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Lowtax – Shipping and Aviation Taxation

By Lowtax Editorial
31 October, 2012

In this article on some key recent developments in shipping and aviation taxation, we focus heavily on events in the European Union (EU) where Malta's burgeoning maritime industry is under considerable threat due to a state aid investigation by the European Commission, and where the aviation sector is confronting some taxing issues.

Malta's Tonnage Tax Under Threat

Thanks in large part to its favourable tax system for shipping, Malta now has the EU's largest shipping registry. By the end of 2011, a total of 5,830 ships were registered under the Maltese Merchant Shipping Act, for a total of 46.6m tonnes. There were also 300 super yachts registered in Malta at the end of 2011, representing 19% growth over 2010.

However, Malta may be told to remove certain tax concessions introduced to improve the attractiveness of its tonnage tax regime following the initiation of an investigation by the European Commission in July 2012.

In an attempt to ensure a level competitive playing field throughout the EU, European law prevents member states from granting 'state aid' to certain industries, companies or geographical regions by way of subsidies or tax breaks. It is these state aid rules that the European Commission now believes that Malta has infringed with regard to its tonnage tax regime and other tax measures.

In opening its investigation, the Commission said Malta may have extended favourable tax treatment, allowed by the EU Guidelines on state aid to maritime transport, to other categories of beneficiary that are not suffering from the same handicaps as those permitted state aid, and may not therefore be entitled to lower taxes.

The Guidelines on state aid to maritime transport allow member states to reduce taxes for the transport of passengers or freight under certain conditions. The Commission has said, however, that the scope of the Maltese tonnage tax scheme seems too wide and includes fishing vessels, yachts, oil rigs, and ship-owners who have no shipping activity of their own, such as pure lessors and financial institutions providing loans and guarantees to ship owners, operators, managers or administrators.

Malta's tonnage tax varies from EUR1,000 for ships not exceeding 2,500 net tonnes, up to EUR7,180 for vessels exceeding 50,000 net tonnes (plus 5 cents for every net tonne above this threshold). However, the amount of tax due can be lower or higher depending on the age of the ship: there is a 30% reduction in annual tonnage tax for ships which are less than five years old; and a 15% reduction for ships which are not less than five years old and not more than 10 years old. Vessels which are no less than 15 years old and no more than 20 years old pay an additional 5% in tonnage tax, rising to 50% for ships which are equal to or exceed 30 years of age. Commercial yachts pay an annual tonnage tax of EUR175 provided they are less than 24 metres in length. Commercial yachts of 24 metres or more in length pay tonnage tax on the same schedule as other ships.

In accordance with the Maltese legislation, profits related to vessels classified as 'tonnage tax ships' can be exempted from the standard provisions of the Income Tax Act. Pursuant to the Merchant Shipping Taxation regulations, the tonnage tax regime covers the income arising from shipping activities, which is defined as “the international carriage of goods or passengers by sea or the provision of other services to or by a ship as may be ancillary thereto or associated therewith including the ownership, chartering or any other operation of a ship engaged in all or any of the above activities or as otherwise may be prescribed”.

“However”, states the Commission's request for information on the tonnage tax regime to the Maltese government, “from Articles 85(1) and 85A(1) of the Merchant Shipping Act, it appears that even vessels of a size below 1,000 net tons can be declared as 'tonnage tax ships', therefore eligible for the tonnage tax regime, irrespective of operations or trade in which they are engaged, on such conditions as responsible ministers may deem appropriate.  It is evident from the table of tonnage tax rates attached to the Merchant Shipping Act that the tonnage tax regime would inter alia cover non-propelled barges, fishing vessels and yachts.”

“Numerous publications by law firms and consultancy companies on the internet seem to confirm the fact that all vessels and all maritime structures are eligible for tonnage tax treatment,” the Commission observes in the letter.

The Merchant Shipping Act in combination with the Merchant Shipping Taxation regulations provide that companies owning, operating, administering and managing ships are exempt from corporate income taxation arising from their shipping activities, subject to payment of the tonnage tax. Also financial institutions providing loans, issuing guarantees or issuing securities in relation to ship ownership, management, administration or operation are exempted from corporate income taxation arising from the relevant activities.

This means that the profits of ship owners without any direct involvement in the transportation of goods or passengers by sea can be covered by the tonnage taxation scheme instead of the corporate income, thus going beyond the Guidelines on maritime state aid.

