May 18, 2000

Non-U.S. Shipping And Cruise Companies Should Be Aware Of Proposed Changes In U.S. Tax Law

Richard A. Crowley

Non-U.S. shipping and cruise companies that claim exemption from U.S. income taxation pursuant to Section 883 of the U.S. federal tax code should be aware that there are proposed regulations to Section 883 that would impose significant new requirements and restrictions if and when the regulations are published in final form.

Shipowners who are residents of countries other than the United States and who own their ships through companies incorporated in the Bahamas, Liberia, the Marshall Islands, Panama, Vanuatu or other countries that do not have a general income tax treaty with the United States rely on Section 883 of the U. S. federal tax code to exempt income earned from the operation of their ships from U.S. federal income tax.

The U.S. Internal Revenue Service has published proposed regulations to Section 883 that impose new conditions on the applicability of the exemption. Shipowners may need to change the shares of their shipowning companies from bearer to registered form and should be prepared to comply with the additional information disclosure requirements of the proposed regulations to avoid losing eligibility for the Section 883 exemption. 

The following paragraphs describe a number of the significant changes in the application of the Section 883 exemption.

1.   The Section 883 Exemption.

For many years Section 883 of the U.S. federal tax code has provided an income tax exemption for income earned by a non-U.S. corporation from the international operation of a ship if –

(a)  the country in which the corporation is incorporated provides an equivalent exemption for U.S. corporations (a country described in this clause (a) is called in this memorandum a "qualified foreign country"), and

(b)  one of the following conditions is satisfied

(i)   the capital stock of the non-U.S. corporation is primarily and regularly traded on an established securities market in the United States or in a qualified foreign country (a corporation described in this subclause (i) is called in this memorandum a "qualified publicly traded corporation"); or

(ii)  more than 50% of the value of the corporation's capital stock is owned (directly or indirectly) by any of the following (called "qualified shareholders"):

(A) one or more individuals who are residents of one or more countries that provide an equivalent exemption for U.S. corporations, or

(B) one or more qualified publicly traded corporations; or

(iii) more than 50% of the voting power or value of the non-U.S. corporation's capital stock is owned (directly or indirectly), or is deemed to be owned as a result of the application of constructive ownership rules, by U.S. individuals or entities each of which owns (directly or indirectly), or is deemed to own as a result of the application of constructive ownership rules, 10% or more of the voting power of the voting stock of the non-U.S. corporation (a non-U.S. corporation described in this subclause (iii) is called a "controlled foreign corporation").

2.   The Proposed Section 883 Regulations.

The U.S. Internal Revenue Service (the "IRS") has published for public review and comment proposed regulations to Section 883 which the IRS intends to re-publish in final form and make effective for the tax year in which the final regulations are published (unless the final regulations are published less than 30 days before the end of the tax year, in which case they will take effect at the beginning of the following tax year) and for all subsequent tax years.

3.   How the Proposed Regulations Would Change or Clarify the Application of the Section 883 Exemption.

The proposed Section 883 regulations, if made effective in their present form, would make important changes or clarifications in the application of the Section 883 exemption to non-U.S. shipping and cruise companies, including the following:

(a)  New rule against bearer shares

For purposes of determining whether the condition described in paragraph 1(b)(ii) above is satisfied, any individual or publicly traded corporation that owns its interest in the non-U.S. shipping or cruise company through bearer shares would not be counted as a qualified shareholder.

(b)  New requirement to obtain shareholder statements

The Section 883 exemption would not apply to a non-U.S. shipping or cruise company that is classified as a corporation for U.S. federal income tax purposes unless the company obtains from each of its direct and indirect shareholders an "ownership statement" that includes, among other things, the shareholder's name, permanent address and country of tax residence and information about other shareholders above and below in the chain of ownership (if any), subject to special rules for qualified publicly-traded corporations and controlled foreign corporations. The non-U.S. shipping or cruise company must retain those ownership statements until the expiration of the statute of limitation for the relevant tax year, and must make those ownership statements available for inspection by the IRS upon request.

(c)  Limitations on eligibility for the exception for publicly traded corporations

A company would not be treated as a publicly traded corporation unless certain conditions are satisfied, including the following:

(i)   Listing: One or more classes of stock of the company which, in the aggregate, represent 80% or more of the voting power and value of the shares of the company must be listed on one or more specified securities exchanges[1]during the tax year; and

(ii)   Trading: With respect to each class of stock described in (i) above

(A) Trading frequency: Trades in shares of each such class of stock must be made on the specified securities exchange or exchanges in more than "de minimis" quantities on at least 60 days during the 12-month tax year (or equivalent for a tax year consisting of fewer than 12 months), and

(B) Trading volume: The total number of shares of each such class of stock traded on the specified securities exchange or exchanges during the tax year must be at least equal to 10% of the average number of shares of that class of stock outstanding during the 12-month tax year (or equivalent for a tax year consisting of fewer than 12 months), and

(C) Not closely held: The shares of each such class of stock must not be "closely held".[2]

(d) Must be owner, lessor or lessee of an entire ship

The Section 883 exemption would not apply to a non-U.S. shipping or cruise company unless the company is the owner, lessor or lessee of an entire ship that is used to carry cargo or passengers for hire. Therefore, a company that has only one of the following relationships to a ship, for example, would not be eligible for the Section 883 exemption:

(i)   A company that offers to provide commercial ocean transportation to the public, but which arranges to have other ocean carriers provide the transportation.

(ii)   A company that has only rights in a ship under a space charter or a slot charter.

(iii)  A company that has only a passive investment in a pool, partnership, joint operating agreement or other joint venture that is engaged in the international operation of one or more ships.

4.  Public Hearing

The IRS will hold a public hearing on June 8, 2000, in Washington, D.C., to discuss public comments on the proposed regulations.

5.  Final Regulations

It is expected that the IRS will publish the Section 883 regulations in final form after considering the public comments it receives. If the regulations are published in final form before December 2, 2000, they could apply retroactively from January 1, 2000.

6.   Further Information

This summary is intended to highlight several important new requirements in the proposed Section 883 regulations and does not discuss all the details of the proposed regulations. For further information about the proposed regulations, including the application of the proposed regulations to particular situations, please contact Richard Crowley or Kenneth Yoon.


[1] A "specified securities exchange" is any of the following: (1) a national securities exchange registered under the U.S. Securities Exchange Act of 1934, or (2) a U.S. over-the-counter market, or (3) a non-U.S. securities exchange that is officially recognized, sanctioned or supervised by a governmental authority of the country in which the exchange is located and has an annual value of shares traded on the exchange exceeding US$1 billion during each of the immediately preceding three calendar years, or (4) any exchange specified in the "limitation on benefits" article of an applicable income tax convention to which the United States is a party.

[2] Shares of a class of stock will be considered "closely held" if one or more "5% shareholders" own, in the aggregate, 50% or more of the value of the shares of that class of stock. A "5% shareholder" is a person that owns (or is deemed to own as a result of the application of constructive ownership rules) 5% or more of the value of the outstanding shares of any class of stock.

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