Summary of UK Tonnage  Tax Legislation  

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Contents 

Introduction ................................................................................................................ 3

Basis of UK tonnage tax............................................................................................. 4

How tonnage tax is calculated.................................................................................... 5

Who qualifies?............................................................................................................ 7

Qualifying shipping activities - the income which is tax exempt ............................. 11

Offshore activities..................................................................................................... 13

Entry ......................................................................................................................... 17

Exit............................................................................................................................ 18

Capital allowances.................................................................................................... 19

Leasing ..................................................................................................................... 21

Capital gains............................................................................................................. 23

Training requirements .............................................................................................. 24

Flagging requirements ............................................................................................. 26

Operating requirements ........................................................................................... 28

UK flag ...................................................................................................................... 29

Our offices and contacts .......................................................................................... 32

This paper aims to provide an overview of the UK’s tonnage tax regime. The statements that we have made are of a general nature, and we have not addressed every detail of the system. Accordingly, this document should not be relied upon as formal legal advice. We would recommend you to seek specific legal advice in relation to any transaction you propose to undertake that is liable to be affected by this area of law.

Introduction 

Commencement

Tonnage tax was introduced in the UK when the Finance Act 2000 became law on 28 July

2000. Supplementary rules are set out in the Tonnage Tax Regulations, which were issued

on 25 August 2000. On the same day, the Inland Revenue (now renamed HM Revenue

and Customs) issued their own detailed guidance on the operation of the system, in

their Statement of Practice SP4/2000.

Purpose

The tonnage tax system was introduced to create a positive fiscal environment for

international shipping based in the UK, in line with other major maritime countries. The UK

system aims to achieve a real and permanent reduction in the tax liability of participating

businesses. This is in contrast to the tonnage tax systems of some other countries, where

there is simply a deferral of tax until a business leaves the system.

Ring Fence

There is careful “ring-fencing” of shipping activities to ensure that only genuinely shipping-

related business profits fall within the regime. There are also certain exit charges but only

where a company leaves the system for a tax-motivated reason, or is expelled from the

system where the company is regarded as having entered into a transaction which is an

abuse of the system.

Pre-Clearance

The clearance process enables an applicant to establish a prior agreement between itself

and the HM Revenue and Customs as to how the regime will apply to it. There is no

mandatory requirement to seek a pre-entry clearance but (bearing in mind that tonnage tax

is subject to self-assessment) use of the clearance procedure is strongly

recommended.

3

Basis of UK tonnage tax 

Notional Profit

Under the regime, a company may opt to be charged to corporation tax on a fixed notional

profit, calculated by reference to the net tonnage of its ships, instead of the actual profits

earned from its shipping activities. Any non-shipping activities will be taxed separately,

remaining under the existing corporation tax rules.

Fixed Level

By fixing the level of tax according to the tonnage of their fleet, rather than their variable

profit stream, tonnage tax companies have the benefit of paying a low, predetermined

amount of tax. It also enhances a company’s prospects, from the perspective of potential

investors. However, as the amount payable is fixed, a company will have to make

tonnage tax payments even if it actually makes an operating loss in relation to its shipping

activities.

Administration

Since tonnage tax is a form of corporation tax, all the ordinary corporation tax rules apply

in relation to administrative and procedural matters, such as the timing of tax payments, the

timing of tax returns, interest and penalties for late payment of tax, rights of appeal to the

courts, and so on. (There are, however, special additional compliance rules in relation to

the training aspects of the system.)

4

How tonnage tax is calculated 

Tax Rate

Tonnage tax is determined by applying the ordinary corporation tax rate to a fixed notional

profit. The notional profit is calculated for each ship, and then aggregated.

The notional daily profit for each qualifying ship is reached by calculating:

per 100 net tons

up to 1,000 tons £0.60

1,000 to 10,000 tons £0.45

10,000 to 25,000 tons £0.30

above 25,000 tons £0.15

The notional profit for any year is worked out by multiplying the notional daily profit of the

ship by the number of days in that year that the ship is within the regime. The notional

profit for all ships is then aggregated and multiplied by the ordinary corporation tax rate

(currently 28%).

Joint Ownership

In the case of joint ownership or joint chartering, notional profits are apportioned,

according to the respective interests held in the vessel by the joint owners or joint

charterers.