“It therefore seems that the profits of companies which are pure commercial managers of ships (i.e. companies which enter into freight or passengers transportation contracts but use the services of other companies for honouring their contracts, through time or voyage chartering) can be subject to the tonnage tax regime,” states the letter. “This conclusion stems from the wide definition of shipping organisations used in the Maltese legislation. In addition, the possibility to subject to tonnage tax the revenues arising from chartering in with crew was confirmed by the Maltese authorities in their letter of 23 January 2012.”

The Commission has also taken issue with certain other “support measures” provided under Maltese legislation, including exemption from taxation of capital gains arising from the sale of ships, exemption from taxation of capital gains and dividends related to shares in shipping organisations, and exemption from the duty on documents and transfers.

The Commission concluded in the letter that, in view of the above, “all measures under examination constitute state aid” within the meaning of the Treaty of the Functioning of the European Union. "Given the multitude of exemptions and reductions available, it appears that in a number of cases the level of tax burden for a given tonnage is lower in Malta than in other member states,” the Commission stated upon announcing the investigation. “This could potentially make the Maltese tonnage tax system more attractive than the ones applied in the rest of the Union. Moreover, no sufficient safeguards are established to ensure that benefits available under the tonnage tax do not spill-over to non-shipping activities of the beneficiaries."

Announcing the Commission's investigation, Joaquin Almunia, Commission Vice-President in charge of competition policy, said: "The Commission acknowledges the contribution of the maritime transport sector to the EU economy. Given the high exposure to competition from third countries offering favourable tax treatment to their shipping companies, the European Union allowed the possibility to reduce taxes for maritime transport activities. In the Maltese case, the support measures apply to yachts, bankers, ship lessors, amongst other beneficiaries. This seems neither justified from a competition perspective, nor appropriate in times of high budgetary constraints."

It is unclear at this stage what the investigation will mean for Malta's maritime industry; the Commission only announced an invitation to submit comments on Malta's tonnage tax regime and other state measures on September 25, 2012, and there are many stages to an EU law infringement process should one be initiated – a process which can last for several years if the European courts get involved. However, it is probable that the Commission will demand some form of change to Malta's tax regime, so this is a development that needs to be watched closely in the months and years ahead.

Aviation: Trade War Looms Over EU Carbon Tax…

Environmental taxation continues to be one of the most pressing issues for the global aviation industry, and at the moment the source of most of the controversy is in Europe.

The extent to which the aviation industry contributes to worldwide carbon emissions is much disputed. Environmentalists consider air transport, particularly of the short-haul variety, to be one of the most environmentally-damaging forms of transport. However, the industry contends that it accounts for just 2% of overall CO2 emissions. Regardless of whether these figures are right or wrong, many governments are of the view that the only way to reduce aviation emissions is through taxation, either by making the airlines pay for what they emit, or by discouraging people from flying in the first place.   

Naturally, this is a great worry for the aviation sector. The International Air Transport Association (IATA) says that high taxes and onerous regulations continue to stymie investment in the industry, making the path towards sustained growth “an uphill struggle” at a time when the industry is barely able to make a profit.

The EU's approach to carbon reduction is also generating much friction between nations.

Europe's carbon tax under the EU ETS was controversially extended to aviation activities from or to European soil on January 1, 2012, to provide a solution to taxing aviation emissions, which were excluded from the Kyoto Protocol. Under the ETS, airlines operating into and out of the EU, regardless of how long a flight is in EU airspace, will be required to surrender varying emission allowances, and will be required to purchase any additional permits outside of their free allowance.

Since its introduction, the EU ETS has been a fractious issue between Europe and foreign nations, and heightened concerns that the measures may trigger retaliatory measures to the detriment of the sector. In defence of the design of the scheme, the European Commission has noted that the Directive provides that airlines would be exempt from carbon charges if their nation were to place equivalent levies on their domestic industry.

China has been leading the opposition against the extension of the ETS to international aviation, and has effectively forbidden its carriers to participate in the scheme.

The United States is also hostile. Following the passage by the House of Representatives in October 2011 of a bipartisan bill to ban US airlines from complying with the European Union's emissions trading scheme (ETS), the Senate unanimously passed similar legislation on September 23 this year.

The opinion has previously been expressed in Congress that the EU ETS is inconsistent with long-established international law and practice, including the Air Transport Agreement between the US and the EU; directly infringes on the sovereignty of the US; and undermines on-going efforts at the International Civil Aviation Organization (ICAO) to develop a unified, worldwide approach to reducing aircraft greenhouse gas emissions.

