Taxation of Non-Residents under Section 830 ICTA 1988: Double Taxation Agreements - Shipping and Air Transport Articles
Many Double Taxation Agreements have an Article covering Shipping and Air Transport modelled on the one found in the OECD Model treaty.
The OECD Model is discussed in more detail in the International Manual at INTM153090 onwards. The OECD also publishes a Commentary on the Model.
There are also countries with which the UK does not have a full double taxation treaty but does have a limited agreement covering only shipping and air transport, e.g. Brazil.
Three questions may arise in deciding whether or not profits arising from operations in the UKCS etc. are exempt under a shipping and air transport Article or agreement namely:
- what is a ship
- have profits arisen from the operation of a ship
- what is meant by “International Traffic”.
What is a ship?
This issue was before the Court of Appeal in 2001 in the case of Perks v Clark and Others (74TC187). Carnwath J agreed that it was reasonable to say that in most cases the categorisation of a vessel, as a ship or not, should be governed by its design and capability, rather than its actual use at any time:
“… the categorisation of a structure, as a ship or not, should be governed by its design and capability, rather than its actual use at any time…”.
The Court ruled that the word “ship” was an ordinary English word and the meaning of an ordinary word was not a question of law and it was for the Commissioners to decide as a question of fact whether the statutory words applied to the facts of the case.
The critical question is whether a structure is used in navigation. Provided navigation is a significant part of the function of the structure in question, the mere fact that it is incidental to some specialised function does not take it outside the definition of ship.
It is also clear that relative infrequency of navigation does not necessarily exclude a structure from the definition of ship. The Court agreed that in most cases, the categorisation of a structure should be governed by its design and capability rather than by its actual use at any time.
It was held in the Perks v Clark case that a jack-up drilling rig was a ship.
Previous to 2001 HMRC held the view that only semi-submersible drilling rigs and certain other multi purpose units could qualify as ships. Now in addition to jack-ups there may be other floating structures in the offshore oil and gas industry that are capable of satisfying the tests advocated by the Court of Appeal. HMRC will consider such structures on the specific facts of each case.
Have profits arisen from the operation of a ship?
It has been contended that a semi submersible drilling rig may be regarded as a ship, profits from drilling operations in the UKCS are exempt under a Shipping and Air Transport Article.
HMRC does not accept this. Paragraphs 4 to 13 of the Commentary on Article 8 describes the sorts of profits covered, namely those which arise from the carriage of passengers or cargo or related auxiliary activities. The operation of a semi submersible drilling rig is clearly therefore outside the scope of the Article. Similarly excluded are profits from the operations of heavy lift vessels, for example those engaged in the emplacement of structures in the North Sea.
What is meant by “International Traffic”?
This is defined in Article 3 of the OECD Model as meaning “any transport by a ship or aircraft operated by an enterprise that has its place of effective management in a Contracting State, except when the ship or aircraft is operated solely between places in the other Contracting State”.
The first point to consider is the definition of the UK in the relevant treaty, see OT41510. Depending on the precise wording and facts of the particular case, the ship or aircraft may or may not be operated “solely within places in the other Contracting State”.
The “Shipping and Air transport article” in a treaty may itself be nullified by an “Offshore Activities Article” see OT41560.
If there is no offshore Article, then the general principle is that the profits from the operation of ships (or aircraft) in international traffic are taxable only in the country in which the place of effective management of the enterprise is carried on. For further information see the OECD Commentary on Article 8. Some agreements, particularly recent ones, give the sole taxing rights to the country of residence of the operator rather than to the country of the place of effective management.