Take stock of changing tax rules

Recently, a number of catalysts have provoked new domestic and international laws geared at foiling alleged tax avoidance. Governments and international organisations alike have moved to introduce new rules governing the way cross-border transactions and arrangements are taxed.

Historically, countries have had a huge degree of autonomy in the way they have taxed international transactions and this has led to variances in the way different jurisdictions have regarded the same transaction. It could be argued that some countries have even adapted their own rules in order to exploit these differences and encourage transactions to take place through their jurisdiction.

The goal of international tax laws is to allocate taxing rights between two countries that have an interest in a transaction in order to balance the rights of the two countries involved. However, domestic measures often unilaterally protect a country’s ability to raise revenue by levying taxes.

New international and domestic laws preventing base erosion and profit shifting (BEPS) – shifting profits from a jurisdiction with a high tax rate to that of a lower one, or reducing the amount of profit subject to tax in a company’s jurisdiction of operation by making excessive payments to reduce their tax base – have already been introduced, and even more are on the horizon.

Given the international nature of the shipping industry, multinational law firm Norton Rose Fullbright says those that own, finance and charter ships will need to understand all the possible implications of these new rules on their business.

Intra-group arrangements

The Organisation for Economic Co-operation and Development (OECD) has been working on 15 actions plans to combat BEPS since 2012. It published the final recommendations on these 15 plans in October 2015, and, in the last few months, has published additional guidance. These action plans must now be implemented by the relevant countries. 

In its Legalseas publication, Norton Rose reveals that many of the action plans by the OECD are aimed at the way multinational groups are structured. In particular, it says, the measures under Action 2, 3 and 7-10, which relate mostly to transfer pricing between group entities or allocating profits to group entities in lower tax jurisdictions.

Although many domestic rules dealing with transfer pricing are already in force in most jurisdictions, the BEPS proposals appear to go one step further; they aim to align transfer pricing outcomes with value creation. This will include looking at allocating profits in line with the chain of value created within the group, explains Norton Rose.

Norton Rose says that revised draft guidance was published on July 4, 2016 which discusses how “transactional profit splits” will be applied in order to achieve this aim.

“Broadly, the ‘transactional profit split method’ looks at the effect that transactions, which are or would be subject to transfer pricing, have on profits by deducing what the profits would have been for the transacting entities if the deal had been on arm’s length terms,” it continues.

“As there is value in both the capital invested in vessels and the marketing, vessel management and operation of vessels, the allocation of this value may be contentious, particularly given that different entities will potentially benefit depending on the function they have.”

There is also the potential that new measures in relation to the attribution of profits to permanent establishments in order to prevent the artificial avoidance of PE status will have an impact on the shipping industry.

“Whilst shipping profits are generally protected by double tax treaties, these measures could still be relevant where activities are split between high and low tax jurisdictions,” says Norton Rose. “For example, where the owners of vessels are based in a different jurisdiction to the entities which deal with chartering and managing the vessels.”

Further guidance in relation to these measures was published on July 4, 2016, which included additional discussion of dependent agent permanent establishments where a non-resident carries on a business in a relevant country via a dependent agent, among more.

Planning for action

Action 6 is also likely to become relevant to the shipping industry when an owner of a vessel is based in a jurisdiction that is imposing withholding tax on outbound payments. Its specific recommendations are that double taxation treaties should contain either a limitation on benefits article or a ‘main purpose’ article.

According to Norton Rose, this will result in further scrutiny of the structures and jurisdictions used in chartering vessels. Here, Norton Rose recommends that those who are party to transactions which relate to shipping may want to include provisions ensuring flexibility in the event that measures are introduced to deal with this.

Additionally, it says, parties should consider using contractual protections in the event that there is a transfer of the business to a party with less substance than the initial parties to the transaction.

“These potential new measures are particularly relevant to the shipping industry as it is common for owners to be based in one jurisdiction, with the chartering of the vessel being managed from an office in another jurisdiction,” it says.  

“Also, entities involved in the shipping industry will need to look out for the rules that will be introduced under Action 4. This action point will restrict interest deductions where they exceed a certain percentage – likely 30% – of earnings before interest, taxes, depreciation and amortisation.”

The rules will undoubtedly be complex. Already, some are beginning to be introduced and are likely to have an impact on those involved in shipping. Norton Rose says that it will be important to monitor these rules as they will probably be introduced on a jurisdiction-by-jurisdiction basis and, therefore, involve a level of inconsistency in their implementation.

Further, Norton Rose adds: “Those involved with transactions that could be affected should begin to undertake a risk assessment of the transactions and structures that are most likely to be affected, and consider putting effective contingency plans in place.”