Marshall Islands Official Warns That Global Anti-Base Erosion Rule Can Be Misinterpreted

PUBLIC CONSULTATION ON THE
GLOBAL ANTI-BASE EROSION RULES IMPLEMENTATION FRAMEWORK

Submission by: Republic of the Marshall Islands Maritime Administrator

11 April 2022

I. Introduction

The Global Anti-Base Erosion (GloBE) Rules correctly exclude international shipping income from their scope, and the rationale for doing so is clear. A stable and well-functioning international consensus has developed with respect to taxation of international shipping income, and modifying that system would risk destabilization, competitive distortions, and an array of other problems.

Notwithstanding the clear intent of the GloBE Rules, Article 3.3.6 is at substantial risk of being misinterpreted or applied inconsistently. This could lead to exactly those problems that the international shipping income exclusion sought to avoid. Administrative guidance is needed to avoid further disruption to the already challenged international supply chain.

II. Background

Due to its unique features, the international shipping industry gives rise to special income tax considerations.¹ As earnings are based on the use of vessels in transit on the high seas between tax jurisdictions, allocation of income and taxing rights are more complex than with other industries. However, these issues were resolved long ago by international consensus: profits from international shipping are taxable only in a shipping company's jurisdiction of residence. As “reflected in Article 8 of both the OECD and United Nations (UN) Model Tax Conventions and in the vast majority of the 3,500+ bilateral tax treaties currently in force,” this consensus has been in place for over 100 years.²

There is also broad international consensus on the applicability of special tax rules to international shipping. Around the world, it is “common for countries, including OECD countries, to create a low tax or substantially tax-free environment to attract and retain shipping investment” by adopting tonnage tax regimes or other special tax regimes in place of ordinary corporate income tax.³ These special tax rules are supported by tax considerations, including the potential for “less volatile tax outcomes for shipping and . . . a more stable basis for long term investment.”⁴ They also are supported by significant non-tax policy considerations, including improving the safety and environmental footprint of maritime transport.⁵

Indeed, tonnage tax and similar regimes have become so widespread that they “can no longer be considered a differentiator” in the analysis of where to flag a vessel⁶, and they are routinely endorsed as not harmful by the OECD Forum for Harmful Tax Practices⁷.

III. Basis for Excluding International Shipping Income

For a wide array of non-tax reasons and due to its global nature, the international shipping industry is complex and highly decentralized, particularly among MNE Groups within the scope of the GloBE Rules. Vessels are regularly flagged across multiple jurisdictions⁸, and each vessel must satisfy the requirement for a “genuine link” between the vessel and the flag state under longstanding international convention⁹. For limitation of liability or other commercial reasons, a subsidiary often is formed to own each vessel. Based on the longstanding consensus reflected in Article 8 of the OECD Model Tax Convention, each vessel-owning subsidiary is subject to tax in the jurisdiction where it is located.

Management is also commonly decentralized, with crewing and technical management being carried out from any array of jurisdictions, commercial operation often delegated to vessel pools potentially based in a different jurisdiction, etc. An appropriate charge for those services may be determined under transfer pricing principles and taxed in the jurisdiction where the management services are performed.

Because the international consensus on shipping taxation has created predictability and removed taxes as jurisdictional differentiator, flagging and management choices are made based on efficiency, quality/safety, service level, and related factors, rather than on tax planning.

The exclusion of international shipping income from the GloBE Rules was obviously intended to avoid disrupting this existing well-functioning multilateral taxation system. As the OECD has stated, applying the GloBE Rules to international shipping would undermine jurisdictions' valid policy choices, could lead to competitive distortions and unstable outcomes, and may have a limited revenue effect in any event.¹⁰ Divergence from the current system also would “rais[e] the prospect of either multiple taxation or considerable income allocation challenges.”¹¹ As such, Article 3.3 of the GloBE Rules “adopts a qualified income approach based on the scope of Article 8 of the OECD Model (OECD, 2017) and excludes from the scope of the GloBE Rules the profits from transportation of passengers or cargo by ships in international traffic.”¹²

IV. Potential for Misinterpreting Article 3.3.6

Despite the clear intent to avoid disrupting over 100 years of consensus on taxing international shipping income, Article 3.3.6 of the GloBE Rules is at risk of being misconstrued.

Article 3.3.6 was derived from the European Union (EU) criteria for granting shipping tax incentives.¹³ The potential for misinterpretation arises because Article 3.3.6 includes only a select portion of the EU criteria and does not mention its original context. The primary requirement to qualify for the incentive under the EU guidelines is for the ship to be entered in a Member State's shipping register. It is only in the exceptional case where preferential tax treatment may extend beyond this to an entire fleet operated by an EU shipowner based on a purely economic link (i.e., flag neutrality), in which case, among other things, “the strategic and commercial management of all ships concerned [must be] effectively carried out from within the [Member State's] territory.”¹⁴

The potential adoption of “strategic or commercial management” in Article 3.3.6 as a general criterion rather than the exceptional case is already causing confusion in the shipping industry, and could be misunderstood as effectively requiring a top-up tax for any vessel-owning Constituent Entity not located in the same jurisdiction as a fleet's strategic or commercial management.¹⁵ Such an interpretation would be problematic for a number of reasons.

