Policy paper

Statement of Practice 4 (2000)

Published 1 April 2000

Introduction

1. This statement covers the general operation of the Tonnage Tax regime for shipping companies. Unless specifically stated otherwise, any reference to a paragraph or part number relates to Schedule 22, Finance Act 2000.

Allocation of cases

2. HM Revenue and Customs (HMRC) will be allocating existing network cases to a number of tax offices specialising in Tonnage Tax. They are:

• Liverpool Queensway (for the Northwest, London and Northern Ireland)
• Hull 2 (for the rest of England and Wales)
• Aberdeen St Nicholas (for Scotland)

3. Cases dealt with by the Large Business Office (LBO) will generally remain where they are, but Liverpool LBO will specialise in Tonnage Tax groups.

4. Oil Taxation Office will continue to work oil industry cases that elect into Tonnage Tax.

Contacting HMRC

5. Existing shipping companies and their agents should initially contact their current HMRC office. Transfers of companies/groups will be arranged in accordance with the previous paragraphs.

6. Newly set up businesses, including overseas concerns, considering entering Tonnage Tax should contact Liverpool Large Business Office. The Tonnage Tax unit at Liverpool LBO will also act as the technical head office for Tonnage Tax. It may be contacted at:

Liverpool Large Business Office
Regian House
James Street
Liverpool
L75 1AE

Telephone: 0151 242 8025 Fax: 0151 242 8046 Email: John Hoggarth

7. A ‘training commitment’ forms a necessary condition of entering the Tonnage Tax regime. However, HMRC do not administer the training commitment. Enquiries on training should be addressed to the:

Department for Transport
Shipping Policy 2A
2/26 Great Minster House
76 Marsham Street
London
SW1P 4DR

Telephone: 020 7944 5438/5421/5121/5280

Fax: 020 7944 2182

Clearance

8. A non-statutory and non-mandatory clearance procedure is available to enable any company or group interested in Tonnage Tax to discuss its own circumstances with HMRC in advance of making the initial election or before making its first Corporation Tax return under the Tonnage Tax regime. Examples of companies that might find this procedure useful include a company considering an initial Tonnage Tax election, or a company considering starting up a new shipping business in the UK.

9. The clearance procedure will generally only be available in advance of a company or group’s first election into Tonnage Tax. However, in exceptional circumstances, HMRC may allow a further clearance application prior to a renewal election being made. For instance, such further clearance may be sought after a major change in the structure of a group, or a major change (temporary or permanent) in its activities, which might create a potential exclusion from Tonnage Tax. Companies considering clearance are encouraged to contact HMRC sooner rather than later.

10. This particular clearance procedure is limited to Tonnage Tax issues only and does not extend to the mechanics of any reorganisation that may be required to put the group or company into the optimum position to make an election.

Examples of issues that could be addressed are:

• (i) whether a particular ship is a qualifying ship
• (ii) whether the strategic and commercial management test is met
• (iii) whether an activity is a core or secondary qualifying activity
• (iv) how to deal with potentially non-qualifying secondary activities
• (v) how a service at sea is to be split out from the associated transport
• (vi) whether dividends from an overseas subsidiary qualify as relevant shipping income
• (vii) how the calculation of excess finance costs is to be made
• (viii) how to apply the 75% limit on time charters-in within a Tonnage Tax group
• (ix) how to record ‘offshore’ activities and their treatment in the computation
• (x) whether incidental income qualifies as relevant shipping income

11. The clearance application must include all pertinent information to enable a decision to be made. This should include full details of the Tonnage Tax group structure (see paragraph 23(iii) below) unless already provided as part of a Tonnage Tax election.

12. Provided that all pertinent information is given to HMRC, the treatment agreed will be binding on HMRC. This will hold until (and unless) company circumstances change such that the original clearance is no longer in point. Reviews to determine whether this is the case may form part of any enquiry into a Tonnage Tax company’s tax return.

13. This clearance facility is likely to be of most use to complex groups, perhaps with substantial non-qualifying activities, with unusual vessels or with offshore activities. However, all interested companies are invited to make use of the facility. The clearance procedure will differ from case to case according to the issues under discussion, but is likely to take the form of correspondence alone or a combination of correspondence and meetings.

14. Clearance applications should be sent initially to the company or group’s usual tax district - HMRC will notify the company or group if the case is then transferred to a specialist district (see paragraph 2 above). Adequate time should be allowed for HMRC to respond to the application (and for correspondence and meetings) before the expected date for making the election.

Foreign company/group considering commencing qualifying activities in the UK

15. A foreign company or group considering commencing ship operations in the UK within the Tonnage Tax regime may seek advice from Liverpool LBO, which will deal with the initial stages of the clearance application.

16. One of the queries most likely to be raised by such a foreign company or group is potential exit charges, should it subsequently cease operations in the UK. Where a branch or a subsidiary company of a foreign ship operator has been set up in the UK and that branch or company subsequently ceases operations in the UK there is unlikely to be a specific exit charge from the Tonnage Tax regime. There may however be a potential liability to tax on pre-migration capital gains on assets brought into the UK, if those gains have not already crystallised in another country before migration.

Group arrangements

17. HMRC recommend that a Tonnage Tax group should operate under a group arrangement as set out in Finance Act (FA) 2000 Schedule 22 paragraph 120. A group arrangement will enable a nominated company to act as a representative of the group. This will reduce (although not eliminate) the need for administrative correspondence between HMRC and each individual company in the group, and make some aspects of the legislation much simpler to implement, for instance, the provisions of FA 2000 Schedule 22 paragraph 37 (75% limit) and 62 (finance costs).