5

Example

Suppose a company operates one ship within the regime throughout the year. The ship

has a net tonnage of 25,000 tons, and the corporation tax rate for that year is 28%. The

tonnage tax would be calculated as follows*:-

Daily profit: £

For the first 1,000 tons 6.00

For 1,000 to 10,000 tons 40.50

For remaining 15,000 tons 45.00

Total 91.50

Notional annual profit:

£91.50 x 365 days = £33,397.50

Tonnage Tax:

£33,397.50 x 28 = £9,351.30100

* for ease of reference, the 28% rate has been used; however, rates of tax vary,

depending on the total profit of the company and the number of companies in a group.

6

Who qualifies? 

Companies qualify for entry into the regime if they operate “qualifying ships” which are

“strategically and commercially managed” in the UK.

Operating a Qualifying Ship

For a company to operate a qualifying ship, it must own or charter in the ship. It is the

operator of a ship that is eligible for tonnage tax treatment and so the owner of a ship will

generally not be eligible if it charters it out on bareboat terms. (It is permissible to bareboat

charter the ship out for a term of no more than three years, provided the ship is temporarily

surplus to the company’s requirements, or to bareboat charter the ship to another member

of the same group.)

Time Charter

A company cannot elect if it time charters in, on average, more than 75% of its net

tonnage (except where this is intra-group). There is some flexibility allowed in making any

transitions required in order to satisfy this “75% requirement” but care needs to be taken in

ensuring that relevant time limits are complied with.

Owning Company

There is no requirement for a tonnage tax company to be incorporated under UK law. A

foreign company can enter tonnage tax provided that it is “within the charge to corporation

tax”, which it will be if it satisfies the ordinary UK legal tests for corporate residence.

Partnerships

Partnerships are able to enter the regime to the extent that the partners are companies.

Individuals who own ships directly (whether alone or in partnership with other individuals)

cannot enter tonnage tax unless they form a company.

7

Group Elections

A group of companies under common control can elect to enter the regime on a collective

basis. Where a company is a member of a group, an election must be made by that

company and all other members that carry on qualifying activities. As “group” is widely

defined, special rules apply where a company could be a member of more than one group.

The rules on mergers between tonnage tax and non-tonnage tax companies (or groups)

depend upon which company (or group) is dominant and the amount of time left to run on

any tonnage tax elections that have already been made by any of the merger parties.

Temporary Cessation

Temporarily ceasing to operate qualifying ships will not disqualify the company provided

that it complies with certain administrative requirements.

“Strategically and Commercially Managed”

In practice, this is the key factor in establishing eligibility for tonnage tax. The phrase

“strategic and commercial management” is not defined in the legislation but detailed

guidance is provided by HM Revenue and Customs.

In HM Revenue and Customs’ view, there are two separate elements of management

activity - “strategic” on the one hand, and “commercial” on the other. It must be shown

that a significant element of each of those two aspects of management is carried out from

within the UK. HM Revenue and Customs will not necessarily require that all the elements of

ship operation be carried out from the UK but there will need to be sufficient UK input into

the operational process to make clear that the shipping activities as a whole are centred upon

the UK, rather than upon some other jurisdiction.

International Groups

Since the essential requirement is to demonstrate that there is overall management of the

tonnage tax fleet in the UK, HM Revenue and Customs accept in principle, that:

the degree of UK management activity will not necessarily be the same for each

vessel in a particular fleet;

8

an element of “reciprocity” is permissible, with some aspects of UK operations

being managed from abroad if, in turn, some aspects of foreign operations are

managed from the UK; and

ultimate group management of a foreign group cannot be transferred entirely to the

UK if the group retains a foreign head office (provided that the UK part of the

group is given a commercially realistic degree of autonomy).

Qualifying Ship

A ship must be over 100 tons gross tonnage and be seagoing. HM Revenue and

Customs have indicated that “seagoing” would include any ships that are certified for

international trading (e.g. by virtue of a load line certificate or an international load line

certificate) even though they may not trade internationally.

Use

The ship must be used for core qualifying activities. These are:

the carriage of passengers or cargo; or

towage, salvage or other marine assistance carried out at sea; or

transport by sea in respect of services necessarily provided at sea.

The ship must not mainly be used for the provision of goods or services that are normally

provided on land.

