Global minimum tax reform - the implications for shipping

As part of their targeted work on base erosion and profit shifting (BEPS) the OECD have recently published further technical guidance on the “Pillar Two” proposals designed to ensure a minimum level of taxation for large multi-national enterprises at an effective rate of 15%. 

The Pillar Two proposals include an exclusion for relevant shipping income, covering profits earned from the transportation of passengers or cargo in international traffic. This is an important exemption for shipping groups as most tonnage tax regimes result in an effective rate of tax which is lower than the proposed minimum tax rate of 15%.

The exclusion for relevant shipping income under the Pillar Two proposals encompasses a wide definition for both ship-owners and ship-operators. It covers circumstances where a vessel is either owned, leased or operated under slot-chartering arrangements, as well as the leasing of a vessel either under either time or bareboat charter (subject to certain restrictions where the charterer is not part of the same group) and the participation in a pool or joint business or international operating agency. Profits on the sale of a ship used for the transportation of passengers or cargo in international traffic are also within the exemption, provided the vessel has been held for a minimum of one year.

One important condition that must be met for the exclusion to apply is that the relevant shipping entity must “demonstrate that the strategic or commercial management of all ships concerned is effectively carried on from within the jurisdiction that entity is located.”

Many preferential shipping/tonnage tax regimes already have strict qualifying requirements on the strategic and commercial management of vessels being located in the relevant country. However, effected groups will need to understand how this rule may affect the management of their fleet as there is currently limited additional guidance on how this test should be implemented.

Whilst the exclusion for relevant shipping income is extended to include certain other ancillary income of the worldwide group, up to a permitted level not exceeding 50% of the total relevant shipping income of the whole group, it is clear that the OECD’s current proposals and technical guidance envisages that the exemption only covers profits for vessels operating in international traffic.

Domestic transportation by sea is therefore not explicitly covered within the definition of relevant shipping income. Given that many tonnage tax regimes allow wider activities “performed at sea” to be included, the profits generated from activities which are not international traffic but are relevant profits for a given tonnage tax regime are potentially still within the scope of the Pillar

Two rules and subject to the minimum 15% effective tax rate. This may therefore lead to an unhelpful distortion and discrepancy in the way in which tonnage tax regimes consider shipping income compared to the Pillar Two exemption rules, potentially eliminating some or all of the benefits of the tonnage tax regime where the Pillar Two rules require a 15% effective tax rate.

Whilst the OECD have provided the blue print for these new rules, with support and agreement from over 130 countries as inclusive framework members, it is now down to each relevant country to implement these rules into their own domestic law. HMRC’s own consultation process on the introduction of the rules closed in early April.

The OECD proposals recommend that the Pillar Two rules apply to groups with global turnover in excess of €750 million but countries may choose to adopt a lower threshold. Shipping groups will therefore need to continue to monitor the adoption of these rules and the adoption of the exclusion for shipping income closely.

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