18. A group arrangement will normally cover the following matters:

• (i) dealing with HMRC on behalf of group companies in respect of clearance applications
• (ii) dealing with HMRC on behalf of group companies in respect of the tonnage tax election and renewal elections
• (iii) making notifications on behalf of group companies as to whether or not the 75% limit on chartering-in (set out in FA 2000 Schedule 22 paragraph 37) has been exceeded and making any appeal under FA 2000 Schedule 22 paragraph 43 (against an exclusion from Tonnage Tax notice)
• (iv) preparing and negotiating with HMRC calculations required under FA 2000 Schedule 22 paragraph 62 (finance costs)
• (v) dealing with HMRC on matters arising under FA 2000 Schedule 22 paragraph 126(4) (dominant party on a merger) and making an appeal under paragraph 126(5) (against HMRC determination)
• (vi) making notifications under FA 2000 Schedule 22 paragraph 129 (duty to notify HMRC of group changes)
• (vii) the provision of any other information in relation to the Tonnage Tax regime, which it would be expedient to be provided on a group-wide basis

19. Notification of a group arrangement will normally include the following details:

• (i) the name and unique taxpayer reference of each qualifying company in the group
• (ii) the name and unique taxpayer reference of the representative company
• (iii) a list of the matters to be handled by the representative company on behalf of the group, if different to the list in paragraph 18(i) to (vi) above, or confirmation that the representative company will handle all items in that list
• (iv) a declaration signed by an authorised person for each qualifying company confirming that the representative company is authorised to act on their behalf in respect of these specified matters
• (v) a declaration signed by an authorised person for the representative company confirming that it agrees to act on behalf of the group companies in respect of these specified matters

20. HMRC will agree in writing to the proposed group arrangement and the issues to be covered by it, or suggest modifications to the proposals, as appropriate.

21. The group arrangement does not need to be renewed if the composition of the group changes unless there is a change in representative company. FA 2000 Schedule 22 paragraph 129 notifications will be accepted as notice of changes to the composition of the group arrangement, provided they include a declaration under FA 2000 Schedule 22 paragraph 19(iv) in respect of any new additions to the group.

The Tonnage Tax election (Part II)

22. Where a company is a member of a group of companies, the Tonnage Tax election must be a group election. It is likely that most Tonnage Tax elections will be group elections. Where, exceptionally, a single company makes a Tonnage Tax election, none of the information requirements listed below in relation to groups will be relevant, and may be ignored.

23. The initial Tonnage Tax election should contain the information listed below:

• (i) the name and unique taxpayer reference of each qualifying company in the group
• (ii) a name for the Tonnage Tax group that can be used as convenient shorthand in correspondence and on tax returns - for example, ‘XYZ TT Group’, it is suggested that ‘TT’ be included in the name, as a Tonnage Tax group may have a different membership to the UK group for other tax purposes
• (iii) full details of the Tonnage Tax group structure, including details of non-qualifying companies - for many groups this will be a straightforward comment to the effect that the group consists of XYZ parent company with 100% subsidiaries A, B and C, however, where control is, for instance, traced through individuals or complex share structures, then appropriate details will be required, for foreign owned groups, the information should include appropriate details of the overseas structure within which the UK companies are placed
• (iv) the accounting period(s) from which the election is to take effect, if this is not the period in which the election is made, then further details must be given (see paragraph 26 below for more information)
• (v) the signature of an authorised person from each company to confirm that the companies are jointly making the election
• (vi) a declaration confirming that:
  • a. all companies included on the election are qualifying companies
  • b. all qualifying companies in the Tonnage Tax group are included in the election
  • c. a certificate of approval from the Department of the Environment, Transport and the Regions is in force with respect to the initial training commitment

24. The 75% limit on chartered-in tonnage is not a qualifying condition for making an election. However, an election made during the initial period will be treated as never having been of effect if the limit is exceeded in the first accounting period after entering Tonnage Tax.

25. Elections made after the initial period will be treated as never having been of effect, if the 75% limit is exceeded in the each of the first three accounting periods (paragraph 38refers).

26. However, where an election is made after the end of the initial period and the 75% limit is exceeded only in the first accounting period, or only in the first and second accounting periods, the election does not have effect for the 1 or 2 ‘exceeded’ accounting periods. Entry is effectively deferred until the first period that the limit is satisfied. In these circumstances, it is essential that the election must still be made within 12 months of becoming a qualifying company.

27. A renewal election should contain similar information to the initial election, with the following changes:

• (i) a start date is not required
• (ii) the training declaration should be that a training certificate is in force and that the group or company is not subject to a certificate of non-compliance

28. An election will usually take effect from the start of the accounting period in which it is made. However, FA 2000 Schedule 22 paragraph 12 provides for an election to take effect from the beginning of certain other accounting periods. Where this is subject to the agreement of HMRC, the election should include details of the commercial reasons why one of these alternative start dates is required. For instance, the group might be carrying out a reorganisation to prepare for Tonnage Tax, and therefore would not wish the election to take effect until after this reorganisation was complete.

29. In ‘exceptional circumstances’, paragraph 12(4) allows the elections made during the initial period to take effect from the second accounting period after the one in which the election is made. The ‘exceptional circumstances’ must be such that it is commercially impracticable for the company/group election to take effect at an earlier date. This could include contractual arrangements that affect qualification and which cannot be renegotiated in time, or unusually complex restructuring that will take more than 1 accounting period to achieve. An example of ‘exceptional circumstances’ might be the inability to renegotiate long-term time charters that would push a company or group above the 75% limit on time chartering-in.

30. HMRC will issue to the representative company an acknowledgment to confirm receipt of the election. The acknowledgment will normally include a statement of the date on which the 10 year period covered by the election will start and end, effectively confirming agreement to any backdating or postponement of the starting date, subject to any necessary enquiry into the date of entry. This acknowledgment will not mean that HMRC necessarily accepts that the companies, their activities or their vessels qualify for Tonnage Tax. A group that wishes to have reassurance on this point should take advantage of the clearance procedure discussed above.

31. FA 2000 Schedule 22 paragraph 10(3) extends an opportunity for newly qualifying groups of companies to elect into Tonnage Tax after the initial window of entry. It includes a rule to prevent a group avoiding the normal time restrictions for making an election (paragraph 10(1) - initial period) by making minor changes to the composition of the group. For example, a group that became non-qualifying by divesting itself of its shipping interests and then became qualifying by buying most of them back would be ‘substantially the same’ group as before and would not be eligible to make an election.

Qualifying companies and qualifying ships (Part III)

Ships

32. Paragraph 16(1)(b) requires a qualifying company to operate ‘qualifying ships’ in this context ‘ships’ can mean a single ship.