First, it would be inconsistent with Article 8 of the OECD Model Tax Convention. It would even be inconsistent with the minority approach referenced in the Commentary on Article 8, which confers taxing rights to the place of “effective management” but expressly provides that management may take place aboard a ship.¹⁶

Second, it also would be inconsistent with the economic substance criteria for shipping regimes under BEPS Action 5. The Action 5 criteria “recognises that significant core income generating activities within shipping are performed in transit” and considers “whether the regime was designed to ensure that the qualifying taxpayer handles all corporate law and regulatory compliance of the shipping company with any additional obligations within the jurisdiction such as ship registration including compliance with International Maritime Organisation (“IMO”) regulations, customs and manning requirements . . . consistent with the IMO definition.”¹⁷

Third, such an interpretation indeed would turn the BEPS principles on their head, shifting tax rights away from where income is generated with no analytical justification and creating baseless tax competition, competitive distortions, and unstable outcomes where there currently are none¹⁸ among jurisdictions with shipping tax regimes determined by the OECD to be non-harmful¹⁹.

Such a striking deviation from the current system also would have serious practical consequences for the shipping industry. Introducing tax-related distortions into flagging decisions would deemphasize non-tax factors, likely eroding efficiency, quality, and safety across the shipping industry by shifting tonnage away from experienced, high-quality shipping registers with strict environmental and safety standards.²⁰ Reorganization and reflagging based on misinterpretations of Article 3.3.6 also would generate needless increased costs for shipping MNE Groups and could prompt shipping delays, worsening the global supply chain disruptions and commodity price inflation already plaguing the international shipping sector.

V. Additional Guidance Needed

The Commentary to the GloBE Rules, released by the OECD/G20 Inclusive Framework on BEPS on 14 March 2022 (the GloBE Commentary), provides some clarification with respect to Article 3.3.6. Further evidencing the intent not to disturb the existing consensus on taxing international shipping income, the GloBE Commentary on Article 3.3.6 draws in other elements of the EU guidelines as well as elements of the Commentary on Article 8 of the OECD Model Tax Convention and the economic substance considerations for shipping regimes under BEPS Action 5. As under those existing sources, Paragraph 182 of the GloBE Commentary provides that activities taking place aboard a ship may satisfy Article 3.3.6, expressly clarifying that relevant factors consider not only the activities within a jurisdiction “but also the strategic or commercial management activities of the ships concerned that are conducted outside the jurisdiction.”²¹

Also, while the mere fact of a vessel's flag is irrelevant, Paragraphs 182 and 185 of the GloBE Commentary clarify that the requirements of the shipping register may be relevant to the Article 3.3.6 determination. Where responsibilities to ensure flagged vessels abide by IMO and International Labour Organisation (ILO) conventions ratified by the flag state are imposed on and managed by a Constituent Entity (or another Constituent Entity located in the same jurisdiction), this may satisfy Article 3.3.6.²²

Notwithstanding the clarification provided by the GloBE Commentary, additional clarification is needed to ensure consistency with the international consensus reflected in Article 8 of the OECD Model Tax Convention. While they describe what “may be relevant” or “may result” in a sufficient level of strategic management, Paragraphs 182 and 185 of the GloBE Commentary provide less guidance as to what flag state connection will satisfy Article 3.3.6. This leaves room for differing interpretations and inconsistent application across jurisdictions, which poses a substantial risk of creating exactly the types of income allocation challenges, competitive distortions, instability, and overall disruption that Article 3.3 of the GloBE Rules was designed to avoid.

To ensure Article 3.3.6 of the GloBE Rules is applied consistently and as intended, administrative guidance should be prepared with respect to Paragraphs 182 and 185 of the GloBE Commentary. At a minimum, the guidance should state that jurisdictions' application of Article 3.3.6 and Article 10.3 must be consistent with the GloBE Rules' intent to avoid disrupting the existing multilateral taxation system for international shipping that is reflected in Article 8 of the OECD Model Tax Convention, clarify that strategic or commercial management may take place aboard a ship in line with the Commentary on Article 8 of the OECD Model, and provide clear examples of what flag state relationship will satisfy Article 3.3.6. Among other things, it should be made clear that, consistent with Article 8 of the OECD Model, a vessel-owning Constituent Entity located in Country X that is subject to the maritime laws and conventions of the vessel's shipping register has a sufficient level of strategic management that is effectively carried on from within Country X to satisfy Article 3.3.6.

The Republic of the Marshall Islands Maritime Administrator respectfully request that administrative guidance be prepared as outlined above. We look forward to continuing to work with the OECD/G20 Inclusive Framework on BEPS on this complex but globally significant issue.