The US, along with the 16 other non-EU countries opposing the scheme, favours a global approach to avoid any conflict of sovereignty and to avert a potential trade war. The US government has already announced it would reject any unilateral EU ETS on airlines kicking in before 2020, and would hope that a global proposal could be discussed during the next meeting of the ICAO.

In that respect, while the Senate bill - the European Union Emissions Trading Scheme Prohibition Act - would prohibit operators of US civil aircraft from participating in the EU ETS, it also provides that the US Secretary of Transportation and the Administrator of the Federal Aviation Administration should “use their authority to conduct international negotiations … to pursue a worldwide approach to address aircraft emissions”.

In addition, the Secretary of Transportation would have to hold a public hearing at least 30 days before imposing any prohibition determined to be in the public interest, and may reassess that determination after any amendment of the EU ETS, the adoption of any subsequent international agreement, or the enactment of legislation or the issuance of a final rule in the US to address aircraft emissions.

The US airline industry welcomed the Senate's action. For example, Airlines for America (A4A), the industry trade organization for the leading US airlines, commended the Senate: "Congress has spoken - US airlines should not be subjected to this illegal scheme that amounts to little more than a cash grab for the EU as none of the funds collected are required to be used for environmental purposes," said A4A President and CEO Nicholas E. Calio.

He called the EU ETS “a breach of US sovereignty that actually limits our ability to build on our strong environmental record by investing in new and more fuel-efficient aircraft." He confirmed that, between 1978 and 2011, US airlines have improved fuel efficiency by 120%, and that US airlines carried 16% more traffic last year than in 2000 while using 2.3bn fewer gallons of fuel.

Calio said A4A supports a global sectoral approach to aviation climate change policy under the ICAO, as does the National Business Aviation Association, whose President and CEO Ed Bolen has previously called the scheme "fatally flawed," adding that, "as badly as the airlines are treated, general aviation is treated even worse" under the EU-ETS, which is “unfair, intrusive, administratively burdensome and fails any reasonable cost-benefit test for the environment.”

The aviation industry itself says that it is not opposed to carbon trading schemes, but only if one was implemented on a global basis.  Speaking at IATA's recent 68th Annual General Meeting and World Air Transport Summit hosted by China, the head of the Association called for nations to back a rational, global approach to achieving aviation-sector carbon-reduction goals, through recommendations under development by the International Civil Aviation Organization (ICAO).

"To meet our ambitious targets we will need a globally-agreed approach covering the areas of technology, operations, and infrastructure as well as positive market-based measures,” said Tony Tyler, IATA's Director General and CEO. “Everyone — including Europe — agrees that the solution must be a global agreement through the ICAO at the 2013 Assembly. But Europe's unilateral and extra-territorial inclusion of international aviation in its emissions trading scheme from 2012 is creating discord when we need harmony.”

Despite mounting international opposition to the ETS, the EU has shown no signs of backing down, and it will be interesting to see how the industry reacts once airlines begin remitting payments for carbon permits in 2013, and how the Commission reacts to cases of non-compliance, with airlines facing stiff penalties for not paying up.

…and Hostility Grows To APD

Airlines are facing another tax threat in the form of ticket taxes. These taxes are ostensibly environmental in nature, although there is next to no evidence that the governments imposing them use the revenues for environmental good, despite their claims.

The most punitive of these is the United Kingdom's Air Passenger Duty (APD). APD was first introduced in the UK in 1994 but it was subject to steep increases within the government's November 2008 pre-Budget report. The new APD system comprises four bands depending on the distance travelled, and has been criticized for being unjust, in particular by imposing higher rates on Caribbean flights compared to those to America and other equidistant destinations. From April 1, 2012, the tax is from GBP13 (USD21) to GBP26 in Europe, between GBP65 and GBP130 for intermediate destinations, between GBP81 and GBP62 for medium long haul flights, and between GBP92 and GBP184 for long haul flights. APD rates are due to rise again in April 2013.