Strategic and commercial management

33. The definition of a qualifying company in paragraph 16 provides that qualifying ships operated by a company must be strategically and commercially managed in the UK. This is a completely different and separate test to that of ‘central management and control’ relevant in determining whether a company is resident in the UK.

34. The ‘strategic and commercial management’ test arises from the European Commission’s guidelines on State Aid in the maritime sector. No specific EC guidance is available on the meaning of strategic and commercial management and HMRC proposes therefore to adopt a common-sense interpretation, taking into account the various different strands of management activity that can be carried out in respect of a ship. HMRC is happy to provide guidance on this test as part of the clearance procedure outlined in paragraphs 8 to 14 above.

35. All elements of management activity relevant to the ships in question will be taken into account in determining whether strategic and commercial management is carried out in the UK may include:

A. Strategic functions for the shipping business, including:

• (i) location of headquarters, including senior management staff
• (ii) decision-making of the company board of directors
• (iii) decision-making of operational board
• (iv) UK stock exchange listing

The types of decision included in (ii) and (iii) above include, decisions on significant capital expenditure and disposals (eg, purchase and sale of ships), award of major contracts, agreement on strategic alliances (eg, shipping conferences and pooling) and the extent to which foreign offices work under the direction of UK-based personnel.

B. Commercial management of the ship/fleet, including:

• (i) route planning
• (ii) taking bookings for cargo or passengers
• (iii) managing the bunkers, provisioning and victualling requirements
• (iv) personnel management
• (v) training organisation
• (vi) technical management including making decisions on the repair and maintenance of vessels
• (vii) extent to which foreign offices/branches work under the direction of UK-based personnel
• (viii) support facilities in the UK (eg, training centre, terminal, etc.)

36. The fact that a vessel may be flagged, classed, insured or financed in the UK may add further weight to the indicators in 35A and 35B above in deciding whether that vessel is strategically and commercially managed in the UK.

37. Elements of each leg of the test, ie, both strategic and commercial management, must be demonstrated the strategic management by features such as in list 35A above, and the commercial management by features such as in list 35B above.

38. The more elements that are carried out in the UK, the more likely it is that the company will be accepted as satisfying this test. However, the approach will not be purely mechanistic, the weight given to each element will depend on the precise facts of each case. Greater weight will be given to higher levels of decision-making and management, as opposed to routine day-to-day management. HMRC recognises that a worldwide shipping operation may have many of the lower level activities devolved to local branches. In assessing the weight and relevance of the various elements of commercial management activity, HMRC will take account of such factors as:

• (i) the extent to which each element is carried out in the UK, as compared with the extent that it is carried on elsewhere
• (ii) the nature and extent of the accommodation occupied in the UK
• (iii) the number of employees engaged in these activities in the UK
• (iv) the country of residence of key management staff, including company directors
• (v) for an international group, the extent to which such activities in the UK correspond to the UK’s share of the worldwide fleet - if some group functions in relation to the fleet are carried out in the UK and other functions elsewhere, the group may still be seen as commercially managing its fleet from the UK provided there is a reasonable balance of activities in the UK considering the proportion of the worldwide fleet represented by ships within the UK’s Tonnage Tax regime

39. An activity, such as ship management, contracted out to a third party will still count as a positive indicator, provided that it is carried on in the UK.

40. The test does not require the vessels to be operated in UK waters.

41. FA 2000 Schedule 22 paragraph 16(1)(c) states that the qualifying ships operated by a UK Tonnage Tax company must be strategically and commercially managed in the UK. This does not mean that each ship operated by the company from the UK must be managed in like manner and to the same extent as every other one. So long as each ship can satisfy some of the criteria in lists A and B above, and the company’s fleet as a whole is strategically and commercially managed in the UK, the para 16(1)(c) test will be satisfied.

Examples of strategic and commercial management

Example 1

42. A wholly UK shipping company, where all management activities in relation to its ships are carried out in the UK.

This company will certainly satisfy the test.

Example 2

43. A company that has no commercial presence in the UK apart from its registered office and the occasional board meeting.

This company will almost certainly not satisfy the test.

Example 3

44. An international group operates a quarter of its fleet from the UK, through a UK sub-group. The UK sub-group has UK premises and employs around 100 staff in the UK. All technical management of the worldwide fleet is carried out in the UK, but personnel management is in the Far East. The booking system for all vessels is intranet-based using a computer in North America, but UK staff contribute a quarter of worldwide bookings. The operational board of the UK sub-group includes directors based in London, but meets at various locations around the world.

The UK ship operating company(ies) would be likely to pass the test, as sufficient activity is carried on in the UK to reflect its share of the ships.

Temporary cessations

45. FA 2000 Schedule 22 paragraph 17 is aimed at a single company that temporarily ceases to operate any qualifying ships, perhaps for instance through loss at sea, and allows such a company to remain within Tonnage Tax throughout the period of temporary cessation. Such a single company would otherwise be excluded from Tonnage Tax for 10 years under the rule in paragraph 140. A group company would not be so excluded, although it may also choose to take advantage of this provision if for example it were to sell all of its qualifying ships at once. HMRC will generally presume that a cessation of more than 3 months is permanent, unless there is evidence to the contrary.

46. A company that takes advantage of this provision will calculate its Tonnage Tax profits as though it still operated the same ships as immediately prior to the cessation. The training obligation will continue to apply.

47. A group election covers all qualifying activities carried on by any company within the group. If one company within the group ceases to operate any qualifying ships, but at least one other company in the group continues to do so, the group election will continue to have effect. If it is still in force, that election will cover the first company if it later starts to operate qualifying ships again.

48. Subject to the rules on mergers in Part XII, the group election also extends to newly acquired companies. If a single company has ceased to have any qualifying activities and is then acquired by a larger group and the company resumes qualifying activities after the merger, it will be within the Tonnage Tax regime if there is a group election in force. The fact that the group contains what was formerly a single ex-Tonnage Tax company does not prevent the group making a Tonnage Tax election or a renewal election (paragraph 140(3) refers).