Exclusions

The following ships are specifically excluded:

fishing vessels, or factory ships that provide processing services to the fishing

industry;

pleasure craft used primarily for sport or recreation (not including cruise ships);

9

harbour or river ferries;

offshore installations;

tankers dedicated to a particular oilfield;

certain dredgers.

There is a general reserve power enabling other types of vessel to be included or

excluded in the future.

HM Revenue and Customs has given an indication of its view on which types of vessels will

qualify. Cable layers, offshore supply vessels, tugs, anchor handlers and nondedicated

shuttle-tankers may qualify, whilst fixed and floating oil rigs and platforms, FPSOs and

flotels will not qualify. Following amendments made by the Finance Act 2005, emergency

rescue vessels and certain multi-function vessels may qualify. In some cases, there may in

practice be scope for apportionment of total profits, with a “shipping” element of profits from

use of a ship such as a cable-layer treated as being within the tonnage tax system and an

“other activities” or “service at sea” element being treated as non-tonnage tax profits, liable

to ordinary taxation.

Any reference to a “ship” in the tonnage tax legislation also includes a hovercraft.

10

Qualifying shipping activities ‐ the 

income which is tax exempt 

The notional profit replaces the taxpayer’s actual profits to the extent that the actual profits of the

taxpayer’s overall business are derived from any of the categories described below.

“core qualifying activities” - these are described in the previous section. They

also include general management of a tonnage tax company’s own ships (e.g.

public relations) and technical management (e.g. ship management and

crewing).

“qualifying secondary activities” - some of these activities qualify in full and

some only qualify up to a “permitted level”. These activities cover a range of

commercial activities that are naturally part of the process of operating ships

on a commercial basis, although not necessarily inherently maritime in nature.

e.g. selling travel tickets, some linked holidays / transport on land and

gambling on cruise ships, etc.

“qualifying incidental activities” - these are any activities not covered by the

above two categories, to the extent that they do not exceed 0.25% of the

taxpayer’s turnover from its “core qualifying activities” and “qualifying

secondary activities” (only up to the “permitted level”, where relevant).

dividends - dividends are within the scope of tonnage tax if they are paid to a

tonnage tax company by a foreign subsidiary which would itself have been

eligible for tonnage tax if its business activities had been based in the UK.

There are a number of conditions which must be satisfied, and HM Revenue

and Customs have provided detailed guidance on how they interpret these

conditions.

interest receipts - HM Revenue and Customs view is that the interest must

arise from the trade consisting of a company’s tonnage tax activities in order to

qualify.

11

Exempt Capital Gains

As well as replacing actual income, the notional profit also replaces capital gains made by a

company while it is within the tonnage tax system. Therefore actual capital gains will be free

of tax to the extent that the gain arose while the company was within tonnage tax, provided

that the asset in question was used for tonnage tax activities. It is important to note that

the capital gains exemption under tonnage tax is available, in principle, in relation to

any assets that are used in a tonnage tax business, not only the ships themselves.

However, it might sometimes be necessary to apportion a capital gain to reflect the fact that

part of its use (either in terms of time or in terms of the nature of its use) fell outside the

scope of tonnage tax.

Ring-Fencing of Shipping Profits and Losses

Finance costs and losses must be apportioned on a just and reasonable basis to determine

what is attributable to a company’s shipping and non-shipping activities respectively.

Finance costs are defined to include certain loan relationships, interest rates and currency

contracts, exchange losses, finance leases, and other arrangements treated as financing

for accounting purposes.

The UK transfer pricing rules are extended, where necessary, to apply to transactions

between tonnage tax companies and unconnected (as well as connected) non-tonnage

tax parties. As this may have a potential impact on the tax position of third parties, a

company proposing to join the tonnage tax system may need to notify any such third

parties of its intention to join. Transfer pricing principles will also need to be applied within a

single company as between its tonnage tax activities and its non-tonnage tax activities (if

any).

The rules on ring-fencing and apportionment only affect businesses where some of their

activities are subject to ordinary UK corporation tax - i.e. where some parts of the business

are not eligible for tonnage tax. Therefore, the rules do not affect foreign shipping

businesses where all of their UK activities are within the scope of tonnage tax.

