U.S. Taxation of International Shipping and Air Transport Activities (Portfolio 6740)

Tax Management Portfolio, 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.

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The three tax regimes this Portfolio discusses are: (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.

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 also discusses 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, the Portfolio discusses various excise taxes and September 11th Security Fees.


U.S. Taxation of International Shipping and Air Transport Activities was authored by the following experts.
Peter A. Glicklich, Esq.

Peter A. Glicklich is a partner resident in the New York office of Davies, Ward, Phillips & Vineberg LLP. His practice is concentrated on the taxation of corporate and international transactions. He advises public and closely held corporations in connection with mergers and acquisitions, cross-border financings, restructurings, reorganizations, spin-offs and intercompany pricing. Mr. Glicklich has dealt with companies in diverse fields, including chemicals, consumer products, real estate, biotechnology, software, telecommunications, pharmaceuticals and finance. As well he has worked with venture funds, investment banks, hedge funds, commodities and securities dealers and insurance companies. He is a contributing editor of the Tax Management International Journal, the Canadian Tax Journal, the Journal of Taxation of Global Transactions, and the International Tax Review, and is a former contributing editor of theJournal of Real Estate Taxation. Mr. Glicklich has written numerous articles on cross-border financing, net loss carryovers, bankruptcy restructurings, the use of conduits, transfer pricing, loss importation, and taxation of internet activities. He also speaks frequently on international and corporate tax topics. Mr. Glicklich presently serves as the New York Regional Vice-President and an Executive Committee member of the USA Branch of the International Fiscal Association, and he is a past Secretary of that Committee. He is also a member of numerous bar associations. Mr. Glicklich received an honors degree from the University of Wisconsin - Madison in 1977 and received his J.D. cum laude from Harvard Law School in 1981.

Michael J. Miller, Esq.

Michael J. Miller is with Roberts & Holland LLP, the largest law firm in the United States engaged primarily in the practice of tax law. He counsels foreign and U.S.-based multinationals regarding a wide range of tax issues pertaining to their cross-border activities. Michael has also authored numerous articles on international tax issues for the Journal of Taxation of Global Transactions and the Canadian Tax Journal. He is a member of the U.S. Activities of Foreign Taxpayers Committee of the Tax Section of the American Bar Association. He received his B.A. cum laude from Columbia College in 1988 and his J.D. from New York University in 1991. He clerked on the U.S. Tax Court for the Honorable James S. Halpern from 1991-1993.

Table of Contents

Detailed Analysis

I. Overview

II. Income Taxation — Inbound: Before the 1986 TRA

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 Introduction of 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 TRA

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 TRA and Beyond

A. Treatment of Nonexempt 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 30% 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

g. Interaction with FATCA

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 TRA

(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 CFCs

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 2003 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 Systems

(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 Nonstock Corporations

(f) Mutual Insurance Companies and Similar Entities

(g) Nongovernment 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) Additional Ownership Test

(a) 2003 Final Regulations — Income Inclusion Test

(b) Hypothetical Income Inclusion Test

(c) Qualified U.S. Person Ownership 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. Bearer Shares

b. General Rule: Requirement of Ownership Statements

c. Ownership Statements and Special Rules

(1) Individuals

(2) Foreign Governments

(3) Publicly Traded Corporations

(4) Not-for-Profit Organizations

(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 Nonstock Corporations

(9) Intermediaries

(a) In General

(b) Widely Held Intermediary Supplemental Statements

(c) Pension Fund Supplemental Statements

(i) Government Pension Funds

(ii) Nongovernment Pension Funds

(d) Taxable Nonstock Corporation Supplemental Statements

d. Document Retention

2. Publicly Traded Test

3. CFC Test

F. Significance of Diplomatic Notes

1. Overview

2. Changes After the 1986 TRA

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. Saving 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 Similar to the U.S. Model Treaty

(3) Treaty Provisions Similar to the OECD Model Treaty

(4) Other Treaty Provisions

4. Inland Transport (By Land)

a. U.S. and OECD Model Treaties

b. Recent U.S. Tax Treaties

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 the 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 Nontransport 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 and Air Transport Income

3. 1975 Changes

a. Foreign Base Company Shipping Income

b. Exclusion for Reinvested Earnings

c. Same Country Exception

4. 1986 TRA Change

5. 1993 OBRA Change

6. AJCA Changes

7. Status of Shipping Income Following the AJCA

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) Harbor Maintenance Tax 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

Additional Resources

Worksheet 1 Glossary

Worksheet 2 Sample Diplomatic Notes

Working Papers

Working Papers

Table of Worksheets

Worksheet 1 Glossary

Worksheet 2 Sample Diplomatic Notes1