is aware of the review work on harmful tax practices and in the event that the Member States make changes to participation exemption regimes in the light of that work, the Commission would take, if necessary, the appropriate measures in line with the changed circumstances. Ceiling of the aid The UK authorities have indicated that the only other specific fiscal aid system offered to the shipping industry is rollover relief for balancing charges, which was registered as Case N 610/94 and cleared by the Commission in a decision on 21 February 1996. This scheme will be phased out for those companies that opt into the tonnage tax regime. The only other forms of aid currently available to the shipping sector, detailed above in section 3.11, are: - Support for Maritime Training (SmarT); - Crew Relief Costs Scheme (CRCS). According to paragraph 2 of section 10 of the Guidelines, total aid in the form of relief of fiscal and social charges, crew relief, direct aid for investment and regional aid, should not exceed the total amount of taxes and social contributions collected from shipping companies and seafarers (the ceiling to aid). The Commission notes that the United Kingdom has at 19