Recent Treasury Regulations Simplify and Clarify International Shipping and Aviation Rules
June 29, 2007
On June 22, 2007, final and temporary regulations were issued, with an effective date of June 25, 2007, that contain positive changes in U.S. tax law as it relates to the treatment of income from the international operation of ships and aircraft.1
These changes include the following:
• eliminating the need to provide names and addresses of ultimate shareholders when claiming the freight tax exemption under Section 883
• simplifying reporting requirements regarding certain CFCs
• treating certain ground services (including cargo handling, maintenance services, catering and customer service) as incidental to the international operation of ships or aircraft, meaning that such incidental income can qualify for the Section 883 exemption
1. Easing of Reporting Requirements Related to Qualified Shareholder Stock Ownership Test
Final regulations under Section 883 were promulgated on August 26, 2003. Subsequently, the American Jobs Creation Act of 2004 (AJCA) provided a number of changes beneficial to those engaged in the international operation of ships or aircraft.2 As part of the AJCA, the effective date of certain new requirements regarding proof of ultimate ownership of a foreign corporation claiming the Section 883 exemption was delayed (these requirements were part of the August 26, 2003, regulations).
The August 26, 2003, final regulations provide that a foreign corporation must satisfy one of three ownership tests to satisfy the ownership requirements of 883(c) and claim the exemption; the foreign corporation must satisfy either: (1) the “publicly-traded test” of Section 1.883-2(a); (2) the “CFC stock ownership test” of Section 1.883-3(a); or (3) the “qualified shareholder stock ownership test” of 1.883-4(a). These tests remain in effect.
The IRS had provided, as part of these August 26, 2003, regulations, that certain foreign corporations claiming an exemption under Section 883 would be required to provide the name and address of the ultimate shareholders who owned 5 percent or more of the foreign corporation.3 Under these prior regulations, a foreign corporation relying on the qualified shareholder stock ownership test was required to include this information about 5 percent-or-more shareholders on the Form 1120-F for each taxable year.
The new final and temporary regulations have eliminated the requirement that the information on such 5 percent-or-more shareholders must be provided on each year’s Form 1120-F. The foreign corporation will still need to file a Form 1120-F with certain summary information regarding the shareholdings that are relied upon to satisfy the applicable stock ownership test, for example, aggregate percentage interests held by shareholders by country of residence.4 The elimination of the requirement to provide the names and addresses of 5 percent-or-more shareholders significantly eases the burden on foreign corporations relying on the qualified shareholder stock ownership test.
2. Modification of Stock Ownership Test for CFCs
Under the August 26, 2003, regulations, there were complicated tests intended to ensure that the owners of a CFC were truly U.S. persons and that the CFC therefore truly met the “CFC stock ownership test.” As a result of comments, the IRS issued Notice 2006-43 which provided interim guidance with respect to the application of the qualified U.S. person stock ownership test contained in Treas. Reg. Section 1.883-3. The new final and temporary regulations generally adopt the approach of IRS Notice 2006-43 and eliminate certain requirements that are contained in the August 26, 2003, regulations.
3. Treatment of Certain Services as Incidental to the International Operation of Ships or Aircraft
The new regulations also provide that income from certain services will be treated as incidental to the international operation of ships or aircraft. As a result, such income will be exempted under the Section 883 exemption, provided that all other requirements are met. These types of activities include the provision of goods and services by engineers, ground and equipment maintenance staff, cargo handlers, caterings staff, customer service personnel, and the provision of facilities such as passenger lounges, counter space, ground handling equipment and hangar facilities. These regulations also clarify that such services will be treated as incidental, whether provided to another enterprise as part of a pooling arrangement, alliance or other joint venture.
In addition, there are a number of other changes in the new regulations regarding the application of the Section 883 exemption to residents of a country which provide an exemption only through an Income Tax Convention, rather than through a provision in their tax law similar to Section 883. These changes will be addressed in subsequent alerts.
The IRS is accepting comments on the regulations until September 24, 2007, and will hold a public hearing on the new regulations on October 24, 2007.
For more information, e-mail Richard A. Crowley or Joseph K. Fletcher, III at
richard.crowley@hklaw.com or
joseph.fletcher@hklaw.com, respectively, or call toll free, 1-888-688-8500.
1 The IRS also issued proposed regulations that cross-refer to the final and temporary regulations and provide for a public hearing on October 24, 2007. Written and electronic comments for this public hearing must be submitted by September 24, 2007.
2 The AJCA, which was signed into law on October 22, 2004, contained a number of significant provisions that changed the treatment of international shipping (and in certain instances international aviation) significantly. These changes included the following:
• establishment of an elective “Tonnage Tax” regime
• repeal of “Subpart F” income treatment of international shipping income
• delay in the effective date of new requirements regarding proof of ownership to claim the freight tax exemption under Section 883
3 The requirements under the “qualified shareholders stock ownership test” are intended to ensure that the ultimate shareholders of the foreign corporation are truly resident in the country for which the Section 883 exemption may be claimed. Section 1.883-4 of the final regulations provides rules for when a foreign corporation satisfies the qualified shareholder stock ownership test. To satisfy this test, qualified shareholders (i.e., shareholders resident in a country for which the Section 883 freight tax exemption can properly be claimed) must own (applying the attribution rules of §1.883-4(c)) more than 50 percent of the value of a foreign corporation’s outstanding shares for half the number of days in the corporation’s taxable year. Under the prior final regulations, the foreign corporation must also meet the substantiation and reporting requirements of §1.883-4(d) and (e). Under the reporting requirements of §1.883-4(e), a foreign corporation must attach a statement with certain information to its Form 1120-F, “U.S. Income Tax Return of a Foreign Corporation,” including the names and addresses of individual shareholders with large shareholdings (at least 5 percent) in the foreign corporation.
4 Other aspects of the former regulations remain, including a requirement that bearer shares cannot be used to meet the ownership test. For example, a foreign corporation must report whether any shareholder whose stock holdings are relied upon to meet an ownership test holds such stock either directly or indirectly through bearer shares. In addition, each qualified shareholder and intermediary (if any) must declare under penalties of perjury that its ownership interest in the foreign corporation or any corporate intermediary is not held through bearer shares.
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