This seventh in a series of articles on the US taxation of shipping income explains the “look through” rule that applies to exemptions from the tax available pursuant to Section 883. The next article will explain what must be done to comply with the filing requirements associated with Section 883 exemptions.
The tax on USSGTI may be avoided, using one of two avenues: a reciprocal exemption provided for in Section 883 of the US Internal Revenue Code or the provisions of a US tax treaty. We have discussed treaty exemptions, and our last article began the explanation of the exemptions available under Section 883. This article describes the “look through” rule that applies to all Section 883 exemptions.
As explained earlier, Section 883 sets out a two step qualification process. The first step relates to the country in which the registered owner of the vessel and its charterers that earn USSGTI are organized. Assuming the company with USSGTI meets the requirement of the first step – i.e., it is organized in a “qualified foreign country” –, it must demonstrate that it is controlled by qualified shareholders.
Section 883 mandates that legal entities (e.g., corporations, trusts, limited liability companies, partnerships, etc.) be ignored. Ownership must be traced to the physical person or persons who ultimately control the company that seeks exemption under Section 883. With a very few exceptions, only human beings can be what the Section 883 Regulations call “qualified shareholders” also referred to as ultimate beneficial owners or UBO.
To be a qualified shareholder a UBO must “reside” in a country which extends an equivalent exemption. The Section 883 Regulations refers to these as “qualified countries”. The countries listed in Revenue Ruling 2008-17, Part I or Part II, are qualified countries. A person residing in any of these countries, regardless of the type of exemption (treaty, diplomatic note or domestic law) that the country has, can be a qualified shareholder, provided he or she meets the residency requirements specified in the Section 883 Regulations.
The Section 883 Regulations set out two residency requirements. The first specifies that the person is a resident of a qualified country only if he or she is “fully liable” to tax in that country and the person has a “tax home” there for at least 183 days in the tax year for which the company of which he or she is a UBO seeks exemption. The definition of “tax home” includes both a “regular or principal” place of business test and a “place of abode” test. The Regulations specifically disqualify persons who reside in a country on a “non-domiciliary” basis, that is, persons who pay tax only on income brought into a country, not on their worldwide income.
The Section 883 Regulations apply the “look through” rule by use of “constructive ownership” or attribution rules, that is, the regulations stipulate how ownership of an entity shall be apportioned. In the simple case of a corporation, ownership is attributed based who owns its shares. There are constructive ownership rules for partnerships, trusts and estates, taxable non-stock corporations, mutual insurance companies, non-government pension funds, and non-profit organizations.
The Section 883 Regulations give particular attention to shares issued to bearer, commonly known as “bearer shares”. Essentially, notwithstanding the constructive ownership rules that attribute ownership of a corporation proportionally to the holders of its shares, the Section 883 Regulations specifically do not allow bearer shares to be attributed to anyone unless the shares are in an immobilized or dematerialized book entry system. Most off-shore jurisdictions that permit bearer shares (Liberia, Marshall Islands, Panama and Cayman Islands, to name four) do not have such systems in place. Thus, the recent amendments to the Section 883 Regulations permitting attribution of bearer shares in such systems are of no practical use to most companies that use bearer shares. Of course, countries that allow bearer shares also authorize companies to issue shares in the names of the shareholders. These are sometimes called “registered” shares.
The look through rule tracks ownership up the chain to the UBO. Thus, when a company seeking exemption under Section 883 is wholly owned by a second company, the look through rule ignores the second company and looks to its shareholders. If qualified shareholders own less than a controlling interest in the second company, that company’s wholly owned subsidiary will not qualify for exemption under Section 883. The same is true no matter how many layers of ownership exist above the company seeking exemption under Section 883. The UBO must have control of the company seeking exemption.
The Section 883 Regulations contain a significant carve out from the look through rule for publicly traded companies. That is, the regulations recognize some publicly traded companies as UBO’s. It is very important to note that “publicly listed” does not equal “publicly traded” for Section 883 exemption purposes. To be considered “publicly traded” under the Section 883 Regulations, a corporation must not only be listed on a recognized stock exchange, but its shares must be primarily and regularly traded. Furthermore, more than 50% of its shares must be owned by shareholders none of whom own 5% or more of the shares. In other words, if a shareholder of a publicly listed company owns 50% or more of the shares of that company, it will be treated as a private company under the Section 883 Regulations.
The next article will discuss the substantiation and documentation of ownership requirements associated with Section 883 compliance.
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