12

Offshore activities 

Restrictions

The tonnage tax legislation contains general ‘ring-fenci ng’ rules on profits and gains based

upon the type of activity being carried on by the taxpayer. However, there are also special

‘ring-fencing’ rules based upon the location of certain activities. These rules are designed to

restrict the application of tonnage tax in the context of energy sector activities on the UK

continental shelf. However, even in that context, some activities and some types of ship

(including platform supply vessels) are still treated as qualifying for tonnage tax, despite

the restrictions that are imposed on offshore activities generally.

Ordinary UK tax rules apply to some of the activities and to some types of vessel. Where

the restrictions apply, activities on the continental shelf remain subject to ordinary UK

corporation tax, even if the taxpayer has elected into tonnage tax. However, if a taxpayer is

charged ordinary corporation tax in respect of any “offshore activities”, then;

there is a proportionate reduction in liability to tonnage tax;

a measure of tax relief is allowed for the cost of meeting the tonnage tax

training requirements;

all normal tax deductions and reliefs may be claimed and set against the profits

or gains that are chargeable to ordinary corporation tax (including capital

allowances, suitably apportioned, where relevant).

There is no charge to ordinary corporation tax in respect of “offshore activities” if such

activities are carried on for no more than 30 ship-days per accounting period. However,

these 30 days are counted by reference to the use of a taxpayer’s entire fleet, not by

reference to the use of each individual ship.

13

Special Rules for Different Shipping Trades

The tonnage tax legislation itself contains very little on the application of tonnage tax

principles to particular types of shipping business but HM Revenue and Customs’

guidance material does cover such issues in some detail.

Cruise Liners/Ferries

As previously mentioned, a vessel which is used to provide goods or services of a kind

normally provided on land will not be a qualifying ship for the purposes of the tonnage tax

regime. Pleasure craft are specifically excluded but HM Revenue and Customs has stated

that a commercially operated cruise liner is not considered to be a “pleasure craft”. Thus, a

vessel which is chartered as a whole by its passengers (e.g. a holiday yacht), is

excluded from the tonnage tax regime but a vessel which has individual fare paying

passengers is not.

Harbour or river ferries are not qualifying ships and such vessels are defined in the

legislation as those used for harbour, estuary or river crossings. Therefore, a ferry used

for sea crossings will be a qualifying ship (provided that it is actually certified as seagoing).

Of particular interest to operators of liners, cruise ships and ferries are the regulations

detailing what may or may not be a qualifying secondary activity for the purposes of

tonnage tax. In terms of the full range of facilities made available to passengers, HM

Revenue and Customs has stated that, for example, car parking, quayside shopping

facilities and excursions may all qualify as secondary activities, subject to certain

conditions being met.

“Core qualifying activities”, do not include, for example, the providing of food for short sea

ferry passengers. However, such a provision may instead come within the ambit of

“secondary activities” and, therefore, qualify as a tonnage tax activity.

Gambling and the sale of luxury goods are accepted as secondary activities if their

turnover is “negligible” (i.e. does not exceed 10% of ticket sales plus receipts from the

letting of cabins and sale of food and drink for that particular voyage). Both “gambling”

and “luxury goods” are given wide interpretations by HM Revenue and Customs.

14

“Speculative” profits from cargo

Operators of ships may decide to take full or part ownership of their cargo, rather than

simply acting as carriers. If the cargo is bought by the operator and subsequently sold at a

different price, there is said to be a “price risk” associated with the cargo. This speculative

element of the ship operator’s business will generally fall outside tonnage tax, and so an

apportionment will need to be made of the resulting loss or profit. If there is no price risk for

the operator then the whole of any profit or loss on the voyage will be treated as falling

within tonnage tax.

Pooling

“Pooling” occurs when ship operators form alliances with other companies as a result of

which they can share routes and carry cargo on each other’s vessels. HM Revenue and

Customs has stated that it regards the carriage of another shipper’s cargo as a qualifying

activity provided that a reasonable balance is maintained between the bookings made with

the original customers and the cargo carried in the operator’s own ships.

Further guidance on this issue from HM Revenue and Customs states that a “reasonable

balance” will be maintained where, over a three year period, the aggregated space

allocated for use by originating customers of tonnage tax companies in a UK tonnage tax

group matches the slots/spaces provided to the pool in ships operated by those

companies.

If there is an excess of bookings over cargoes of no more than 10%, then this excess will be

disregarded. However, where there is consistent “structural under-provision” of more than

10% carrying capacity in the tonnage tax company’s own vessels, bookings in excess of the

10% difference will be regarded as the carrying on of a separate trade outside tonnage tax

(and, thus, as fully taxable).