Seagoing

49. Paragraph 19(1) describes a qualifying ship as a ‘seagoing ship of 100 tons or more gross tonnage’. Sub-paragraph (4) defines ‘seagoing’ as ‘certificated for navigation at sea by the competent authority of any country or territory’. HMRC will normally accept that a ship is seagoing if it is certificated as such under the International Load Line or the SOLAS (Safety of Life at Sea) conventions.

Excluded vessels

50. Paragraph 19(2) prevents a vessel that is used to provide ‘goods or services of a kind normally provided on land’ from being a qualifying ship. Examples of businesses where HMRC will apply this rule include:

• (i) retailers
• (ii) restaurants
• (iii) hotels
• (iv) prisons
• (v) radio stations
• (vi) casinos
• (vii) financial service providers

This list is not exhaustive.

51. Pleasure craft are excluded from the Tonnage Tax regime under paragraph 20(1)(b). HMRC accepts that a commercially operated cruise liner, although operated primarily for the recreation of its passengers, is not a ‘pleasure craft’. This exclusion will be interpreted so as to exclude a vessel that is chartered as a whole by its passengers (for instance a holiday yacht) but not to exclude a vessel that has individual fare paying passengers. Chartered ‘as a whole’ will include charter by a passenger alone, or by passengers acting together, or by a third party acting on behalf of one or more of the passengers.

The 75% limit (Part V)

52. Where a company or group has breached the 75% limit for chartered-in tonnage under FA 2000 Schedule 22 paragraph 37, and the breach has continued for two or more consecutive periods then, in the absence of any mitigating circumstances, HMRC will consider excluding the company or group from Tonnage Tax under FA 2000 Schedule 22 paragraph 39.

53. If a company or group is to avoid exclusion, there will have to be mitigating circumstances of an exceptional commercial nature and the company or group must demonstrate a reasonable expectation of falling within the limit in the near future. An example of such mitigating circumstances might be the accidental loss of an owned vessel and its temporary replacement with another on time charter.

54. The power to exclude is a permissive one. If HMRC considers that there is evidence of an attempt to engineer an early exit from the Tonnage Tax regime, then it may decide not to exercise the power to exclude.

Anti-avoidance (Part V)

55. Paragraphs 41 and 42 provide that a company or group that abuses the Tonnage Tax regime may be expelled. The provision is aimed at deliberate cases of serious or repeated abuse and will not be used to attack minor errors in the computations or genuine misunderstandings. Nor will it be used to attack any bona fide pre-election restructuring that is required to enable a group to opt for the regime, for instance the divisionalisation of shipping and non-shipping activities.

56. Examples of situations where the provision may bite include:

• (i) the artificial engineering of non-qualifying income so that it falls within the Tonnage Tax ring-fence, for example, including within the sale price of a cruise entitlement to a significant discount on the purchase of goods or services to be provided onshore
• (ii) creating a financing structure that circumvents the rules in paragraph 62
• (iii) involvement in leasing arrangements designed to circumvent the restrictions in Part X on finance leases

Relevant shipping profits (Part VI)

Core qualifying activities

57. Paragraph 46 provides that core qualifying activities include the operation of qualifying ships and activities integral and necessary to such operation.

58. Operation of the ship is defined by FA 2000 Schedule 22 paragraph 18 in terms of ownership, but to be qualifying the ship must, under FA 2000 Schedule 22 paragraph 19(1), be used for transporting passengers or cargo, providing marine assistance, or providing transport for services at sea.

59. Activities ‘necessary and integral’ are those activities that are essential to enable the ship operation to take place. These include ship management operations such as purchasing fuel and hiring crew and commercial management operations such as booking cargo. They do not include activities that are merely customary or desirable, although such activities may count as qualifying secondary activities. For instance, providing food for short sea ferry passengers is not integral and necessary to their transport and is therefore not core. However, it is a wholly qualifying secondary activity.

60. The following paragraphs give guidance on some specific maritime activities.

Tugs

61. The operations of a seagoing tug will normally be accepted as core qualifying activities. These will include:

• (i) assistance at sea
• (ii) salvage (but see also paragraph 62 below)
• (iii) construction work in the marine environment
• (iv) support activities for seagoing ships

62. Where a tug is involved in raising sunken cargo, this will be regarded as diving support and will need to be treated under the principles described below for transport for services at sea. Any profits from the sale of salvaged goods will fall outside the Tonnage Tax ring-fence.

Vessels providing transport for services at sea

63. Vessels providing services at sea include diving support vessels, cable layers and crane barges (or ships performing a similar function). It is necessary to apportion the profits/losses from the operation of such vessels between that attributable to transport and that attributable to the service provided. HMRC will accept any method of apportionment, which produces a just and reasonable result.

64. For example, HMRC will accept that the profit from transport will be the income that would be receivable on a time charter of a similarly modified vessel for the duration of the accounting period, less the actual expenses of running the vessel (excluding any expenses relating to the provision of the service). Any remaining profit will be the profit relating to the provision of the service and will remain outside the Tonnage Tax ring-fence.

65. Alternatively, the reverse of the method in paragraph 64 above could be used. For example, where both divers and a diving support vessel were provided, the income and expenses of providing the divers alone could be deducted from the overall profit or loss. Any remaining amount would then be ‘relevant shipping profits’ for Tonnage Tax.

Merchant adventurers

66. Some ship operators behave as ‘merchant adventurers’ by taking full or part ownership of their cargo, rather than simply acting as carriers. If there is a price risk associated with the cargo, then a just and reasonable apportionment of the profit or loss on the voyage must be made. A price risk is any situation where the operator buys and sells the cargo at different prices. HMRC will accept that where the ship operator does not bear any price risk relating to the cargo, then the whole of any profit or loss on the voyage will be within relevant shipping profits for Tonnage Tax purposes.

67. Tanker operators provide an example of merchant adventuring. For instance, some tanker owners load their own cargo of oil and transport it to a destination in the hope of reaching the market at the right time to achieve a larger profit. Similarly, oil can be sold on a ‘delivered’ basis, where the oil is sold at the end of a voyage at the prevailing price, the price risk remaining fully with the ship operator. In these situations a profit split would need to be made between the non-Tonnage Tax profit on the oil and the Tonnage Tax profit on its transportation.

