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Income tax treatment under the tonnage scheme

In this article we will examine the tax treatment and reporting obligation on the application of the tonnage scheme that is effective from 1 July 2020.

The Maritime Administration advises and regulates those applying the tonnage scheme (resident companies) regarding their operations, ships, dredgers or tugboats meeting the conditions required (questions related to state aid and shipping tax differences: estonianflag@vta.ee or tel +372 6205 775).

The Estonian Tax and Customs Board advises resident companies regarding their tax reporting obligations (for example, transitioning to the tonnage scheme, adoption of the tonnage scheme). If you have any questions, please contact us at ariklient@emta.ee.

Legal basis

The Act Amending the Law of Ship Flag and Ship Registers Act and Income Tax Act and Act Amending Other Related Acts was published in Riigi Teataja on 4 March 2019 and on 18 February 2020.

What is the tonnage scheme?

Pursuant to § 521 of the Income Tax Act, a resident company may pay income tax on income received from activities of international carriage of goods or passengers by sea specified in § 521 (6), (7) and (9)–(11) or in subsection (13) of the Income Tax Act by using a ship meeting the conditions of § 13 (5) 1) or (6) of the Income Tax Act by not applying the provisions of §§ 49–52 (hereinafter tonnage scheme). (Income Tax Act, § 521 (1))

Companies applying the tonnage scheme (resident companies) pay income tax on income earned under the tonnage scheme which is reported in Annex 8 of Form TSD of the tax return (hereinafter Form TSD) by the 10th day of the following calendar month.

Companies applying the tonnage scheme must only indicate the ship IMO number in the e-MTA on a monthly basis under code 8101 of Annex 8 to Form TSD. The rest of the ship data (codes 8102–8107 corresponding to the ship name, flag country, net tonnage, number of calendar days and age of the ship) is pre-filled in the e-MTA based on data received from the Maritime Administration.

The Maritime Administration verifies if the ship meets the conditions and if the ship data is correct.

The application of the tonnage scheme constitutes state aid as per the definition of Article 107 (1) of the Treaty on the Functioning of the European Union, the granting of which is based on guidelines of state aid related to maritime transport, guidelines on ship management companies and the European Commission’s decision authorising such state aid. (§ 521 (2) of the Income Tax Act)

The tonnage scheme shall be applied for as long as its application conditions are met not longer than until the end of the validity period of the decision by the European Commission authorising such state aid. In case of a failure to meet the conditions for the application of state aid there exists a right to apply state aid once again after the expiry of the decision by the European Commission authorising such state aid under the condition that the European Commission has issued a new permission for state aid and conditions for the application of state aid have been met. (Income Tax Act, § 521 (17))

Under what conditions may resident companies apply the tonnage scheme?

A resident company may apply the tonnage scheme if the following conditions have been met (Income Tax Act, § 521 (3)):

  1. it has assumed the liability for managing the maritime safety and technical service of a ship meeting the conditions provided for in clause 13 (5) 1) or in subsection 13 (6) of the Income Tax Act and has a corresponding certificate;
  2. the strategic, business and technical management decisions related to the operation of the ship are made in Estonia;
  3. the decisions related to the management of the crew are made in a Contracting State[1];
  4. it is not an undertaking in difficulty within the meaning of Guidelines on State aid for rescuing and restructuring non-financial undertakings in difficulty established by the European Commission;
  5. it has not failed to perform the obligation to repay the State aid declared illegal and incompatible with the internal market on the basis of the decision of the European Commission.

A ship meeting the conditions stipulated in § 13 (5) 1) of the Income Tax Act is a ship which has gross tonnage of at least 500 and is used for international carriage of goods and passengers by sea within the meaning of § 521 (5) of the Income Tax Act, except for passenger ships engaged in regular service in the European Economic Area.[2]

The conditions set in § 13 (6) of the Income Tax Act are met by a dredger or tugboat with gross tonnage of at least 500 and that flies the flag of a Contracting State on the condition that more than 50% of the ship’s operational time is spent in maritime transport (activities carried out with a dredger or a tugboat outside the port and the territorial sea of Estonia).

In order to implement the tonnage scheme, the ships used by the resident company and the undertakings belonging to the same group as the company and included in the calculation of the tonnage scheme shall meet the following conditions:

  1. at least 25% of the gross tonnage of the ships must be owned by the company and the undertakings belonging to the same group as the company or used by them on the basis of a bareboat charter party;
  2. at least 60% of the gross tonnage of the ships, including all dredgers and tugboats, must be registered under the flag of a Contracting State. (Income Tax Act, § 521 (4))

The tonnage scheme may also be applied by a resident company that earns income from the management of a crew of or provision of technical management service to a ship complying with the conditions provided for in clause 13 (5) 1) or in subsection 13 (6) of the Income Tax Act and that meets the conditions provided for in clauses (3) 4) and 5) of § 521 of the Income Tax Act [3] if (Income Tax Act, § 521 (13)):

