The proposed National budget for 2021 is a disappointment for many shipping and offshore companies.
Contrary to expectations, there is no proposal in the budget for rules that allow companies within the tonnage tax scheme to also perform business activities that do not qualify for tonnage taxation.
Furthermore, it is proposed to introduce withholding tax on payments for leasing of rigs, vessels etc. from related companies in low tax jurisdictions outside the EEA. The proposed rules for withholding tax on interest and royalty payments will also apply to shipping and offshore companies. Exceptions will however apply to payments from companies within the tonnage tax regime. Please refer to our blog on withholding tax on interest, royalties and lease payments for a general review of the proposals.
On the positive side, the exemption from the duty on mineral oil is proposed to be extended to include all vessels used in "domestic shipping industry", instead of the current application to vessels that are "used exclusively for freight or passenger transport". This means that the exemption will also apply to service / special purpose vessels, vessels used for slaughtering and bleeding fish, well boats performing delousing etc.
Expected changes in the tonnage tax scheme are postponed
The current Norwegian tonnage tax scheme is an “all or nothing” scheme. Companies that are taxed within the scheme can only have income from qualifying activities in the form of lease and operation of qualifying vessels, as well as financial income. Income from lease and operation of qualifying vessels is exempt from ordinary taxation, while financial income is subject to ordinary tax.
The current Norwegian tonnage tax regime is challenging for companies wanting to combine business activities which include services that do not qualify for tonnage tax. This can for example be storage or accommodation services while the vessel is in a stationary position, or various types of services performed on board the vessels while sailing, e.g. related to processing of fish, sale of goods from shops on board and excursions ashore.
The Parliament therefore in Innst. 360S (2019-2020) requested the Government to review and assess changes in the tonnage tax scheme, in order to enable companies within the scheme to perform activities that do not qualify for shipping taxation, the income of which will be subject to ordinary taxation.
In the National budget, the Ministry states that it is working on following-up the Parliament’s request, and refers that a legislative proposal must be submitted for consultation and be notified to and approved by ESA before it can be implemented. According to the Ministry, new legislation can therefore probably not take effect before 2022 at the earliest.
Considering the clear guidelines from the Parliament, it is surprising that the Ministry has not given further priority to propose changes in the tonnage tax regime with effect from 2021. The need for an update of the rules is pressing, and there is broad consensus that changes are required. Prior changes in the tonnage tax regime have also been introduced subject to a subsequent approval by ESA. As Norway is the only European country that has such a “ring fencing” within its tonnage tax regime, it seems unlikely that ESA would not disapprove a legislative change which would align the Norwegian tonnage scheme with other European tonnage tax schemes.
Withholding tax on lease payments
There has been great interest related to the possible introduction of withholding tax on lease payments, and whether the application of such potential rules would be limited to payments to related parties in low tax jurisdictions.
Under the current rules, it is possible to lease vessels and rigs on bareboat terms from related non-Norwegian companies without this triggering tax liability to Norway for the lessor, provided that the relevant foreign company does not participate in activities carried out in Norway.
It is now proposed to introduce a 15% withholding tax on lease payments for ships, vessels, rigs, etc., as well as aircrafts and helicopters to related companies that are resident in low tax jurisdictions outside the EEA. The rules are proposed to enter into force at 1 July 2021.
Please refer to our blog post on withholding tax on interest, royalties and lease payments for more details of the general terms and conditions for imposing withholding tax, including which companies are considered related and what is considered a low tax jurisdiction.
Norway's taxing rights are often restricted in tax treaties. This is particularly the case with respect to withholding tax on lease payments. Tax treaties that are wholly or partly based on the UN Model Tax Treaty may, however, have a definition of royalty which includes lease of industrial equipment. This is the case, for example, for the tax treaty with Singapore, which provides for a withholding tax at 7% on such payments.
Remuneration for use or the right to use ships, vessels, rigs, etc.