68. However, where the oil is sold free on board (FOB) to the ship operator and then sold on cost and freight (C&F), the ship operator would not have a price risk on the oil itself. In effect, the operator would receive freight income for the route, depending on supply and demand for tankers, plus additional remuneration from the shipper if diversions were made from that route to another port. In such a situation a profit split would not need to be made.

Pooling on liner services

69. A ship operator may form alliances or pools with other companies and share liner routes. It is the nature of a pooled liner service that the cargo, having been booked by the ship operator, may actually be carried in one of the partners’ ships. HMRC accepts that, provided a balance is maintained between the bookings made with originating customers (not being other shipping lines) and the cargo carried in its own ships, then the trade will be regarded as one of ship operation and will be a core qualifying activity.

70. A reasonable balance will be regarded as maintained where in an alliance or pool, over a 3 year period, the aggregated slots/space allocated for use by originating customers of Tonnage Tax companies in a UK Tonnage Tax group match the slots/spaces provided to the alliance or pool in ships operated by those companies. An excess of bookings over cargoes carried of not more than 10% will be disregarded. Where there is consistent structural underprovision of more than 10% cargo carrying on own vessels, bookings over the 10% will be regarded as the carrying on of a separate trade outside Tonnage Tax.

71. Where similar arrangements exist in other non-liner sectors, similar principles will be applied as appropriate, suitably adapted to the circumstances of the sector.

Secondary activities

72. Qualifying secondary activities are defined in the Tonnage Tax Regulations 2000 (Statutory Instrument 2000/2303). This next section provides guidance on some of the operational aspects of these regulations.

73. Some of the regulations and notes below contain provisions whereby activities are allowed up to a certain limit. Where this limit is breached, then the whole of the profit or loss from that activity will fall outside the Tonnage Tax ring-fence. However, where the limit is breached to a minimal extent then HMRC may accept, on de minimis grounds, that no adjustment is required. This relaxation is to apply in exceptional circumstances only and will not apply to habitual breaches.

74. Activities that are not listed in the regulations and which are not core qualifying activities will be outside the Tonnage Tax ring-fence. It is not possible to provide an exhaustive list, but some examples are given below:

• (i) the operation of a port or harbour - in small ports where the port and a qualifying wharf/terminal are effectively one and the same, the non-qualifying element should be determined on a just and reasonable basis
• (ii) the processing of goods and materials whether on-board, on the quayside or elsewhere, other than consolidation and breaking of cargo under the regulations - the protection and maintenance of cargo (such as refrigeration or the maintenance of any ripening fruit) will not be regarded as processing
• (iii) the storage of cargo beyond what is immediately necessary whilst awaiting loading onto ships or onward transportation - for example, a warehousing or cold storage trade will not be within Tonnage Tax
• (iv) the hire of containers to customers for use otherwise than for cargoes booked by the Tonnage Tax company for transit by sea
• (v) dealing or speculation in shipping futures or other shipping related financial instruments such as bunkers, not wholly entered into to hedge the company’s Tonnage Tax trade
• (vi) a ship based holiday where the ship remains moored and there is no sea transportation element
• (vii) sales where orders are taken on-board for goods to be subsequently delivered to an address provided by the customer or where the goods are not of a customary type for cruise or ferry passengers to purchase
• (viii) operations that would fall to be treated as a separate trade under normal tax principles, for example, it is accepted the buying and selling of ships is part of the normal operation of ships and is a core qualifying activity - however, where the buying and selling takes place to such an extent that the trade effectively becomes one of ship-dealing rather than ship operation, then it would fall outside Tonnage Tax

75. The regulations allow activities carried out by one member of a Tonnage Tax group in connection with qualifying ships operated by another member of the same group to be qualifying secondary activities.

76. The regulations also set out that if such activities are carried out additionally for third parties they may qualify as secondary activities if certain conditions are met. The first condition is that the activities for third parties should only use such staff and resources as are necessary to carry out the main function of the company - that is to say all qualifying activities (core or secondary) which it carries out in respect of qualifying ships that it (or another member of the same Tonnage Tax group) operates. The second condition is that the level of third party services should be minimal compared with the level of activities carried out in respect of those qualifying ships. These conditions refer to the total of all third party activities, but in most cases, it will be simpler and more practical to apply them on an activity by activity basis. For example if a booking office for a cruise line also sold railway tickets, the level of railway ticket sales which could qualify as secondary activities would depend on the level of staff needed to sell the group’s cruise tickets and the comparative volume of railway tickets sold compared with cruise tickets.

77. Companies may prefer to separate out secondary activities carried on for third parties and compute and return the profit on such activities outside the ring-fence. In such cases, HMRC would only look at the third-party work still conducted within the Tonnage Tax ring-fence in applying the test to determine whether third-party work was minimal.

78 For example, say a ship operator within Tonnage Tax has a substantial ship management department providing services to third parties as well as other members of the group. It divides its 32 staff into 12 managing group ships and a dedicated section of 20 staff doing third party ship management. If the 20 third party staff do occasional work to help the in-house department, this work should be transfer-priced across the ring-fence. If the 12 in-house staff do occasional work for the third-party department then, provided this is minimal in comparison with the level of the in-house work done by those 12 staff, then any profit from that third-party work would be within Tonnage Tax.

79. In order to determine whether the conditions are met, the level of activity may be determined by any reasonable method including reference to turnover, costs, tonnage of ships or number of TEUs, as appropriate. Only if the conditions are not met will it be necessary to make a full and proper allocation of income and expenditure between secondary activities inside the ring fence and those outside it.

80. Whether the level of an activity is minimal will depend on the measure used and the facts of the case, but HMRC will not normally accept that third party activity is minimal in any case where it exceeds 20% of that activity carried out in support of ships operated by the Tonnage Tax group.

81. Where third party services are provided under a reciprocal arrangement between two operators, HMRC will accept that third party services may qualify as secondary activities to the extent that they are reciprocated by the other party.

