U.S. Taxation of International Shipping and Air Transport Activities discusses the three tax regimes to which nonresident alien individuals and foreign corporations that conduct shipping or air transport activities within the United States may be subject: (1) the general provisions of the Internal Revenue Code of 1986, as amended, for foreign persons with certain modifications; (2) a “reciprocal exemption” provided by §§872(b) and 883; or (3) the similar, but different, exemption available under many U.S. income tax treaties. Written by Peter A. Glicklich, Esq., Davies Ward Phillips & Vineberg LLP, and Michael J. Miller, Esq., Roberts & Holland LLP, this Portfolio sets forth in detail the U.S. tax rules applicable under each of the three tax regimes, including in particular the requirements that must be satisfied to qualify for an exemption under either §§872(b) and 883 or an applicable U.S. income tax treaty. In this regard, particular emphasis is given to Treasury Regulations issued in 2003 that make it substantially more burdensome for foreign corporations to claim the reciprocal exemption provided by §§872(b) and 883.

This Portfolio addresses both “inbound” and “outbound” aspects of U.S. taxation of international shipping and air transport activities, but its principal focus is on U.S. income taxation of inbound international shipping and air transport activities.  This Portfolio also sets forth the U.S. tax rules applicable to income earned by U.S. persons from international shipping and air transport activities. Of particular importance are provisions designed to prevent deferral of U.S. tax on such income through the use of controlled foreign corporations and limitations on the ability to use such income to utilize excess foreign tax credits.

In addition, this Portfolio discusses various excise taxes and September 11th Security Fees, U.S. income taxation of outbound international shipping and air transport activities, and miscellaneous matters, including U.S. income taxation of crews, various excise taxes, and taxes and fees imposed under the Aviation and Transportation Security Act.

In order to provide a more complete understanding of the current inbound rules, this Portfolio reviews the sourcing rules for transportation income as they existed prior to the Tax Reform Act of 1986 and then considers the changes made by the 1986 Act and later legislation.  Both the reciprocal exemption and the U.S. tax treaty provisions are discussed in detail.

Definitions of various terms commonly used in the shipping and air transport industries are set forth in a glossary, found in the Worksheets.

U.S. Taxation of International Shipping and Air Transport Activities allows you to benefit from:

• Hundreds of hours of original research on specific tax planning topics from leading practitioners in this area
• Invaluable practice documents including tables, charts and lists
• Plain-English guidance from world-class experts
• Real-world and in-depth analysis that lets you explore various options
• Time-saving access to relevant sections of tax laws, regulations, court cases, IRS documents and more.
• Alternative approaches to both common and unique tax scenarios

This Portfolio is part of the Foreign Income Portfolios Library, a comprehensive series containing more than 90 Portfolios, which covers critical transactions and issues in international taxation. This highly-regarded resource service offers commentary on a wide range of foreign income topics including: Foreign Tax Credit, Business Operations in more than 40 foreign countries, Branch ProfitsTax, Source of Income Rules, Subpart F (Controlled Foreign Corporations), Foreign Partnerships and Partners, Transfer Pricing, and more.

Detailed Analysis

I. Overview

II. Income Taxation - Inbound: Before the 1986 Act

A. General Tax Provisions

1. Historic Source Rule for Rent

a. General Rule

b. Rev. Rul. 75-483

2. Historic Source Rule for Other Transportation Income

3. 1984 Act Introduced New Source Rules

a. Transportation Beginning and Ending in the United States

b. Fifty-Percent Rule for Transportation Between the United States and Possessions

(1) General Rule

(2) Exception for Certain Aircraft Leases

c. Transportation Beginning and Ending Outside the United States

d. Definition of Transportation Income

4. U.S. Trade or Business

B. Reciprocal Exemption

1. Regime for Avoiding Double Taxation

2. Double Tax Concerns for Shipping Income

3. The Revenue Act of 1921: Exemption for Shipping Income

4. Extension to Aircraft Income

5. Reciprocal Exemption Immediately Prior to the 1986 Act

6. Importance of "Flag" (Registration)

7. Implementation of the Reciprocal Exemption

8. Coordination with U.S. Income Tax Treaties

III. Income Taxation - Inbound: The 1986 Act and Beyond

A. Treatment of Non-Exempt Income Under the Code

1. Introduction of Gross Basis Tax

a. Reasons for the Tax

b. Section 887: General Rule

c. Scope

(1) Income Derived from or in Connection with the Use (or Hiring or Leasing for Use) of a Vessel or Aircraft

(2) Income Derived from or in Connection with the Performance of Services Directly Related to the Use of a Vessel or Aircraft