The above applies in particular to pooling in the liner sector but, where appropriate, similar

principles will be applied to arrangements existing in other sectors.

Tugs and Dredgers

In order to qualify for tonnage tax treatment, tugs and dredgers must spend more than

50% of their operational time carrying out qualifying activities at sea and not in port or

harbour, or in an estuary, a tidal or other river or inland waterway. As dredging is not a

qualifying activity, a dredger must spend at least half its time transporting the extracted

material (i.e. carrying cargo) by sea to qualify.

16

Entry 

Entry is by means of an election. HM Treasury has the power to declare periods during

which qualifying companies outside the regime may elect to enter tonnage tax.

A company which has not previously qualified to enter the regime may elect within one year

of first becoming eligible. A company which at any time since 28 July 2000 had been eligible

to join but did not elect within the one year limit will be excluded from entering the regime,

other than in special “election windows” which may be declared by HM Treasury.

Such an election window was opened between 1 July 2005 and 31 December 2006.

Generally, the tonnage tax election takes effect from the date the electing company first

became eligible to enter the regime.

The election is for a period of ten years. It can be renewed at any time before expiry. This

means that it can be renewed annually on a “rolling” basis so that, at any point in time, there

may be an election in place for the succeeding ten years. This may be advisable for

companies wishing to stay in tonnage tax in order to try to guard against future changes in

the law.

17

Exit 

A company leaves the regime either through its current election expiring without being

renewed or by being expelled from the system for certain breaches of the rules.

If a company leaves the system, at any time other than through mere expiry of its existing

election, then it is prohibited from re-entering the system for at least ten years thereafter. It

seems that, in practice, there is some flexibility so as to ensure that bona fide mergers and

acquisitions do not result in accidental disqualification from tonnage tax.

Consequences of leaving

There is no exit charge, as such, when a company leaves the tonnage tax system.

However, some tax savings or other tax benefits that are enjoyed while the company is

within the regime are liable to be recalculated if the company leaves the system. These

are in relation to capital (but not income) taxation, and may mean that there is an increased

liability to capital gains tax or a liability to pay a balancing charge in relation to past claims

for capital allowances. However, there is no provision entitling HM Revenue and Customs

to recalculate tax on past operating profits for any part of the period spent within the

tonnage tax regime. Tax recalculations may occur where:

tax avoidance arrangements are entered into (although the legislation makes clear

that finance leasing is not in itself regarded as an “abuse” of the system); or

a company ceases to be a “qualifying company” (e.g. by ceasing to manage its

ships from the UK) for tax-motivated reasons.

For foreign ship owners entering tonnage tax without a prior UK tax position and leaving for

neither of the reasons mentioned above, it is unlikely that HM Revenue and Customs will

impose penalties, as the UK revenue yield will not have been prejudiced. HM

Revenue and Customs have also emphasised that there is no penalty for leaving, even for

tax-motivated reasons, at the natural expiry date of an election.

18

Capital allowances 

[NB: most discussions of capital allowances in the context of tonnage tax concern the allowances applicable to

“plant and machinery”, such as ships, but the tonnage tax legislation also makes certain adjustments to the

separate capital allowances regime applicable to industrial buildings]

In principle, the tonnage tax system is intended to tax companies on a fixed notional profit.

No deductions or reliefs are allowed, and so there is no scope for claiming capital

allowances. However, there is a need to deal in some way with any capital allowances

benefit or burden that a company may have already acquired from exposure to the UK tax

system prior to its entry to the tonnage tax system. Broadly speaking, the rules aim to have

the following effects:

entering the tonnage tax system is not in itself an event which has any impact

on a company’s pre-existing capital allowances position;

the company has no entitlement to any capital allowances for expenditure on

assets for its tonnage tax activities (although limited allowances are still

available to a lessor that leases to the company - see below);

on leaving tonnage tax, the company is put into roughly the same position that

it would have been in if it had never entered tonnage tax in the first place.

Therefore, where expenditure on a tonnage tax asset was incurred before entering the

regime, it is held in suspension for the time the company is within the tonnage tax system. If

the company leaves the system, a proportion of the expenditure once again becomes

eligible for capital allowances.