  1. the provider of the crew management service makes management decisions in Estonia and fully adheres to and applies all the requirements of the Maritime Labour Convention of the International Labour Organization;
  2. the provider of the technical management service makes management decisions in Estonia, has assumed the liability for managing the maritime safety and technical service of the ship and has a corresponding certificate;
  3. all the ships and crews managed by the service provider specified in clauses 1) and 2) comply with international standards and requirements arising from the law of the European Union related to the maritime security and safety, training and certification of seafarers, environmental conservation and working conditions on a ship;
  4. at least 60% of the gross tonnage of ships included in the calculation of the tonnage scheme used by the company and the undertakings belonging to the same group as the company, including all dredgers and tugboats, has been registered under the flag of a Contracting State;
  5. the service provider has at least one crew manager and four other employees to manage crews of up to ten ships and at least two crew managers and eight other employees to manage crews of more than ten ships;
  6. the service provider has at least one technical manager and four other employees for technical management of up to ten ships and at least two technical managers and eight other employees for technical management of more than ten ships;
  7. at least 51% of the employees specified in clauses 5) and 6) are citizens of a Contracting State.

An undertaking who meets the conditions provided for in subsection (4) or clause (13) 4) is an undertaking who meets the conditions together with the undertakings that belong to the same group as the company and comply with the requirements for application of the tonnage scheme, provided that all the foregoing undertakings have joined the tonnage scheme. (Income Tax Act, § 521 (15))

The Maritime Administration of Estonia advises and regulates those applying the tonnage scheme (resident companies) regarding their operations, ships, dredgers or tugboats meeting the conditions required.

When is the transport of goods and passengers deemed international?

Carriage of goods and passengers by sea is deemed international within the meaning of § 521 of the Income Tax Act if more than 50% of the voyages take place:

  1. between an Estonian port and a foreign port;
  2. between an Estonian port and a facility located outside the territorial sea of Estonia;
  3. between the ports in a foreign country or in foreign countries;
  4. between a foreign port and a facility located off the shore. (Income Tax Act, § 521 (5))

What source of income is subject to taxation under the tonnage scheme?

Sources of income specified in § 521 of the Income Tax Act in subsections 6, 7 and 9–11 or subsection 13 subject to taxation under the tonnage scheme.

Core activities of international carriage of goods or passengers by sea are:

  1. carriage of goods or passengers for a fee;
  2. granting cabins for use for a fee;
  3. sale of food and drinks for immediate consumption on board;
  4. granting a ship for use for a fee on the basis of a charter party (hereinafter chartering out), except chartering out on the basis of a bareboat charter party. (Income Tax Act, § 521 (6))

Ancillary activities of international carriage of goods or passengers by sea are:

  1. provision of services or sale of goods, usually on passenger ship, provided that these activities are directly related to the carriage of passengers by sea;
  2. salvage;
  3. loading, unloading and securing of cargo if these activities are carried out by crew members of a resident company;
  4. granting containers or other tanks for use for a fee;
  5. renting out a space on board to a seller of goods or a provider of services;
  6. granting an advertising space on board for use for a fee;
  7. mediation of sightseeing during a voyage to a passenger on a ship, provided that the passenger’s cabin remains in his/her use. (Income Tax Act, § 521 (7))

Income received from the ancillary activities provided for in above is taxed pursuant to the tonnage scheme if it does not exceed 50% of the income received from the activities of international carriage of goods or passengers by sea of a ship complying with the conditions of clause 13 (5) 1) or subsection 13 (6) of the Income Tax Act. (Income Tax Act, § 521 (8))

The following activities shall also be deemed to be international carriage of goods or passengers by sea:

  1. crew or technical management of a ship;
  2. chartering out a ship on the basis of a bareboat charter party to an undertaking in a Contracting State which belongs to the same group as the company. (Income Tax Act, § 521 (9))

Chartering out a ship on the basis of a bareboat charter party shall also be deemed to be international carriage of goods or passengers by sea, provided that:

  1. the reason for chartering out is the excess capacity of the tonnage of a ship temporarily not used in business by a resident company due to other reasons than purchasing or chartering a ship for the purpose of chartering it out;
  2. the ship is chartered out for no longer than three years;
  3. the chartering out does not exceed 50% of the gross tonnage of the ships used by the resident company and included in the calculation of the tonnage scheme. (Income Tax Act, § 521 (10))

Activities carried out with a dredger or a tugboat outside the port and the territorial sea of Estonia shall also be deemed to be international carriage of goods or passengers by sea if more than 50% of the operational time of the dredger or tugboat is spent in maritime transport, and only in respect of such transport activities. (Income Tax Act, § 521 (11))

The proportion requirements provided for in subsections (5), (8) and (11) are met if an undertaking meets the conditions within a calendar year in proportion to the number of months during which the tonnage scheme was applied. (Income Tax Act, § 521 (16))

Companies applying the tonnage scheme (resident companies) report their income for the calendar year earned from core activities and ancillary activities in Annex 8 to Form TSD of the month of December, which must be filed by 10 January.

