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HMRC internal manual

Tonnage Tax Manual

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Relevant shipping profits: Relevant shipping income

Certain interest etc

As described in TTM06500, investment income cannot be ‘relevant shipping income’. The fact that the recipient of interest carries on a trade does not of itself displace the general rule that the income should be brought to account for tax under its normal head of charge.

However certain interest etc may be included in relevant shipping income - but only if it would fall to be treated as trading income under the normal corporation tax rules.

For accounting periods beginning on or after 1 October 2002, the types of income which may come within this rule include:

  • anything giving rise to a credit that would fall to be brought into account for the purposes of Chapter II of Part IV of the Finance Act 1996 (loan relationships);
  • any exchange gain under Chapter II of Part II of the Finance Act 1993(exchange gains and losses); and
  • any profit on a qualifying contract under Chapter II of Part IV of the Finance Act 1994 (interest rate and currency contracts).

There are limited circumstances, in which interest may be regarded as a trade receipt and such interest may be included in relevant shipping income

Trade receipt

The conditions to be satisfied before we accept that interest income should be treated as trading income are described in BIM40805 onwards.

The general test is that interest will normally rank as trade receipts only where it is an integral part of the business operations to employ capital to produce such income, for example, in the case of banks and other financial concerns. (See Nuclear Electric Plc v Bradley *[1996] 68TC670 where the House of Lords approved the reasoning in an earlier Court of Session case, *Bank Line Ltd v CIR *[1974] 49TC307; and, by way of contrast, *Liverpool and *London and *Globe Insurance Co v Bennett [1913] 6TC327.)

In the *Bank Line *case (which related to the treatment of interest on a ship replacement fund), 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………Turning to the present case it is found as a fact that the capital sum in issue was created for the purpose of replacement of ships as an when they became obsolete. In my opinion it is absolutely clear that the retained monies were not employed in the business carried on by the appellants. Of course the appellants could not carry on business without ships and for that reason they set up a capital fund with which to purchase new vessels as and when existing vessels became obsolete. That fund, in truth, far from being employed in the carrying on of the business, was created by withdrawing money from the business. Naturally, it has been put out to earn interest and does so, but that interest cannot be looked upon in the circumstances as ‘trading receipts’.”

The point is a difficult one: see Euroceanica (UK) Ltd v HMRC [2013] UKFTT 313 (TC).  This tribunal decision is not binding and HMRC are advised that aspects of it are open to challenge.  It does, however, support the view that FA00/SCH22/PARA50 is an exclusive provision.  The treatment of a credit arising under a loan relationship or derivative contract therefore falls to be tested under that paragraph, and treatment for tonnage tax follows normal corporation tax principles.

Interest on an investment

Interest on an investment may be treated as trading income if:

the investment is for a short term, and

it is an integral feature of the trading activity to make such an investment, and

the funds deposited can be regarded as continuing to be employed in the business and to form part of the current working capital.

Investments made in the course of banking, insurance and other financial trades will normally meet these conditions. See for example the London and Liverpool and Globe Insurance case.

Investments by non-financial concerns are unlikely to meet these conditions if for example they:

endure from one period of account to another, or

represent capital even if it is only temporarily surplus to requirements, or

although short term, represent part of a series of deposits which together constitute a long term setting aside of part of the capital.

Interest on working capital

Where interest is received on balances required in the company’s trade as working capital, then that income will normally form part of the company’s ‘relevant shipping income’, but only to the extent that the balances did not exceed the amount genuinely needed for working capital.

‘Working capital’ of a company may be defined as:

  •  funds held on a day-to-day basis to meet revenue expenditure obligations as they fall due.

Reasonable assumptions about the receipt of trading income and payment of expenditure must be made in arriving at the working capital required so that, for example, the working capital requirement in respect of a ship which is chartered-out on the spot market may be higher than that for a ship which is chartered-out on a long term charter (in order to provide for the potential loss of charter hire income caused by market fluctuations).

Working capital, by its nature, must be held in liquid or near-liquid form. HMRC does not accept that interest on term deposits or other long-term investments can be relevant shipping income.

Interest and forex gains and losses on deposits integral to leases

As part of the arrangements for obtaining loan finance, a shipping company may be obliged to make a deposit on which interest arises. This most commonly occurs in cases where the finance is being provided by means of a finance lease and the lender requires a defeasance deposit (see TTM10100) because it is not prepared to take on the whole of the underlying risk.

Interest and forex gains and losses on loan and defeasance deposits

As part of the arrangements for obtaining loan finance, a shipping company may be obliged to make a deposit on which interest arises.  This most commonly occurs in cases where the finance is being provided by means of a finance lease and the lender requires a defeasance deposit (see TTM10100) because it is not prepared to take on the whole of the underlying risk.  Security deposits may also be required in conjunction with ordinary loans.  As a general principle, HMRC does not accept that interest arising on security deposits of this kind constitute relevant shipping income.

In the light of the unsatisfactory aspects of the Euroceanica decision referred to above (which HMRC were not in the particular circumstances of the case able to challenge further on appeal) officers should refer any claims that interest on deposits constitutes relevant shipping income to the Tonnage Tax Technical adviser.  The only exception to this referral is if the arrangements were clearly designed to raise working capital within the meaning above.

Interest that does fall to be treated as trading income will be a relevant shipping profit within FA00/SCH22/PARA44 (2)(b).

Examples

See TTM06520 for some illustrations as to what may come within relevant shipping income, and what may not.

References

FA00/SCH22/PARA44 (2) (relevant shipping income) TTM17261
   
FA00/SCH22/PARA50 (certain interest etc.) TTM17291
FA00/SCH22/PARA51 (general exclusion of investment income) TTM17296