The proposed rules will apply to "remuneration for use or the right to use ships, vessels, rigs, etc.".
The rules are particularly aimed at bareboat payments for leasing of ships, vessels and rigs, i.e. passive leases of fixed assets.
The Ministry emphasizes that in cases where the lease agreement includes more than the asset itself, for example in so-called time charter agreements, it must be considered specifically how much of the payment that relates to the lease of the asset itself, which in turn will be subject to withholding tax.
It is difficult to see that the proposed rules concerning "remuneration for use or the right to use" the relevant assets should apply to part of the remuneration under a time charter agreement, which is a remuneration for work or an overall transport service. It is explicitly stated in the White Paper that payment for services shall generally not be subject to withholding tax. Decomposing of time charter payments is not a known concept in Norwegian tax practice, and should obviously have been subject to a more thorough evaluation and consultation.
In any case, the Ministry assumes that a company that enters into a time charter agreement will, as a general rule, be considered to provide a service, so that the company in question will be tax liable to Norway according to the General Tax Act section 2-3 first paragraph letter b or the Petroleum Tax Act section 2, cf. no. 1. Assumingly, the Ministry considers that such decomposition in any case will only be relevant in exceptional cases.
Request to relocate from low tax jurisdictions vs measures against profit shifting?
The overall purpose of the proposed rules is to prevent profit shifting.
During the consultation period for the proposed withholding tax, it was pointed out and documented in many submissions that introducing withholding tax on gross lease payments will entail a far higher overall taxation than if the rig owner had been resident in Norway. This is considered by many to be a significant argument against the introduction of withholding tax on lease payments.
According to the proposition, the Ministry considers this argument to be of less importance, and assumes that it will be a desired effect of the withholding tax legislation that the use of low tax jurisdictions is reduced. The Ministry acknowledges that a withholding tax of 15% on lease payments for physical assets is a harsh measure which could involve a negative return after tax. It is also stated that a withholding tax of 15% on rig leases etc. will likely act as a “stop rule”, and that entities as a result of the withholding tax will have to restructure. The Ministry expects that some of the tax increase will be reflected in the day rates for drilling services to oil companies on the Norwegian continental shelf, but at the same time states that this is not an argument against introduction of the withholding tax. It is surprising that preventing establishments in low tax jurisdictions is now presented as a key object of the rules, regardless of whether the establishments are commercially justified.
Exemption for lease payments from companies within the tonnage tax regime
Special rules have been proposed for lease payments from tonnage taxed companies. According to the proposal, payments from such companies shall not be subject to withholding tax.
Since tonnage taxed companies are not subject to taxation of net income from qualifying shipping activities, there will not be any profit shifting in these cases. Lease payments from companies that are subject to ordinary taxation shall, however, be subject to withholding tax. It is difficult to see the rationale for such a distinction from the lessor’s perspective, but the rules ensure, in line with the purpose, that only situations where there is a potential profit shifting from Norway are affected by the rules.
Tax exemption for foreign companies with lease income on vessels in international traffic, etc.
It is confirmed in the proposition that income that is exempt from taxation according to the rules in the General Tax Act section 2-34, may not be subject to withholding tax.
According to the General Tax Act section 2-34, foreign companies that have income originating from ownership and operation of ships in international traffic, as well as drilling- and entrepreneurial vessels in international operations, are exempt from taxation in Norway, also in case the business is managed from Norway. This is subject to Norway not being granted exclusive taxing rights under a double tax treaty, and that Norwegian taxpayers own 34% or less of the company or are taxable in Norway for their proportionate shares of the company's profits (through NOKUS/CFC taxation). In practice, it is assumed that the provision includes income from lease on bareboat terms (confirmed by the Supreme Court in Rt. 2015 page 1360).