Such has been the negative impact on tourism in certain destinations popular with British holiday makers, that foreign governments, as well as passenger groups, business lobbyists, and the aviation industry, have urged the UK to at least rethink the tax, if not scrap it altogether. The islands of the Caribbean have had a particularly strong voice on this issue. Saint Lucia's Prime Minister, Kenny Anthony, said in a letter to UK Chancellor of the Exchequer George Osborne in July that APD was having a “deleterious effect” on the economies of the Caribbean. “Visitor arrivals from the UK [have] declined every year for the past three years,” Anthony wrote. “In 2010 arrivals fell 19.4% below the 2008 level and 2011 registered 14.4% less compared with 2008. This decline in arrivals is exacerbated by a further reduction in on-island expenditure as the tax has had a negative impact on travellers' budget, resulting in reduced economic benefit to the country," he said. "Indications are that tourism receipts associated with these declining numbers in the last three years have fallen on average more than 25% below the 2008 level."

APD was also criticized by New Zealand Prime Minister John Key last year. “The APD places a significant burden on New Zealand businesses, on families who travel, and on our tourism industry. With the tax for New Zealand-bound passengers set at four or five times the costs of offsetting the carbon emissions produced, this logic is without basis,” said Key. “The British government's announcement... maintains this cost difference, and ignores the fact that environmental concerns about emissions are being addressed through the European Union's extension of its Emissions Trading Scheme to aviation emissions."

There are signs that the authorities are at last beginning to listen, however. In September, British Members of Parliament backed representations from the UK aviation industry in a new report, which calls for a drastic rethink to the UK's aviation policy. The report, from the All-Party Parliamentary Group on Aviation, says that government policy is stifling the nation's economic potential by imposing the highest tax burden in Europe under its APD regime. The report calls for a quantitative cost-benefit analysis of the impact of APD on growth and employment in the UK, against the revenues derived from the levy.

Later that month, a survey revealed that over half of the UK's members of parliament back a rethink of APD rates, with 40% fearing that the levy is damaging the country's position as a global air travel hub. The survey, carried out on behalf of the travel association ABTA, found that almost half of all MPs questioned believe that current rates of APD are putting UK businesses at a competitive disadvantage. 150 lawmakers were surveyed between May 22-June 22, with ABTA finding that 51% believe that a reduction in APD should be considered as a way to increase the UK's international competitiveness and encourage economic growth. 

Whether the government itself will listen is another matter. Office of Budget Responsibility forecasts suggest not, given the contribution the tax now makes to the government budget: APD is expected to provide GBP2.7bn receipts in 2011-12, rising to GBP3.9bn by 2016-17.

The government is also planning to expand the scope of the tax to include business jets from April 2013. This includes all flights on aircraft with an authorized take-off weight of 5.7 tonnes or more. Flights on aircraft of over 20 tonnes but with less than 19 seats will have to pay a new premium rate of APD which will be double the standard rate for each of the bands.

But the Isle of Man Goes its Own Way

If APD must stay, its  extension to business jets at least makes the system somewhat fairer, given that passengers using these types of aircraft have a much larger 'carbon footprint' than passengers travelling on large commercial aircraft. For the Isle of Man however, which has a rapidly growing aviation register, this is a step too far on the part of London, and Manx Treasury Minister, Eddie Teare  confirmed on October 19 that the island will not be following the UK's decision to subject business jets to APD.

Teare explained that the decision has been taken in support of the island's rapidly-expanding aircraft registry, which specializes exclusively in the registration of private- and corporate-owned business jets and twin turbine-engine helicopters. Isle of Man-registered aircraft cannot be used for commercial air transportation.

Teare commented: "The feedback Treasury received from the Department of Economic Development was that the vast majority of industry professionals and representatives saw the extension of APD to business jets as detrimental and contrary to the island's aims to support and encourage further inward investment in the island's growing aircraft sector. I hope that Treasury's decision not to extend APD to business jets will send out the message to the aircraft sector that the Isle of Man gives you freedom to fly."

Hartley Elder, Director of Civil Aviation at the Department of Economic Development added: "Business aircraft owners and operators are a valuable and flourishing component of the island's economy and they will be encouraged to visit the island by the Treasury's decision not to extend APD to business jets. The Isle of Man is already recognized as the registration 'one-stop shop' for business aviation, with ourselves at the Aircraft Registry, our colleagues in Customs & Excise and the private sector delivering a first class service to the industry. This decision supports our work and underlines the island's reputation as a business friendly location for the business aviation sector."

Under the constitutional framework governing the UK's relationship with its Crown Dependencies, the Isle of Man is permitted to set its own rates of taxation. However, don't be surprised to hear some rumblings of discontent from Westminster in reaction to the Isle of Man's decision.


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