If the asset is subsequently disposed of whilst within the regime, any balancing charge

that would otherwise have been imposed will be written off fully over seven years, and

partially (at a rate of 15% per whole year spent within the tonnage tax system) if the

company exits before year seven (unless the taxpayer is expelled from the tonnage tax

system for breach of the rules - see “Exit” above).

19

If an asset is not used wholly for the purposes of the tonnage tax regime, special rules

apply in order to apportion allowances on the basis of qualifying and non-qualifying uses.

Subject to conditions, balancing charges may be deferred if replacement assets are

purchased. Balancing charges may also be reduced or extinguished through a form of

group relief.

This only affects businesses that already had a UK tax liability of some kind prior to

entering tonnage tax.

20

Leasing 

Operating and finance leasing into tonnage tax companies or groups is permitted, subject

to certain restrictions.

Sale and leaseback structures are not generally permitted, although there is limited scope

for sale and leaseback in relation to new vessels (reflecting a change that was made in the

Finance Act 2000 for finance leasing cases outside the sphere of tonnage tax). The Finance

Act 2005 extended this to enable sale and leaseback transactions to be used to finance

major vessel refits.

There is also a general rule that arrangements under which more than half of the lessor’s

risk is removed are not allowed. However, the legislation contains a fairly broadly worded

list of forms of “permitted security”, which will not be regarded as infringing that restriction.

Examples of forms of permitted security include parent company guarantees and security

attaching to the earnings of the leased vessel.

Operating and finance lessors are able to claim capital allowances on:

the first £40 million of expenditure per ship at the rate of 20% per year;

a further £40 million of expenditure at the reduced rate of 10% per year.

The restrictions described above do not apply to non-UK finance leases (i.e. tax benefits

obtained from foreign tax systems), nor do they apply to ordinary ship charters where

specific conditions are met. It should also be noted that the restrictions on capital

allowances only apply to leases of ships; there are no special restrictions on leases of

containers or any other maritime assets.

Additional restrictions on leasing to tonnage tax companies were introduced along with the

reforms to the UK rules on the taxation of leases in the Finance Act 2006.

21

The UK’s long funding lease rules (under which capital allowances are generally

allocated to a lessee rather than to a lessor) do not apply to leases to tonnage tax

companies if the following conditions are met:

(a) the lease is made directly to a tonnage tax lessee company or via an intermediate

lessor company who is in the same group as the tonnage tax company;

(b) the tonnage tax company is responsible for the operation of the ship and for

defraying the ship’s expenses, other than costs which are incidental to a particular

voyage;

(c) any sub-leases must be at market rate and for a period not exceeding 7 years.

The most burdensome of these conditions in practice is that any sub-chartering of the

vessel by the tonnage tax company must be at a market rate and the term of the charter

cannot exceed 7 years.

If a charter can be extended beyond an initial 7 year term, it must contain provisions

allowing the charter rate to be adjusted to the market rate applicable at the time of the

extension.

If the sub-chartering is for an indefinite period, capital allowances remain available to the

lessor only if :

(a) the amount payable under the charter is at a market rate and is to be reviewed at

least once every 7 years; and

(b) the amount payable following such a review is to be changed to the market rate

applicable at that time.

None of the restrictions on finance leasing apply to leases entered into before 23

December 1999.

22

Capital gains 

The tonnage tax system is designed to be a tax free environment, so that no capital gains

tax is charged on assets used within the tonnage tax system.

However, this is only to the extent that the asset is used “wholly and exclusively” for tonnage

tax activities and the capital gain arose during the asset’s period of use within the tonnage

tax system.

If the asset is used by a company prior to it joining the regime, any capital gains tax

charge is confined to the time that the asset was used outside the tonnage tax system. This

means that even when an asset is disposed of whilst operating in the tonnage tax regime, a

company may be liable to capital gains tax in relation to gains made for the period before

entering the system. This includes a foreign company that owns assets that are used in a

business which is outside the scope of UK tax before that company then enters the tonnage

tax system. Thus, it appears that a person who enters the UK tax system for the first time is

at risk of importing a latent capital gain that is referable to any period of use in a trade or

business that was not itself within the scope of UK tax. In principle, this can create (or

increase) a UK tax liability but there are ways of mitigating this potential liability. HM

Revenue and Customs have indicated that they will not object to such mitigation being

undertaken.