The provision in the General Tax Act section 2-34 will in many cases provide for an exemption from withholding tax on lease payments to related companies resident in low tax jurisdictions, even if Norway has not entered into a double tax treaty with the country in question. If the requirements for Norwegian ownership etc. are met, the withholding tax on lease payments will likely only affect vessels used in domestic operations in Norway, i.e. where the vessels, etc. are located in Norwegian territorial waters or on the Norwegian continental shelf, and for vessels not deemed to be «ships» and «drilling- and entrepreneurial vessels».
Interest and royalty payments
Withholding tax on interest and royalty payments will as a starting point apply also to companies within the shipping and offshore sector.
According to the proposal, interest payments from tonnage taxed companies will be subject to withholding tax on the same terms as interest payments from companies subject to the ordinary tax regime. This will apply even if tonnage taxed companies only have a right to deduct interest costs according to their finance capital ratio.
A special rule has however been proposed for interest payments in financial leases of physical assets, for which the withholding tax will not apply when the payment is made by a tonnage taxed company. The reason provided is that interest payments in financial leases are not related to the tonnage taxed company's finance capital but used to finance its qualifying shipping assets, and hence the interest would not be deductible. Ordinary interest on debt to related companies in low-tax countries shall, however, according to the proposal be subject to withholding tax, even if the debt is established to finance purchase of ships. This appears inconsistent, as such interest is typically also related to financing of the company’s shipping assets.
Payments involving partnerships
Shipping activities are often organised through partnerships which are treated as transparent entities for tax purposes. In the consultation paper, it was unclear how the rules were intended to apply to payments from and to partnerships.
In the updated proposal, the Ministry has clarified that the withholding tax liability shall be determined based on the partner's tax position. In the case of payments from a partnership, only the proportion of the payments that corresponds to the partnership shares held by partners liable to tax in Norway shall be subject to withholding tax. In the case of payments to a partnership, only the proportionate share of the payments that accrues to partners resident in low tax jurisdictions outside the EEA shall be subject to withholding tax.
We refer to our blog on withholding tax on interest, royalties and lease payments for a further review of the rules on withholding tax etc.
Proposed changes of the duty on mineral oil used in vessels operating in freight and passenger transport
In item 10.7 of the budget proposal the Government proposes to extend the exemption from duty on mineral oil currently available for vessels engaged in freight and passenger transport to include all vessels used in "domestic shipping activities for commercial purposes".
Current regulations and administrative practice
According to the parliamentary resolution for duty on mineral oil etc. for the budget year 2020 section 2 first paragraph letter g, an "exemption is granted for duty on mineral oil used for freight and passenger transport in domestic shipping", cf. further provisions on implementation, scope and conditions for exemption in regulations on excise duties (Excise Duties Regulations) chapter 4-3.
An exemption can be granted directly in the case of sales from registered companies, or upon application for refund from the end user in case of sales from non-registered companies trading with taxable products, cf. Excise Duties Regulations section 4-3-1 first and second paragraphs and section 4-3-2 first and second paragraphs.
It follows from the Excise Duty Regulations section 4-3-3 first paragraph, first sentence that "the person eligible for exemption must, on delivery, provide a declaration to the registered undertaking stating that the products are solely for use as described in Sections 4- 3-1 and 4-3-2, and that the vessel will only be used for freight or passenger transport within the exempted user’s business. " (our highlight). According to the wording, the vessels cannot engage in any other activity than freight and passenger transport.
This strict interpretation is confirmed in a statement from the Tax Administration from 27 September 2019, where it is stated that when vessels used for freight transport are also used for assignments which, for example, involve delousing or bleeding, the vessel will not be considered to meet the conditions to be used exclusively for freight transport, as such assignments are not freight transport, but rather a special assignment.
In practice, the condition has led to i.a. refund applications being rejected for well boats on which, in addition to transporting fish, delousing is performed, or blug boats on which, bleeding of fish is performed in addition to the transport.