Therefore, companies applying the tonnage scheme must annually under codes 8201–8230 of Annex 8 to Form TSD of the month of December (income of ship operators from the carriage of goods or passengers by sea) or under codes 8401–8450 (income from the provision of the crew management service or technical management service of a ship), reporting the ship IMO number and income for the calendar year and profit for the calendar year which are subject to taxation under the tonnage scheme (code 8280) and what is subject to taxation under the ordinary regime (code 8260). Income from ancillary activities during the calendar year (code 8250) is used to calculate compliance with the tonnage regime application criteria.

Income tax is not charged on income earned by companies within at least three years from transfer of a ship used for earning income taxed under the tonnage scheme. This is conditional upon the following:

  • if income tax has been paid upon transfer of the ship pursuant to § 50 (42) of the Income Tax Act or

  • if the ship had been acquired out of the income taxed pursuant to the tonnage scheme. (Income Tax Act, § 521 (12))

What is the tax treatment of asset transfers?

The principles of taxation of transfer pricing stipulated in § 50 (4) of the Income Tax Act also apply to transactions between business entities belonging to a legal person if tax is charged on the income of at least one of them on the basis of the tonnage scheme. (Income Tax Act, § 50 (41))

Upon transfer of assets from a business entity belonging to a legal person the profit of which is taxed on the basis of §§ 49–52 of the Income Tax Act to a business entity the income of which is taxed on the basis of the tonnage scheme, the assets are deemed as being taken out from the business of the first business entity and the undertaking will have the tax liability on the basis of the market value of the assets. The tax liability also arises to the full extent if the tonnage scheme only applies in part to the income received from activities carried out with the assets. (Income Tax Act, § 50 (42))

The tax liability upon transfer of the assets is reported under code 6000 in Annex 6 to Form TSD.

What is the amount subject to taxation?

Upon implementation of the tonnage scheme, the amount of the income subject to tax is calculated for each ship complying with the conditions provided for in § 13 (5) 1) or in § 13 (6) of the person implementing the tonnage scheme per 24-hour period that has started, irrespective of whether or not the ship is used. (Income Tax Act, § 521 (18))

The amount of the income subject to tax is calculated as the product of the net tonnage of the ship used by the person implementing the tonnage scheme and the corresponding ratio as follows (Income Tax Act, § 521 (19)):

  1. the ratio applicable to the tonnage range of up to 1,000 is 0.0084 euros;
  2. the ratio applicable to the tonnage range of 1,001 to 10,000 is 0.0062 euros;
  3. the ratio applicable to the tonnage range of 10,001 to 25,000 is 0.0040 euros;
  4. the ratio applicable to the tonnage range starting from 25,001 is 0.0020 euros.

The ratios apply as follows depending on the age of the ship (Income Tax Act, § 521 (20)):

  1. 50% for ships not older than five years;
  2. 75% for ships older than five years but not older than ten years;
  3. 100% for ships older than ten years.

 Based on ship data and ratios specified by law the monthly tax liability is calculated automatically under codes 8108–8111 in Annex 8 to Form TSD.

 

Examples
  • The tax liability of a 12-year-old ship with net tonnage of 30,000 is calculated as follows.
    The amount of taxable income per day (ratio multiplied by net tonnage):
    0.0084 × 1,000 + 0.0062 × 9,000 + 0.004 × 15,000 + 0.002 × 5,000 = 8.40 + 55.80 + 60 + 10 = 134.20 euros
    The amount of taxable income per calendar month (30 days): 134.20 × 30 = 4,026 euros
    Income tax liability for the calendar month: 4,026 × 20% = 805.20 euros

  • The tax liability of a 5-year-old ship with net tonnage of 30,000 is calculated as follows.
    The amount of taxable income per day (50% of the ratio multiplied by net tonnage):
    0.0042 × 1,000 + 0.0031 × 9,000 + 0.002 × 15,000 + 0.001 × 5,000 = 4.20 + 27.90 + 30 + 5 = 67.10 euros
    The amount of taxable income per calendar month
    (30 days): 67.10 × 30 = 2,013 euros
    Income tax liability for the calendar month
    : 2,013 × 20% = 402.60 euros

Notes

[1] Contracting States are hereinafter Contracting States of the European Economic Area Agreement, which are European Union Member States and Iceland, Norway and Liechtenstein.

[2] The European Economic Area flag condition included in § 13 (5) 2) of the Income Tax Act is not applicable to the tonnage scheme. However, it is important for the application of favourable tax treatment to crew member pay.

[3] It must not be a firm in difficulty within the meaning of the community guidelines issued by the European Commission on state aid for rescuing and restructuring firms in difficulty and must not have failed to perform its obligation to repay state aid deemed illegal and incompatible with the internal market under a decision by the European Commission.

June 2020
 

29.10.2020