82. Companies may seek confirmation concerning the extent to which an activity for third parties will qualify as part of the clearance procedure outlined in paragraphs 8 to 14 above.

83. Where administrative and financial services provided under the regulations also relate to the ‘non-sea leg’ of an inclusively priced journey or, in the case of passengers, to a related excursion or holiday on land, then they will be accepted as being part of the wholly qualifying secondary activity.

Passengers

84. HMRC will accept that the following activities are carried out in connection with the embarkation or disembarkation of passengers or as part of an inclusive transport service bought in at an arm’s length price:

• (i) car parking, provided that receipts from non-passengers do not on average exceed 10% of receipts from passengers
• (ii) train, coach, bus or other transport services (including flights) to take passengers to or from the ship or eligible linked holiday, including:
  • a. purchase of single seats or block of seats on scheduled services
  • b. chartered-in transport to and from cruise, provided that only qualifying passengers are carried
• (iii) a single night’s accommodation for passengers in transit immediately prior to embarkation or immediately after disembarkation
• (iv) the provision of quayside shopping facilities for passengers, provided that the range of goods available is no wider than would qualify to be sold on board under the regulations.

85. HMRC will accept that the ‘provision of excursions for passengers’ regulation includes:

• (i) excursions on non-qualifying vessels
• (ii) the provision of a shore-based facility for the exclusive use of own passengers
• (iii) trips of longer than a single day provided the cabin on board ship remains ‘occupied’ by the passenger

Gambling

86. Gambling is to be interpreted broadly and will include slot machines, casino games of chance, raffles, bets on horse racing etc. HMRC will accept that the turnover from gambling is negligible if it amounts to less than 10% of ticket sales plus receipts from the letting of cabins and sale of food and drink for immediate consumption for that voyage. For the purposes of this test, turnover will be regarded as receipts from gambling after deducting winnings paid out, but before any other expenses. The test applies separately to each individual voyage. In this context, a round-the-world cruise will be viewed as a single voyage.

87. Where the turnover from gambling on a particular voyage is more than negligible, then the whole of the profits from gambling on that particular voyage will fall outside the ring-fence.

88. Where third party concessionaires offer gambling facilities and the ship operator’s income from the concessionaire varies partly in relation to turnover, then the ‘negligible’ test will also apply to the income from the concessionaire.

Sale of luxury goods

89. Whether or not goods are luxury goods depends upon the standard of goods and services that would normally be expected by the passengers on a particular cruise or journey, and the extent to which they will continue to be enjoyed by the purchaser after completion of the journey. HMRC will accept that turnover from the sale of luxury goods is negligible if it does not exceed 10% of total ticket sales plus receipts from the letting of cabins and sale of food and drink for immediate consumption for that voyage.

90. Where the turnover from sale of luxury goods on a particular voyage is more than negligible, then the whole of the profits from sale of luxury goods on that particular voyage will fall outside the ring-fence.

91. Where luxury goods are offered for sale on-board by third party concessionaires and the ship operator’s income from the concessionaire varies partly in relation to turnover, then the ‘negligible’ test will also apply to the income from the concessionaire.

Slot charters

92. Slot charters between shipping companies will be accepted as qualifying secondary activities under the same principles set out in paragraphs 69 to 71 above on pooled liner services.

Incidental activities

93. This category of income will be very restricted in scope and will deal with minor items of shipping related income that do not fit comfortably into core or secondary categories. The aim will be to prevent what is otherwise a wholly qualifying shipping company from having to apply normal Corporation Tax rules to insignificant items of ship-related income.

94. Incidental shipping related activities may come within Tonnage Tax if the turnover from them is less than 0.25% of the turnover from other activities that fall within the Tonnage Tax ring-fence. Any unused balance of this limit will not be available to set off against non-qualifying secondary activities.

95. However, if ship-related activity, which could fall within the definition of ‘qualifying incidental activities’ is consistently returned outside the Tonnage Tax ring fence, then HMRC will not argue that it should be treated as a qualifying incidental activity for the purposes of applying the 0.25% of turnover test to other items of incidental income.

Distributions of overseas shipping companies

96. The tests set out in FA 2000 Schedule 22 paragraph 49(2) are very strict, in particular the paragraph 49(2)(d) requirement that all the overseas company’s income is such that it would be relevant shipping income if it were a Tonnage Tax company. HMRC appreciate that this test may in practice be very difficult to comply with, particularly where the company is not wholly owned. For instance, dividends from a company with income from a secondary activity in excess of permitted levels could not be included under this provision.

97. Tonnage Tax groups wishing to ensure that overseas companies will qualify under paragraph 49(2) should make sure that any non ship-related activities are taken out of those companies. The condition in 49(2)(d) will be satisfied if the overseas company has no activities which could generate income other than relevant shipping income. However, the test applies to income and not to activities, and HMRC will accept that the test is satisfied if effective arrangements are in place to ensure that no income arises which is not relevant shipping income. This will ensure that all profits arising from non-qualifying activities will be taxed outside the Tonnage Tax ring-fence when paid up to the UK as dividends.

98. HMRC will accept that the tests should be applied afresh for every period of account of the overseas company. For example, suppose a Tonnage Tax company has an overseas subsidiary with a December year-end that carries out mixed activities. During 2005, this overseas company sells its non-shipping activities so that in 2006 and 2007 it complies with the paragraph 49(2)(d) condition. Half way through 2008, it again becomes a mixed activity company. In this example, dividends declared out of 2006 and 2007 profits paid in either of those 2 years would meet the conditions. Dividends declared out of profits for 2005 and prior or 2008 and subsequent (whenever paid) would not meet the conditions.

99. HMRC will also accept that where an overseas company receives minimal levels of non-relevant shipping income, this may be disregarded on de minimis grounds when considering the paragraph 49(2)(d) condition. Minimal in this case means income up to the level specified in paragraph 48(2), ie, 0.25% of turnover from core and qualifying secondary activities.