The Government's proposal for duty on mineral oil etc. for 2021
Over some time, significant organisational and political pressure has been exercised to extend the exemption from duty on mineral oil to all freight and passenger transport carried out as part of commercial business activities. As a result, the Ministry of Finance in 2019 requested the Directorate of Taxes to consider the wording of the Excise Duties Regulations section 4-3-3. Following a report to the Ministry of Finance in February 2020, the Directorate of Taxes prepared a proposal for changes in the parliamentary resolution for duty on mineral oil etc. and the Excise duty regulations which was submitted for consultation in May.
Based on the consultation, the following wording is proposed in section 2 letter g of the Government's proposal for the Norwegian parliamentary resolution for duty on mineral oil etc. for the budget year 2021: "An exemption from the duty on mineral oil is granted for use on board vessels engaged in commercial domestic shipping". The person/company eligible for the exemption must declare that "... the vessel will only be used within the exempted user’s business".
By extending the exemption to include all vessels used in "the exempted user’s business", the criteria for exemption will no longer be linked to the "transport". All commercial domestic shipping activities will in principle be within the scope of the exemption, i.e. all freight and passenger transport in domestic shipping used in the exempted user’s business. According to the consultation paper, this means that the exemption will also apply to service/special purpose vessels, vessels for slaughtering or bleeding of fish, well boats performing delousing, etc.
On the other hand, a change is proposed to the Excise Duties Regulations in order to exclude the following vessels from being considered “used” in the exempted user’s business:
- vessels in storage,
- vessels that are permanently taken out of service,
- vessels used for residence, hotel, office, workshop, warehouse,
- vessels undergoing repair, construction, conversion, or which are docked or similar.
This is a codification of the current administrative practice. The reasoning for the changes is that these vessels are able to use electricity from on shore supplies, and the vessels are not considered to be used in domestic shipping. In our view, there will most likely be a need for further clarification of what vessels are excluded that must be resolved by practice.
As the exemption is extended to apply to all "domestic shipping", it will also be relevant to define what is included within this concept. The suggested definition is "traffic in Norwegian territorial waters". Basically, this is a clear definition, in practice however, it will in practice be inconvenient with a different definition of the term compared to what is used in regulation of the NOx duty. For NOx duty purposes, “domestic traffic” is defined as "traffic between two Norwegian ports and between the Norwegian port and Svalbard, Jan Mayen, Norwegian overseas territory and facilities on the Norwegian continental shelf". However, in the consultation paper it is pointed out that the NOx regulations are aimed at reducing NOx emissions and contribute to fulfil Norway's obligations under the Gothenburg Protocol, and then with a different geographical scope. Thus, it has been considered natural not to apply the same definition.
As the exemption from duty on mineral oil has been extended to include all domestic shipping in the exempted user’s business, it is not necessary to uphold the special exemption for vessels harvesting seaweed and sea kelp. In the consultation, the special exemption was therefore proposed to be repealed. The Government has followed up on this proposal in the National budget for 2021, and entails a cash advantage for such vessels, as the current exemption is only available upon a refund application.
Overall, the exemption from duty on mineral oil will have an expanded scope, and some difficult interpretation issues and avoidance situations will be avoided. In order to determine whether a vessel meets the conditions for exemption under the new rules, a specific assessment must be made considering whether the vessel is used within the exempted user’s domestic shipping business.
This blogpost is written by Bendik Svendsen, Hilde Thorstad and Elin Sund.
Jeg heter Elin Sund og arbeider som advokat i Advokatfirmaet PwC. Jeg har vært ansatt i PwC siden 2003, og har bred erfaring fra arbeid med nasjonal og internasjonal bedriftsbeskatning. Mitt hovedfokus er nasjonal og internasjonal beskatning av selskaper innenfor shipping- og offshorebransjen.
My name is Elin Sund and I am an attorney-at-law at PwC Tax & Legal Services. I have been employed by PwC since 2003. I assist clients with general tax advice on Norwegian and international corporate tax law. My main focus is taxation of companies within the shipping and offshore industry.