(a) On-Board Services

(b) Off-Board Services

(3) Dispositions

(4) Source

(5) Interaction With Thirty Percent Withholding Tax on Rental Income

d. Calculation of the Gross Basis Tax

e. Interaction with the Reciprocal Exemption and Income Tax Treaties

f. Collection of the Gross Basis Tax

2. Higher Threshold for Effectively Connected Income

a. General Rule

b. Fixed Place of Business

c. Substantially All Test

(1) USGTI Other than Leasing Income

(2) USGTI Leasing Income

3. Revised Source Rules for Transportation Income

a. Problems with the Prior Sourcing Rules

b. Expanded 50% Sourcing Rule

(1) General Rule

(2) Exception for Personal Service Income

(3) Guidance for Certain Round Trip Income

c. Additional Source Rule Changes

d. Coordination with the Source Rules for Space and Ocean Income

B. The Reciprocal Exemption

1. Access to the Exemption

a. General Rule: Access Keyed to Residence

(1) Immediately Following the 1986 Act

(2) Subsequent Changes

(a) Independent Treatment of Individuals and Corporations

(b) International Operation

(c) Current Provisions

b. Additional Requirements for Foreign Corporations

(1) General Rule

(2) Exception for Publicly Traded Corporations

(3) Exception for Controlled Foreign Corporations

c. Special Rules

d. Interaction with Treaties

(1) No Override of Existing Treaties

(2) Broad View of Equivalent Exemption

2. Scope of Exemption

a. Bareboat Charter Income

b. Application on a Case-by-Case Basis

IV. Income Taxation - Inbound: A More Detailed Examination of the Reciprocal Exemption

A. Overview: Basic Code Provisions

B. The Regulations

C. Qualified Foreign Corporation

1. Basic Definition

2. International Operation of Ships or Aircraft

a. Operation of Ships or Aircraft

(1) General Rule

(2) Partnership Activities

(a) The 2000 Proposed Regulations

(b) The 2002 Proposed Regulations

(c) The Final Regulations

(3) Nonqualifying Activities

(4) Examples

(5) For Hire

b. International Operation

(1) General Rule

(2) Rules of Operation

(a) In General

(b) Passenger Income

(i) General Rule

(ii) Round Trip Cruise

(c) Cargo Income

(d) Comments on Scope

(e) Lightering

(f) Military Cargo

(g) Allocating Bareboat Charter/Dry Lease Income

3. Qualified Foreign Country

a. General Rule

b. Equivalent Exemption

(1) Means of Providing an Equivalent Exemption

(2) Category-by-Category Determination

(3) Exemptions Not Treated as Equivalent

(4) Territorial Tax System

(5) Countries that Tax U.S. Corporations on a Residence Basis

(6) Treatment of Possessions

4. Stock Ownership Tests

a. Qualified Shareholder Test

(1) Basic Rule

(2) Qualified Shareholder - Principal Requirement

(a) General Rule

(b) Residence of Individual Shareholders

(c) Provision of Equivalent Exemption Through an Income Tax Treaty

(3) Qualified Shareholder - Additional Requirements

(4) Measuring Qualified Shareholder Ownership: Attribution Rules

(a) In General

(b) Partnerships

(c) Trusts and Estates

(i) Attribution to Beneficiaries of Nongrantor Trusts and Estates

(ii) Attribution to Owners of Grantor Trusts

(d) Corporations That Issue Stock

(e) Taxable Non-Stock Corporations

(f) Mutual Insurance Companies and Similar Entities

(g) Non-Government Pension Funds

(5) Substantiation Requirements

(6) Reporting Requirements

b. Publicly Traded Test

(1) Publicly Traded Corporation

(a) Established Securities Market

(b) Primarily Traded

(c) Regularly Traded

(i) General Rule

(ii) Stock Traded on an Established Market in the United States

(iii) Closely Held Exception

(iv) Anti-Abuse Rule

(2) Substantiation Requirements

(3) Reporting Requirements

c. CFC Test

(1) Definition of a CFC

(2) Income Inclusion Test

(3) Substantiation Requirements

(4) Reporting Requirements

D. Qualified Income

1. General Rule

2. Incidental Income

a. Activities Considered Incidental

b. Activities Not Considered Incidental

c. Partnerships and Other Joint Ventures

E. Documentation Requirements

1. Qualified Shareholder Test

a. General Rule: Requirement of Ownership Statements

b. Ownership Statements and Special Rules

(1) Individuals

(2) Foreign Governments

(3) Publicly Traded Corporations

(4) Not-for-profit Organization

(a) Ownership Statement

(b) Special Rule

(5) Individual Beneficiaries of Pension Funds

(6) Shareholders of Airlines Covered by a Bilateral Air Services Agreement

(7) Widely Held Corporations

(8) Taxable Non-Stock Corporations

(9) Intermediaries

(a) In General

(b) Widely Held Intermediary Supplemental Statement

(c) Pension Fund Supplemental Statement

(i) Government Pension Fund

(ii) Non-Government Pension Funds

(d) Taxable Non-Stock Corporation Supplemental Statement

c. Document Retention

2. Publicly Traded Test

3. CFC Test

F. Significance of Diplomatic Notes

1. Overview

2. Changes After the 1986 Act

3. Distinguishing the Treaty Exemption

4. Scope of the Reciprocal Exemption

G. Equivalent Exemption Under Foreign Law

H. Effective Date of the Regulations

V. Income Taxation - Inbound: Income Tax Treaties

A. Purpose of Income Tax Treaties

B. Access to the Treaty

1. Residence Requirement and Limitation on Benefits Provision

2. Savings Clause

C. Overview of the Treaty Exemption

1. The Basic Exemption

2. Registration Requirement

3. Interaction with Other Treaty Provisions

D. Scope of Exemption

1. Profits from the Operation of Ships or Aircraft

2. International Traffic

a. Definition

b. Meaning of "Solely"