If “roll-over relief” is claimed on the replacement of a ship or other relevant business asset

(i.e. if there is deferral of a capital gains tax charge by re-investing the sale proceeds of one

business asset in another business asset) before a company enters tonnage tax and that

replacement ship or other asset then begins to be used within the tonnage system, the

entitlement to roll-over relief is lost (although no tax is actually charged until the replacement

asset is sold).

23

Training requirements 

A company wishing to enter and remain within the tonnage tax regime will need to commit to

provide officer training places in proportion to the number of officers employed by the

company on its qualifying ships.

The logic behind the requirement for training was to increase the cadet training for those

benefiting from the Tonnage Tax Regime at a time when the employment of cadets was

declining.

The company will need to obtain approval from the Department for Transport (“DfT”) for its

proposed training plan, and comply with certain reporting requirements. Election to the

tonnage tax regime can only be made once the DfT have formally issued the approval.

The minimum requirement is to train one eligible cadet per year for every 15 officer posts

entered on the Safe Manning Certificates of all ships in the tonnage tax fleet, plus a

notional 50% to cover back-up officers.

As training takes approximately three years for each trainee, the ratio of cadets to officers

effectively reduces to one cadet for every 5 officer posts once the training arrangements

have been in place for at least three years.

Tonnage tax companies training cadets benefit from a government subsidy (SmarT). This

currently amounts to around 50% of the actual training costs. The company will need to

report to the DfT every four months to show compliance. It must also report any change

that may have taken place in the numbers in the fleet.

The DfT recognises that in some cases shipowners may be unable to employ cadets on

their vessels. The legislation makes provision for the use of a third party manager to be

appointed to find suitable cadets and, where necessary, berths on other shipowners’

vessels.

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In exceptional circumstances only (and then for only very limited periods), there is a

provision for a shipowner to make a payment in lieu of such training (“PILOT”).

Where a company fails to train sufficient cadets for reasons within their control then any

PILOT could be increased by way of a penalty.

For a cadet to be “eligible” for training, he/she must be a UK, Channel Islands, Isle of Man

or EEA national and ordinarily resident in the UK.

Failure to implement or comply with the training programme is an offence. In serious

cases of repeated failure, the company will be prevented from renewing its election to

remain within the regime until it has complied properly with its training obligations.

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Flagging requirements 

The revised European Commission Guidelines on State Aid to Maritime Transport which

were published in January 2004 introduced a requirement that the benefits of the various

European tonnage tax regimes should be linked to an obligation to carry an EU flag. The

exact requirements for UK tonnage tax were enacted in the Finance Act 2005. The

flagging requirements apply to new ships. For these purposes, a new ship is one that

comes to be operated by a tonnage tax company or group for the first time.

The flagging requirements will only apply if all the conditions set out in the relevant

legislation are met.

The first condition is that the Government must not have excepted the financial year from

being one in which the flagging requirements apply. The Government must except a

financial year if it is satisfied on the basis of information available to it that the proportion of

all vessels within tonnage tax flying an EU flag has not reduced on average over a

prescribed three year period. Whilst the Government excepted all financial years up to and

including the year beginning 1 April 2007, the flagging rules have applied to the financial

years running from 1 April 2008 and 1 April 2009.

The second condition is that less than 60 per cent (on average over a prescribed period)

of the company’s aggregate net tonnage is Community-flagged. In computing the

percentage of the company’s tonnage that is Community-flagged, the rules will include all

other ships in the group that are within tonnage tax, as well as all ships operated by a

company (wherever it is situated) that is a subsidiary of a tonnage tax company within that

group.

The third condition is that the percentage of the company’s total tonnage that is Community-

flagged (on average over a prescribed period) is less than the percentage that was

Community-flagged on the later of 17 January 2004 and the last day of the accounting

period in which the company (or the group) first entered tonnage tax. It is not clear how this

condition will apply to companies that have no Community-flagged ships.

The new ship must be registered on a Community flag within three months from the first

date that all of these conditions are met. If it is not, it can never be a qualifying ship

26

operated by the company, or any other company in its group. An operator may

alternatively elect to register a substitute ship of equivalent or greater tonnage under an

EU flag within three months of starting to operate the new ship.

It should be noted that all qualifying tugs and dredgers will have to be registered on an EU

flag, regardless of the general flagging conditions above.

