Denmark adopts tonnage tax legislation

LAST year, the Danish parliament adopted an act on tonnage taxation for commercial vessels. The legislation came about as a result of heavy pressure from the Danish shipping community, which had for some time been watching with envy its Dutch, German and UK competitors successfully pressing their politicians for just this kind of functional tax haven.

When the Norwegians followed suit shortly thereafter, Danish politicians were sent a clear message by the national shipping industry that either a similar regime was introduced, or flagging-out on a vast scale would be the consequence. The shipowners got what they wanted, and the legislation was formally adopted on 19 April 2002.

Like its foreign models, the new taxation scheme in Denmark is based solely on the amount of tonnage at the disposal of the shipowner. The taxation is independent of earnings or losses that may be incurred in the given taxation period.

Parties eligible for taxation under the tonnage act are Danish companies, primarily limited liability companies, companies incorporated in other EU member states and having a place of business in Denmark, and foreign companies that have the seat of their management in Denmark.

For all companies, it is a prerequisite that they actively carry on the business of ship-ping. But it is not necessary for the company to be engaged exclusively in shipping. In appropriate cases, a division of the company's activities will be made between that part which relates to shipping and is therefore eligible under the new taxation act, and those non-shipping parts, which will remain subject to taxation under the general rules.

Since the tax-regime is so attractive, the definition of "shipping activity" no doubt caused the legislators some sleepless nights. Yet the wording of the legislation re-mains broad. It covers "Transportation of passengers or goods between different des-tinations by vessels owned by the shipping company, or by ships being taken on charter."

Each vessel to be included in the tax scheme under the legislation must be of at least 20 gross tonnes and the vessels should be "strategically and commercially" be oper-ated from Denmark. But it is not a requirement that the vessels be registered under the Danish flag. In other words, the legislation is "flag blind".

The test in deciding where the "strategic functions" are placed is whether the ship-ping company has its principal place of business and its senior personnel in Denmark, and whether strategic decisions in respect of the fleet are made in Denmark. Strategic decisions include contracts of major importance, for example decisions relating to the sale and purchase of vessels, and decisions in respect of participation in pooling agreements or other strategic alliances.

"Commercial operation" is understood to include the planning of fleet schedules, par-ticipation in ordinary commercial contracts concerning the trading of vessels, provi-sioning, manning, technical management and maintenance, and the location of sup-port facilities. Not all vessels operated by the shipowner have to satisfy these criteria, but each vessel has to fulfil the conditions to a reasonable degree. The strategic and commercial operation of the fleet as a whole must be conducted mainly from Den-mark.

Where chartered tonnage is concerned, it should be noted that the legislation allows for only up to four times the shipowners' own tonnage. Chartered tonnage in excess of this amount will be subject to general rules of taxation. Bareboat-chartered vessels are deemed to be owned by the shipping company. The same applies to vessels taken in on time-charters, when a vessel is chartered for between one and five years and the charterer is granted a purchase option on commercial terms.

The legislation applies to shipowners chartering out vessels only when the charterer of the vessel is using it for a purpose within the ambit of the legislation. If a vessel is bareboat-chartered out, the hire earned will be deemed taxable under the general re-gime, not under the Tonnage Act, unless the vessel is chartered out for a maximum of three years due to temporary overflow of capacity. This effectively bars financial in-stitutions engaged in leasing from benefiting from the legislation.

Income gained from operations closely connected to core transport services may also fall within the scope of the legislation. This includes container services, including equipment and facilities, the operation of ticketing facilities and passenger terminals, the operation of office facilities, and the sale and distribution of ship supplies.

Earnings from business activities not included in the transport service itself or among ancillary services are taxable according to general rules. For ferries, this distinction has given rise to an ongoing dialogue between operators and the tax authorities in re-spect of onboard shops.

A number of related operations fall outside the scope of the legislation. These include offshore oil and gas extraction, fisheries and processing, diving services and any use of permanently anchored vessels. Furthermore, various marine structures are ex-cluded from the legislation, e.g., barges of less than 2,000 gt capacity, dredgers, float-ing cranes, floating docks and similar equipment.

Shipowners who qualify and who elect to be taxed in compliance with the legislation are required to draw up appropriate returns, together with any ordinary taxable in-come in accordance with existing rules. Taxable income is calculated by the amount of tonnage. There is a sliding scale per 100 net tonnes (NT) on a ship-by-ship basis, whether in operation or not. The scale runs from DKK 7.00 per day per 100 NT for the first 1,000 NT, falling to DKK 2.00 above 25,000 NT. This sum is taxed at thirty per cent, because the nominal tax level under the legislation has been set to mirror the general corporate rate of taxation. For example, a 30,000 NT vessel (roughly 40 - 45,000dwt) would pay annual tonnage tax of around DKK 122,000 (US$19,400) per year.

Because of the attractive tax regime, Danish lawmakers have found it necessary to spell out in the legislation the fact that companies operating within a group are to deal at arm's-length with each other so as to prevent them from placing their (otherwise taxable) profits in tonnage-taxed group companies. For the same reason, the legisla-tion stipulates that the ratio between equity and borrowed capital for companies sub-ject to taxation must be a maximum two-to-one. If the equity exceeds this threshold, an imaginary six per cent per annum interest gain is calculated on the surplus amount, which will be subject to taxation under the ordinary rules.

Shipowners must decide whether to bring themselves within the legislation at latest when they file their tax returns for the financial year, at which time they first became eligible for the new tonnage tax. The commitment is binding for ten years, to prevent shipowners from opting in and out for short-term advantage.

Group-related shipowning entities are obliged to make a mutual election unless they are not jointly taxed, do not have a shared management or shared operational organi-sation, or do not operate within related business areas. There are also a number of additional special rules applying to group- related shipowning companies, so any pro-spective overseas buyer of Danish shipping interests will be well-advised to look carefully into whether a purchase or merger transaction could affect the tax position in respect of its existing fleet..

The pattern attending the emergence of tonnage tax regimes in other countries pro-vides a clear-cut example of what is often referred to as "tax competition". So far, scenarios of this type have been less prominent between North European countries, but it is worth noting that, shortly after the Danish legislation had been introduced, a comparable regime was established in Sweden, albeit limited only to ferries. Most recently, Germany announced its intention to introduce more benefits of this type.

It is difficult to predict whether this reverse tax-squeeze will continue. But within the framework of the EU, the rules on state aid are under revision with a view to effect-ing a six-year phase-out term in a number of areas, and it would be surprising if tonnage tax were left completely untouched.