Since October we have been writing a series of articles for Global Tax Weekly on the subject of the US Shipping Tax. Below is the full text of the first article. You may also download the article here.
US Taxation Of Income From International Shipping And Offshore Activities
This is the first in a series of articles on US taxation of income from the transportation of cargo or passengers to or from the US, or from the provision of services on the US Outer Continental Shelf, and the compliance regimes that apply to companies that receive such income.
There are two separate US tax regimes that apply to foreign corporations that own vessels that call at US ports or operate on the US Outer Continental Shelf. The first covers income generated by the carriage of passengers, or cargo to or from US ports. It is often referred to inaccurately as the “US Freight Tax.” We will only address the tax as it applies to the transportation of cargo. The second regime covers operations within the US exclusive economic zone (EEZ), primarily dealing with offshore oil and underwater mining activities.
Although commonly referred to as the “US Freight Tax,” the tax is not levied based on cargo nor is it restricted to “freight” as that term is commonly understood in the voyage charter context. The US tax is a tax on income received by owners, operators and charterers of vessels engaged in the transportation of cargo lifted or discharged at US ports. For that reason we will refer to it as the “US Shipping Tax.”
Prior to enactment of the Tax Reform Act of 1986 (“TRA86”), the US did not tax income generated by the transportation of cargo originating in, or destined to, non-US ports. Furthermore, the US treated all such income as “foreign” source. Thus, foreign corporations engaged in moving cargoes to and from the US for hire were not considered to have earned US source income and, thus, were not subject to US taxation on their income.
TRA86 amended Section 863(c) of the Internal Revenue Code (the “Code”) to change the “sourcing” rule for international shipping income. The new rule deemed 50 percent of the gross income earned from the operation of ships engaged in international transportation of cargo to and from the US to be US source, thus creating US source gross transportation income (“USSGTI”). TRA86 also added a gross tax of 4 percent on USSGTI by enacting Section 887. The changes adopted in TRA86 became effective as of January 1, 1987. Thus, for the first time, foreign shipping companies that had laden vessel calls at US ports were generating USSGTI that was subject to tax. Like other foreign corporations with US source income, these foreign shipping corporations were now required to file US tax returns to report that income.
Lastly, TRA86 amended Section 883 of the Code to create an exemption from the tax based on the place of incorporation of the foreign shipping corporation and on the residence of its controlling ultimate beneficial owners. In effect, Section 883 looks through the foreign shipping corporation’s ownership structure to find the physical persons who control it. The aptly named “look through” rule ignores non-physical persons in the ownership structure and rests the second branch of the exemption on where the controlling ultimate beneficial owners live.
As mentioned above, the US Shipping Tax is a flat 4 percent tax assessed on 50 percent of the gross income earned for the transportation of cargo to or from a US port whether the income is bareboat, period or voyage hire. Because the US Shipping Tax is a gross tax, it is imposed on all parties which earn income from the transportation of cargo to or from the US. In effect, it applies to each party that receives hire. No party in the chain can deduct anything from the gross income that it receives. Thus, registered owners receiving bareboat hire, disponent owners receiving timecharter hire, and sub-charterers receiving timecharter or freight from the transportation of a cargo to or from the US, are subject to the US Shipping Tax on their own income from the voyage independently of the others. Throughout this series we will often refer to “shipping corporations”; however, the same rules apply to any charterers or sub-charterers that earn USSGTI from a voyage.
TRA86 also added Section 638 to the Code to clarify that non-US vessels operating on the US Outer Continental Shelf (“OCS”) are operating within the US by defining the term “United States” to include the “seabed and subsoil of those submarine areas which are adjacent to the territorial waters of the United States.” Combined with Sections 871 and 864 of the Code, the new section made it clear that these non-US vessels were considered to be engaged in an active trade or business with the US. In effect, these vessels, which are not engaged in transportation, but servicing various offshore oil and gas or mining operations, become “places of business” in the US.
Unlike the owners of vessels lifting or discharging cargo at US ports, owners of vessels operating on the OCS are subject to US income taxes on their net profits, and not their gross income, like the US Shipping Tax. However, the owners of these vessels are subject to all US tax and reporting requirements, including payroll taxes.