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Operating requirements 

The Department for Transport has the power to make regulations requiring tonnage tax

companies and groups to provide evidence of compliance with prescribed standards

relating to:

health and safety on board ships;

environmental performance of ships; and

working conditions on ships.

Such regulations, if enacted, may create regular reporting requirements and may carry

such penalties as expulsion from the tonnage tax regime and even criminal sanctions.

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UK flag 

UK flagging is not required for UK tonnage tax purposes. However, the UK flag will

normally be taken into account as a positive factor in determining the application of the

strategic and commercial management test.

The UK flag is “whitelisted” under the Paris MOU (the highest possible status). The Paris

MOU is a compilation of statistics by all of the European Port State Controls on all flags

entering their waters.

There is a misconception that reflagging and the manning requirements for UK flag

vessels are restrictive and more onerous than for other flags. We believe this to be

inaccurate.

Officers of UK-flagged vessels can be of any UK/EU/EEA nationality, or from around 25

other non-EU countries. These non-EU countries are the main suppliers of officers to the

international shipping market. Ratings nationalities are not restricted. Non-UK officers must

obtain Certificates of Equivalent Competency. The procedure for acquiring these

certificates is relatively simple.

The Maritime Coastguard Agency (“MCA”) has undertaken a major overhaul of the

equipment and safety requirements for registration under the UK flag. The overhaul has

ensured that the requirements are no more onerous than in other flag states who are

signatories to the IMO SOLAS Convention.

Existing ships (and to some extent partly constructed new buildings) reflagging into the UK

flag must have type-approved equipment. The equipment must be in accordance with either:

(i) the EU Marine Equipment Directive;

(ii) IMO SOLAS, or

(iii) the previous Flag State (as long as such State is a signatory to the IMO SOLAS

Convention).

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Under point (iii), when equipment is exchanged or replaced the replacement equipment

must always be to the latest standards. For an EU ship “wheelmarked” equipment is

required. The choice of this “wheelmarked” equipment is broad and it is no more

expensive than other types of equipment.

Whilst there is no real age limit on vessels, in practice vessels will be treated more

stringently if they are aged or deemed to be “high risk”.

Second hand ships (or new ships where the keel was laid after 1 August 1999) should not

require substantial changes in order to come into the UK Flag. The MCA will assist in this

where the ship owners are not experienced in the UK flag. The MCA in Southampton have

dedicated technical personnel to advise and assist on reflagging.

In brief, the requirements and procedures for corporations to register merchant ships

under the UK flag are as follows:

Eligibility

Either:

(i) incorporated in the UK or any British overseas territory with the principal place of business in the UK

(or overseas territory), or

(ii) incorporated in one of the EEA countries.

Where the corporation is not resident in the United Kingdom, a representative person must be

appointed. This is a straightforward process.

Preliminary

MCA will carry out a paper assessment of the vessel and the ship owner and review records from their

Paris MOU computer.

Survey

Once the preliminary checks are completed, the MCA appoints a specific MCA Customer Service

Manager who will arrange for a survey of the vessel. This manager will also handle all other matters

once the ship owner decides to proceed with UK flagging.

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• Post Survey

If the MCA is satisfied it (or the relevant approved classification society) will issue the necessary

trading certification for UK flagging. This occurs prior to or on the date of registration of the vessel

under the UK flag.

Registration

The vessel can now be registered under the UK flag, using the following forms:

Application Form

Declaration of Eligibility Form

Certificate of Incorporation

Evidence of Ownership (Bill of Sale)

History of ownership (if a Second Hand Vessel)

Generally the MCA will not allow a vessel to be registered under UK flag unless the vessel is in

port.

Deletion Certificate from Foreign Registry (where applicable) This

can be faxed, provided originals are received by the MCA within six weeks.

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Our offices and contacts 

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All references to ‘Watson, Farley & Williams’ and ‘the firm’ in this brochure means Watson, Farley & Williams LLP and/or its affiliated undertakings. Any reference to a 'partner' means a member of Watson, Farley & Williams LLP, or a member or partner in an affiliated undertaking, or an employee or consultant with equivalent standing and qualification.

This brochure is produced by Watson, Farley & Williams. It provides a summary of the legal issues, but is not intended to give specific legal advice. The situations described may not apply to your circumstances. If you

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