On April 24, President Trump extended the existing waiver of the Jones Act (the “Waiver”), which permits foreign-flagged vessels to transport oil, fuel and fertilized between U.S. ports.  The original waiver was set to expire on May 17; the President’s action extended the waiver for another 90 days until mid-August.

The Waiver raises novel U.S. tax considerations for foreign corporations which operate foreign flag vessels.  Foreign corporations which are engaged in the international operation of ships are typically exempt from U.S. federal income tax on their U.S. source shipping income, provided that certain organization and ownership requirements are satisfied under Section 883 of the Internal Revenue Code.  Foreign shipping companies which are not exempt from U.S. federal income tax are in most cases subject to an alternative tax regime that imposes a four percent gross basis tax on their U.S. source shipping income.

The exemption and gross basis tax regimes are only applicable to income from the international operation of ships and certain incidental income derived therefrom.  Therefore, there is a significant question as to whether, and at what rate, the income generated by foreign corporations is subject to U.S. federal income tax.

A foreign corporation that operates a vessel between U.S. ports pursuant to the Waiver could be (i) subject to U.S. federal corporate income tax on a net basis at a rate of 21% plus a 30% branch profits tax on its net income (charter hire less allocable expenses, including allowable vessel depreciation deductions) from the voyage, (ii) subject to U.S. federal income tax at a rate of 30% on its gross income from the voyage or (iii) exempt from U.S. federal income tax under Section 883 because the income generated from the voyage is treated as “incidental income.” 

Shipping income is also normally exempt from U.S. federal withholding taxes. However, there is a withholding on certain U.S. source non-business income that applies to rental income (e.g., bareboat charter hire) and to other remunerations, including U.S. source services income (which could apply to time or voyage charter hire payments).

As a policy matter, the 4% gross basis tax maybe makes the most sense, but the statute limits its application to shipping income from voyages that begin or end, but not both, in the United States. Therefore, without further guidance from the Internal Revenue Service, there is no clear legal pathway to apply the 4% gross basis tax to revenues derived under the Waiver.

Foreign flag shipowners should be aware of the potential U.S. federal tax implications of engaging in a voyage between U.S. ports under the Waiver and carefully consider the after-tax returns on any such voyage.  One potential mitigation strategy is to require the charterer to pay an additional amount of charter hire to cover any U.S. federal income taxes that are imposed on voyages undertaken by the shipowner’s vessel pursuant to the Waiver.

If you have any questions about the U.S. federal income tax implications of the Waiver, please contact Jim Cofer or Brett Cotler.