100. In FA 2000 Schedule 22 paragraph 49(2)(f) there is a condition that the profits from which the dividends are paid must be subject to tax. This test may still be satisfied even if there is no actual liability to tax on those profits (for example because of the operation of loss relief), so long as the profits in question are ‘subject to a tax on profits’. The rules of computation for tax purposes of those profits are also immaterial - for example, dividends paid by a company within a comparable Tonnage Tax regime in another country would satisfy the ‘subject to a tax’ test.

101. HMRC will accept that a qualifying dividend that is credited in the accounts of a Tonnage Tax company will fall within the Tonnage Tax ring-fence, even if it is actually received when the company has ceased to be a Tonnage Tax company. A dividend that is credited in the accounts of a company after it has ceased to be a Tonnage Tax company will not fall within the Tonnage Tax ring-fence, even if it meets the conditions of paragraph 49.

102. HMRC will accept that profits arising on the disposal of all or part of an overseas shipping business may be paid out as dividends under these rules, provided that the overseas company has qualified to pay such dividends (see above paragraphs) for the 5 years prior to the disposal.

103. Where dividends from overseas shipping companies are regarded as relevant shipping income, the supporting computations must give appropriate details. These should include all the information to justify inclusion within Tonnage Tax, such as name of ship, IMO number, type of charter, etc. plus of copy of the accounts for each foreign company.

Exclusion of interest income etc

104. Under FA 2000 Schedule 22 paragraph 50, only such interest, as would under normal Corporation Tax rules be treated as being trading income arising from the trade consisting of a company’s Tonnage Tax activities, may come within the ring fence as relevant shipping profits.

105. In deciding whether or not interest received would be treated as a trade receipt under normal Corporation Tax principles, companies should bear in mind the cases of Nuclear Electric v Bradley (68 TC 760) and Bank Line Ltd v CIR (49 TC 307). In the latter case Lord Avonside commented

“Income becomes a trading receipt when it arises from capital actively employed and at risk in the business because it is required for its support or, perhaps, to attract customers looking to the credit of the business. Trading income is ‘the fruit’ of the capital employed in the business in the present and active sense.”

This description would not extend to cover interest arising from the proceeds of ships held on deposit whilst replacement ships are sought.

The ring fence (Part VII)

Transfer-pricing

106. Paragraphs 58 and 59 require adjustments to be made (in accordance with Schedule 28AA ICTA 1988) where transactions or arrangements involving connected persons, or indeed Tonnage Tax and non-Tonnage Tax divisions of the same company, are not on arm’s length terms. This applies to all transactions regardless of whether or not a hard charge would normally be made for the goods/services provided. The existence of the special ring-fencing rules for finance costs does not over-ride the requirement to apply the transfer-pricing rules to financial transactions across the ring fence or with a connected party outside the UK.

Finance costs

107. HMRC will not insist on ‘hard charging’ for the cost of finance across the ring fence. However, where finance costs across the ring fence are at less than arm’s length rates, transfer pricing across the ring fence should be undertaken before reallocation of finance costs is computed.

108. A Tonnage Tax company or group must ensure that an appropriate proportion of its finance costs, in accordance with FA 2000 Schedule 22 paragraph 61 or 62, is included in the company’s or group’s return(s) of profits, if it is not already charged against its relevant shipping profits. Further guidance is available in the annex to this Statement of Practice.

Capital allowances (Part IX)

Transfers of ships within a Tonnage Tax group

109. ICTA 1988 section 343 (company reconstructions without a change in ownership) can apply to transfers of shipping trade between members of the same Tonnage Tax group. Where a shipping business is transferred between members of a Tonnage Tax group in such circumstances as section 343 would normally apply, the Tonnage Tax pool relating to that shipping business may be transferred along with the shipping business itself to the new owner.

110. One member of a Tonnage Tax group may own a ship which it bareboat charters to another member of the same group. HMRC will accept that this is a trade for the purposes of ICTA 1988 section 343. If the ship (still subject to the bareboat charter) is transferred to a third company within the group, the Tonnage Tax pool relating to that ship may also be transferred to the third company.

Industrial buildings

111. Paragraph 82 provides that where an ‘identifiable’ part of a building is used for Tonnage Tax purposes, then that part of the building will be treated as though it does not qualify for industrial buildings allowances. Normal principles should be followed when applying this rule. For instance, the 25% rule in Capital Allowances Act (CAA) 1990 section 18 (now CAA 2001 section 283) will apply in the usual manner.

Finance leasing (Part X)

112. Part X applies special rules to ships leased into the Tonnage Tax regime under finance lease terms. Paragraph 90 prevents a finance lessor claiming capital allowances in respect of the cost of a ship leased to a Tonnage Tax company where the leasing arrangement includes provision of security to such an extent that most of the non-compliance risk associated with the lease is removed from the lessor.

113. In measuring the ‘non-compliance risk’ it will be necessary to take into account the future realisable value of the ship. This may be derived from a series of valuations carried out as at regular intervals over the length of the lease. For example on a 20 to 25 year lease, valuations should be made at intervals of not less than 5 years. These should be professional valuations taking into account normal valuation principles, factors such as the anticipated state of that sector of the shipping market, the forecast of future trends, the adaptability or otherwise of the ship to other purposes and the dominance of the lessee in that particular sector may be relevant if they are part of a normal valuation process.

114. The valuation should be done from the perspective of Day 1 if the circumstances subsequently change, HMRC will not seek to revisit the valuation.

115. The ship should be valued unencumbered by any security sought (such as a mortgage given to a third party guarantor), to avoid any difficulties with circularity.

116. Paragraph 90 will not apply to certain types of security. These are:

• (i) any security inherent in the leased ship itself, provided to the lessor or to a third party guarantor, including:
  • a mortgage on the leased ship
  • an attachment of the lessee’s earnings from the leased ship
  • assignment of any insurance proceeds arising in respect of the leased ship
  • rental rebates arising from the arm’s length sale of the leased ship
• (ii) any guarantee or other security which satisfies the conditions set out in paragraph 91(3) to (5)

117. Parental guarantees are also left out of account in considering whether the 50% limit has been breached. In the case of a guarantee by the lessee’s parent this is because sub-paragraphs 92(2) and 91(3) apply equally to the lessee and a person connected with the lessee. In the case of a guarantee from the lessor’s parent, it is by virtue of paragraph 91(6).

