Cyprus Tax Alert: New tonnage tax system introduced

The Cyprus Parliament approved the Merchant Shipping (Fees & Taxing provisions) Law on 29 April 2010, which introduces a new tonnage tax system in Cyprus, applicable retroactively as from 1 January 2010.

The new regime has received EU approval and it extends the favorable benefits applicable to owners of Cyprus flag vessels and ship managers to owners of foreign flag vessels and charterers. It also extends the tax benefits that previously only covered profits from the exploitation of vessels in shipping operations to cover profits on the disposal of vessels, interest earned on funds used other than for investment purposes and dividends paid directly or indirectly from shipping-related profits.

The new tonnage tax system contains most of the favorable features found in tonnage tax systems in other countries, and more. The regime therefore provides Cyprus with a competitive advantage and is expected to significantly contribute to the improvement of the already strong position of the country in the shipping world.

The main provisions of the new tonnage tax regime are described below.


Beneficiaries

The tonnage tax system is available to any owner, charterer or ship manager who owns, charters or manages a qualifying ship in a qualifying shipping activity. The tonnage tax is calculated on the net tonnage of the ship according to a broad range of bands and rates prescribed in the legislation. The rates applicable to ship managers are 25% of those applied for ship owners and charterers.


Qualifying ship

A qualifying ship is any seagoing vessel certified under applicable international or national rules and regulations and registered in the ship register of any member of the International Maritime Organisation and/or the International Labour Organisation that is recognized by Cyprus.

The regime specifically excludes certain types of ships, such as fishing vessels, ships used primarily for sports or recreation, river ferries, non-self propelled floating cranes and tug boats, among others.


Qualifying shipping activity

Any commercial activity that constitutes maritime transport, crew management and/or technical management is considered a qualifying activity.

The definition of maritime transport includes the traditional carriage of goods and passengers, as well as ancillary services such as all hotel, catering, entertainment and retailing activities on board a vessel, the loading and unloading of cargo, the operation of ticketing facilities and passenger terminals, tonnage and dredging, cable laying, and so on.


Ship owners

Ship owners of Cyprus flag ships automatically fall within the scope of the tonnage tax system. Ship owners of EU flag ships and/or third country flag ships may elect to be taxed under the tonnage system.

Ship owners of third country flag ships must comply with certain requirements to qualify for an election to be taxed under the new regime. These include the requirement that a share of their fleet be comprised of EU flag ships, which share must not be reduced in the three-year period following the election and that the commercial and strategic management of the fleet be carried out from the EU.

Any ship owner electing the tonnage tax system must remain in the system for 10 years. Early withdrawal will result in penalties, calculated as the difference between the amount paid during the period the ship owner was under the tonnage tax system and the amount that would have paid had it been subject to corporation tax in the same period. In addition, the ship owner will lose the right to elect for tonnage taxation until expiration of the 10-year period from the date of the first election.

The tonnage tax system covers profits from shipping operations, dividends paid directly or indirectly out of such profits, profits on the disposal of the ship and interest earned on funds used as working capital or for the financing, operation and/or maintenance of the ship.


Charterers

Any charterer who charters a ship under bareboat, demise, time or voyage charter is eligible for the tonnage tax system provided the tonnage of the ships under time and/or voyage charters do not exceed 75% of the total tonnage of ships chartered and owned for more than three consecutive years. This eligibility percentage increases to 90% if the ships chartered are EU ships or their crew and technical management are carried out from the EU. The charterers of third country flag ships must comply with the additional requirements that apply for third country flag ship owners.

An eligible charterer may elect to be taxed under the tonnage tax system, but once the election is made, it must remain in the system for 10 years. Early withdrawal will result in the penalties outlined above for ship owners.

The tonnage tax system covers profits from shipping operations, dividends paid directly or indirectly out of such profits and interest earned on funds used as working capital or for the payment of expenses arising out of the charter party.


Ship managers

A ship manager who provides crew and/or technical ship management services is eligible for the tonnage tax system provided it satisfies certain criteria. These include the maintenance of a fully fledged office, the employment of a sufficient number of qualified personnel (51% of whom should be EU citizens) and at least two-thirds of the management is carried out from within the EU. Further, at least 60% of the fleet under management should be carrying an EU flag, while all ships and crew under management must comply with international standards and EU law requirements relating to maritime security, safety, training and certification of seafarers, the environment, on-board working conditions, and so on.

Other specific criteria must be complied with, depending on the ship management service provided (i.e. full implementation of the Maritime Labour Convention and, for crew managers, the ISM Code certification for technical managers, etc.).

The tonnage tax system covers profits from the provision of crew/or technical ship management services, dividends paid directly or indirectly out of such profits and interest earned on funds used as working capital or for the payment of expenses relating to the management of the ships. The 10-year election rule also applies to eligible ship managers and the same penalties apply for early withdrawal.