3. Full and Bareboat Rental Income

a. Full Charter Income

(1) U.S. and OECD Model Treaties

(2) Treaty Provisions Consistent with U.S. and OECD Model Treaties

(3) Variations

b. Bareboat Rental Income

(1) U.S. and OECD Model Treaties

(2) Treaty Provisions Following the U.S. Model Treaty

(3) Treaty Provisions Following the OECD Model Treaty

(4) Other Treaty Provisions

4. Inland Transport (By Land)

a. U.S. and OECD Model Treaties

b. U.S. Tax Treaties - 1996 and Later

5. Inland Waterways Transport

6. Container Income

a. U.S. and OECD Model Treaties

b. Treaty Provisions Following the U.S. Model Treaty

c. Treaty Provisions Following the OECD Model Treaty

d. Other Treaty Provisions

7. Gains

a. U.S. and OECD Model Treaties

b. Treaty Provisions Following U.S. and OECD Model Treaties

c. Treaties with Similar Provisions

d. Treaties with No Express Gains Exemption

8. Other Related Income

a. Lighterage

b. Related Non-Transport Services

9. Income Earned Through a Partnership

E. Filing Requirements

F. Interaction with Other Rules

1. Section 887

2. Branch Profits Tax

3. State Taxes

4. Reciprocal Exemption

VI. Income Taxation - Outbound

A. Subpart F

1. Overview

2. Pre-1975 Subpart F Treatment of Shipping/Air Transport Income

3. 1975 Changes

a. Foreign Base Company Shipping Income

b. Exclusion for Reinvested Earnings

c. Same Country Exception

4. 1986 Act Change

5. 1993 Act Change

6. 2004 Act Changes

B. PFIC Rules

C. Foreign Tax Credit Rules

1. Background

2. Special Basket for Shipping Income

D. Elective Tonnage Tax Regime

1. Overview

2. Requirements

3. Other Aspects of the Elective Tonnage Tax Regime

4. Making or Terminating an Election

VII. Miscellaneous

A. Income Tax Treatment of Crews

1. Source of Income

a. General Rule

b. De Minimis Exception

c. Additional Exemption for Certain Crew Members

2. Treaty Exemptions

a. General Exemption for Employee Compensation

b. Additional Exemption for Crews

3. Substantial Presence Test for U.S. Residency

a. General Rule

b. Certain Days of Presence Disregarded

c. Treaty "Tie-breaker" Provisions

B. Excise Taxes

1. Shipping Excise Taxes

a. Harbor Maintenance Tax

(1) General

(2) Liability for the Tax

(3) Definitions

(a) Port Use

(b) Port

(c) Commercial Cargo

(d) Commercial Vessel

(e) Value

(4) Special Rule for Alaska, Hawaii, and Possessions

(5) Other Exemptions and Exceptions

(a) Coordination with § 4042

(b) Exception for Certain Cargo

(c) Exemption for the United States

(d) Tax Imposed Only Once

(e) Exception for Intraport Movements

(f) Exception for Humanitarian and Development Assistance Cargos

(6) Applicability of Customs Provisions

(7) HMT Unconstitutional as Applied to Exports

b. Passenger Tax

2. Air Transport Excise Taxes

a. Passenger Taxes

(1) Percentage Tax

(a) General

(b) Taxable Transportation

(2) Fixed-Dollar Tax

(3) International Arrival/Departure Tax

(4) Exemptions

b. Property

C. Aviation and Transportation Security Act

Working Papers

Table of Worksheets

Worksheet 1 Glossary

Worksheet 2 U.S. Model Income Tax Convention (2006), Article 8

Worksheet 3 Treasury Department Explanation of U.S. Model Income Tax Convention (2006), Article 8

Worksheet 4 U.S. Model Income Tax Convention (2006), Article 13

Worksheet 5 Treasury Department Explanation of U.S. Model Income Tax Convention (2006) Article 13(4) and (5)

Worksheet 6 Sample Diplomatic Notes¹

Worksheet 7 Sample Attachment to Form 1120-F: Qualified Shareholder Test Satisfied

Worksheet 8 Appendix 14 Sample Attachment to Form 1120-F: Publicly Traded Test Satisfied

Worksheet 9 Sample Attachment to Form 1120-F: CFC Test Satisfied

Bibliography

OFFICIAL

Internal Revenue Code:

Committee Reports/Public Laws:

Revenue Rulings and Procedures:

Cases:

UNOFFICIAL

Tax Treatises:

Tax Management Portfolios:

Periodicals:

2007