118. Whilst FA 2000 Schedule 22 paragraph 91 only refers to the security inherent in the leased ship, where more than 1 ship is leased as part of the same deal, HMRC will accept that the cross-collateralisation of all the ships leased under that deal falls under this heading.

119. The forms of security listed in paragraph 91 will be completely disregarded in considering whether or not more than 50% of the non-compliance risk associated with the lease is removed from the lessor (or a person connected with the lessor). This means that any such security should not be taken into account in computing the non-compliance risk and furthermore any security within paragraph 91 will be treated as not removing any of that non-compliance risk from the lessor.

120. Pre-delivery guarantees, whereby the putative lessor obtains guarantees in respect of interim finance during the construction stage, may also be left out of account in looking at the extent of removal of non-compliance risk from the lessor, since HMRC accepts that such guarantees are not part of the leasing structure once the ship has been delivered and the lease is in place.

Offshore activities (Part XI)

121. FA 2000 Schedule 22 paragraph 103(2) provides that the special rules applicable to offshore activities do not apply unless the number of days in which qualifying ships are operated in offshore activities exceeds 30. The 30 days to be taken into account are the total number of ship-days within the designated area operated by all of a company’s vessels in the accounting period. Thus, a company operating 2 vessels in offshore activities, the first for 15 days and the second for 16 days, exceeds the 30 days total and both ships come within the special rules for offshore activities.

122. Qualifying ships engaged in the search for oil or gas on the UK continental shelf, eg, a seismic vessel, fall within the description of offshore activities in FA 2000 Schedule 22 paragraph 104(1) and, similarly, qualifying ships engaged in the exploitation of UK continental shelf oil or gas, eg, a pipe-laying vessel also fall within it. However, the term ‘offshore activities’ is much wider than this because of the words ‘in connection with’ and covers all types of ships used in the actual task of exploring for or exploiting gas or oil either in an ancillary, subordinate or supporting role, eg, a diving support vessel.

123. FA 2000 Schedule 22 paragraph 105 excludes certain vessels from the special rules for offshore activities. The reference to supply vessels, tugs and anchor handling vessels includes vessels performing one or more of the activities of supply, towage and anchor handling.

124. The period of inactivity referred to in paragraph 106(a) will include the period during which the vessel is being commissioned in preparation for its forthcoming operation. Similarly, any decommissioning activity on completion of the contract will also be included.

125. Paragraph 110(4) refers to where plant and machinery ceases permanently to be used for the purposes of offshore activities. In this context the question of whether an item of plant and machinery has permanently ceased to be used for offshore activities purposes is primarily a question of fact. In general HMRC would be prepared to regard a period of 2 years or less during which the item of plant and machinery is not used for offshore activities as being merely temporary.

Groups, mergers and related matters (Part XII)

126. Paragraph 117(2) provides that a company will not be brought into a Tonnage Tax group if the individual treated as controlling it does not in practice have any ‘significant influence over the affairs of the company in question’. Whether significant influence exists will be interpreted according to the facts of each particular case. It will generally be presumed that where there is a close family relationship, such as husband and wife or parent and minor child, then significant influence will exist. An example of where significant influence may not exist is where there has been a long-term demonstrable family rift and the controlling parties have no contact with each other.

127. Where a foreign group including companies operating qualifying ships comes to the UK for the first time, it will have 12 months to decide whether to elect into Tonnage Tax under FA 2000 Schedule 22 paragraph 10(3). If it decides to elect in, the election will have effect from the time that the group came to the UK. If such an election is made, the group will be considered as a Tonnage Tax group from the moment it comes to the UK for the purposes of applying the rules on mergers set out in FA 2000 Schedule 22 paragraphs 123 to 126

Corporate partnerships (Part XIII)

128. Companies that are members of a partnership may bring qualifying activities carried on through that partnership into Tonnage Tax, even if some or all other partners are outside the regime. The detailed rules are contained in Paragraphs 130 to 136 and in Regulation 8 onwards of the Tonnage Tax Regulations 2000.

129. These rules cover, amongst other things:

• (i) the computation of Tonnage Tax and non-Tonnage Tax profits
• (ii) the application of the 75% chartering-in limit
• (iii) the computation of chargeable gains
• (iv) the calculation of capital allowances following a partner’s exit from Tonnage Tax

and will apply equally to those partnerships that have legal personality (as in Scotland), as they do to partnerships that do not.

130. Broadly speaking, the effect of these provisions will enable a partner, which is a Tonnage Tax company to calculate the partnership profit along Tonnage Tax lines. Partners, who are not within Tonnage Tax, will calculate their share of partnership profit by reference to normal UK Corporation Tax principles. Thus, there may be different parallel computations of the profits of one partnership, eg, 1 on Tonnage Tax lines and 1 on normal Corporation Tax lines. The Tonnage Tax Unit at Liverpool, Large Business Office (see paragraph 6 above) will advise on points of concern or difficulty.

Exit charges (Part XIV)

131. FA 2000 Schedule 22 paragraph 137(2) provides that exit charges will apply where a company ceases to be a Tonnage Tax company ‘…for reasons relating wholly or mainly to tax’. This paragraph is aimed at situations where a company or group deliberately engineers an exit from Tonnage Tax, perhaps through a temporary cessation of all qualifying activities or a deliberate manipulation of corporate structures. HMRC will not seek to apply exit charges if:

• (i) the company has reached the natural expiry date of its election (even if the reason that the company chooses not to renew its election is ‘relating wholly or mainly to tax’, for instance, if the reason for not renewing is that it wishes to utilise shipping losses)
• (ii) the company has good commercial reasons, aside from considerations of tax, for leaving Tonnage Tax or the company is wound up, except in circumstances where company liquidations are a feature of a group scheme to engineer a deliberate exit from Tonnage Tax
• (iii) the company leaves the UK except in circumstances where the change in company residence is a feature of a group scheme to engineer a deliberate exit from Tonnage Tax (iv) the company ceases to be a Tonnage Tax company as a result of the operation of the rules on mergers

Annex - Finance costs