International Shipping Industry Benefits from Recent Tax Changes
Lifson, David A., Bentley, Peter E., The CPA Journal
Despite its continuing importance, the shipping industry has lost most of the prestige it held in this country. One reason is that although several U.S. shipping companies are publicly traded, the nation is less well represented in international shipping than in other, comparable global industries.
Several explanations have been offered for this decline. The explanation favored in the shipping world is that the U.S. and other Western countries have not competed with low-cost shipping centers in other nations. Labor costs, tort laws, and taxes are often cited as contributing factors.
To partially address this complaint, and in an attempt to incentivize the U.S. shipping industry, the American Jobs Creation Act of 2004 includes four measures-the deferral of freight tax regulations; changes to the controlled foreign corporation rules; changes to the foreign tax credit rules; and the introduction of a tonnage tax for qualified entities-that represent a dramatic change in federal tax policy and will likely make the U.S. environment more attractive to businesses engaged in U.S.-international shipping.
Stricter Regulations Delayed One Year
Although technically an income tax assessed on the U.S. activities of foreign ship-owners and operators, the 4% tax on U.S. gross transportation income, the so-called "freight tax," has concerned the international shipping community since its introduction in its current form in 1986 under IRC section 887. Regulations implementing the freight tax have been delayed by one year under the Jobs Act, allowing one more year to stabilize the rules going forward.
Background. Under established U.S. law [IRC sections 863(c)(2)(A) and 887(a)], foreign ship-owners that derive income from U.S. voyages are generally taxed at a 4% rate on half of the gross income related to U.S. voyages (i.e., an effective 2% rate). This method apportions half of the revenue from international voyages to the U.S. and leaves half offshore. This gross income tax is assessed without offset or deduction on each foreign person engaged in international shipping that calls on a U.S. port. Several persons could owe a tax on the same voyage, including, for example: a vessel owner who "bareboat" charters the vessel (i.e., a captain or crew is not provided, and the owner relinquishes dominion and control of the boat to the customer) to an operator for five years; the operator, who hires a crew, manages the vessel over the bareboat period, and "timecharters" the vessel to another party for a fixed period; and the voyage charterer who hires the vessel from the timecharterer for a single voyage and charges his customer "freight" for hauling the cargo from a foreign port to the U.S.
Without an exemption, the owner must pay a U.S. tax of 2% of the bareboat charter fees from the day the ship leaves a foreign port for the U.S. until it arrives in another foreign port even though the owner had no control over the vessel's ports of call. Similarly, the timecharterer pays 2% of the fees it has charged for the same voyage, and the voyage charterer pays 2% of the total charges for delivering freight (i.e., the cargo) to or from foreign ports.
Exemptions are available to ship-owners and operators that either claim benefits under a U.S. tax treaty or qualify under a statutory rule for ship-owners and operators that operate in jurisdictions that provide a reciprocal (also known as equivalent) exemption from local taxes to U.S. ship-owners [IRC section 872(b)(1)]. IRS rules promulgated since 1986 have required that a foreign ship-owner file a U.S. tax return to document the claim of exemption, even when no tax is due. (see Revenue Procedure 91-12 and Revenue Ruling 2001-48.)
2003 regulations. In 2003, the 1RS finalized the freight tax regulations to fully implement the statutory exemption from freight tax (Treasury Regulations sections 1.883-1 et seq). These regulations significantly expanded the requirements under prior nilings and procedures and instituted extensive additional reporting, including detailed information about vessel ownership and U. …