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EU leaders have recently called for stricter rules to stop companies such as Google and Apple aggressively avoiding taxes in Europe, despite acknowledging they had done nothing unlawful. What does this mean for the shipping industry
At a summit to discuss energy and tax policy, the leaders of the three largest EU countries Germany, United Kingdom[ds_preview] and France took the opportunity at news conferences to lament the impact of corporate tax avoidance, following several cases involving US firms.

Large multinationals such as Google, Amazon and Apple have come under pressure as the levels of tax paid in the EU appear to be small compared to turnover or perceived profitability, as opposed to actual profitability disclosed in their EU subsidi­aries’ accounts.

Where does this leave shipping? Will shipowners feel the pressure of public opinion to force up taxes? Or will existing exemptions come under review and cease to apply?

No permanent establishment – no corporation tax

Most of the developed world taxes on the basis of a water’s-edge approach. That is to say it taxes income earned in a country rather than income earned from overseas activities by bona fide trading subsidiaries, but with anti-avoidance rules to protect tax take. In the case of Amazon and Google, it is perceived that, since they derive billions of dollars of turnover from EU clients, there should be tens or hundreds and millions of dollars of tax payable in Germany, Britain and France. But that is not the case. An overseas company, for example a US, Irish or Luxembourg company trading with customers in Germany or the UK via a website, will not even be treated as trading through a permanent establishment for German or UK tax purposes. If there is no permanent establishment, there is no corporation tax.

In its early years, Amazon invested heavily in infrastructure and in building up

market share at the expense of short-term profitability. This gave rise to substantial accounts and tax losses in the United States. The EU consumers purchased from the Amazon US website. The only function in the EU was the operation of warehouses, i.e. the EU subsidiaries operated a fulfilment warehouse on behalf of their US parent. Fulfilment warehouses are generally low-margin businesses, so most of the profits and revenue accrued to the United States.

It was only when the losses were used up that Amazon reorganised via a Luxembourg structure so that US tax was mitigated. There is very little German or UK tax avoidance. The Luxembourg structure avoids US – rather than German or UK – tax.

Shipping is the most international of businesses, even more so than Google or Amazon. Deep-sea ships trade globally and at first glance their only interaction with countries charging tax is when they call at ports in those countries. Hence the proliferation of freight taxes, especially in the Indian Ocean region, and in the Americas.

Low taxation in shipping

Up until the 1930s, most shipping was registered in the country in which it was owned. It was only after 1945 that open registers became popular, at the same time as Greek shipowners expanded dramatically. They were assisted by a benevolent Greek tax regime that exempted qualifying shipping activities from Greek tax. This resulted in the decline of mainstream flags as open registers became more popular. Thus, instead of being owned by British, French, German and US companies with British, French, German and US flags, ships were owned and flagged offshore. Their profits were not taxable in the high-tax countries. How was this possible?

Modern ships are quite difficult to trade on their own, with the master managing everything. They generally require the owning company to be managed, and they need onshore management, including shipbroking services, technical management, as well as crewing and manning services.

A company is generally resident for tax purposes in the country where it is incorporated or where it is managed and controlled from. In the UK a company is resident in the UK if incorporated there or, if not incorporated in the UK, managed and controlled from the UK. The key issue here, and the potential focus of taxing authorities, is the location of the shipowning company’s corporate residence. It is vital that the shipowning company is not managed and controlled from the UK and this means ensuring that the principal business decisions are taken by the directors outside the UK. Once this is achieved it is important that the offshore companies are not trading through a permanent establishment in the UK, or elsewhere, and that all services provided by companies under common control are on an arm’s-length basis.

It was therefore possible, with careful planning, for international shipping groups to structure matters so that comparatively little tax was payable.

Tonnage tax regimes

High-tax countries, in particular in Europe, reacted with tonnage tax regimes designed to compete with countries operating open registers. In north-west Europe, that is the Dutch/German tonnage tax model, ships are required to be owned by companies resident in the relevant country and vessels to be strategically and commercially managed from that country. The ships owned within the European tonnage tax regimes are owned in the most part by companies subject to normal (high corporate) taxes but with special rules governing the calculation of taxable profit.

This means that, generally, they pay a

flat rate of tax depending upon the net rate of tonnage of the vessels operated. This deemed profit is substituted for the actual shipping profits. Since they are operated and owned by a company resident in a high-tax country, it means that they can generally take advantage of tax treaties with countries charging freight tax, which reduces the overall tax charge.

International shipping therefore now falls into three categories:

1) Ships owned and operated by a high-tax country but without any tonnage tax regime to exempt profits. This is becoming less and less popular.

2) Ships owned in low-tax areas with open registers.

3) Ships owned and operated in the EU or similar taxable location but with a tonnage tax exemption.

How does the above compare to Amazon or Google?

Shipping’s profile is lower and the end-customers are companies. Shipping companies do not sell directly to the public (with the exception of ferries/cruise lines). Amazon and Google appear to the public to be businesses headquartered in the US, a high-tax country, and earn their revenues from the US and other countries with large populations and large GDPs, and with mostly high-tax regimes. It appears that the US Internal Revenue Service (IRS) does not agree with Amazon’s tax analysis, as last year Amazon revealed that the IRS wants 1.5 bill. $ in back taxes. The claim, which Amazon said it would vigorously contest, is linked to its foreign subsidiaries and associated payments. This contrasts with shipping, which is not selling or interacting directly with consumers in high-tax countries. Deep-sea ships trade with – rather than in – high-tax countries. The ships operated in high tax countries, but within tonnage tax, are complying with the spirit and intent of the tax law, rather than circumventing the law to achieve a tax result that was not intended.

It is the circumvention of the tax law that UK’s Prime Minister David Cameron was referring to when he called for global action on tax avoidance at the World Economic Forum in Davos. When making such comments as: »Those that avoid tax need to wake up and smell the coffee«, it is clear that Cameron is referring to consumer groups rather than to international shipping companies taking advantage of legislation designed to attract them. Germany’s Chan­cellor Angela Merkel has expressed her frustration that existing laws were not sufficient to capture taxes fully: »We will work towards ensuring that companies have to pay more where they are based,« she told reporters, adding that new rules would affect big companies most, although in many cases companies are basing themselves in low or no-tax jurisdictions.

Conclusion

Any further pressure will therefore come from high-tax areas increasing the impact of their anti-avoidance rules so that profits made by low-tax subsidiaries are imputed through to the parent company unless there is a conscious decision by the relevant high-tax country to exempt certain types of income. Therefore, going forward, it should continue to be possible for shipping companies to be located in low-tax areas, provided those companies are fully managed and controlled from those countries by real – as opposed to nominee – directors. Where companies are resident for corporate tax purposes in low-tax areas, but use services provided from higher tax countries, it will be important to analyse the transfer pricing position and, if necessary, to have this fully documented rather than waiting for an enquiry from either the IRS or similar tax authorities in France, Germany or the UK. To conclude, it seems unlikely that shipowners will come under significant pressure regarding their low tax position, as more and more countries are introducing tonnage tax regimes or similar, rather than reducing them. It is accepted that shipping is a special case that needs to be encouraged. Shipping can therefore easily distinguish itself from Apple, Amazon and Google. It is taking advantage of existing tax rules rather than circumventing them.

Philip Parr