Last week, speaking on Fox News, Commerce Secretary Howard Lutnick appeared to threaten the repeal of the exemption under Section 883 of the Internal Revenue Code for foreign corporations engaged in the international operation of ships. In that interview, Lutnick said “You ever see a cruise ship with an American flag on the back? They have flags of Liberia or Panama. None of them pays taxes. Every supertanker — none of them pays taxes. This is going to end under Donald Trump. Those taxes are going to be paid.”
Section 883 provides that a foreign corporation which is engaged in the international operation of ships will be exempt from U.S. federal income taxation if (i) the foreign corporation is organized in a “qualified foreign country,” which is a foreign country that provides an equivalent exemption to U.S. corporations and (ii) the foreign corporation satisfies an ownership test. If a foreign corporation’s stock is publicly traded in the United States, then the foreign corporation will generally satisfy the ownership test. A corporation can also satisfy the ownership test if it is majority owned by residents of one or more qualified foreign countries or is a “controlled foreign corporation” for U.S. federal income tax purposes.
Section 883 has been utilized by both the cruise industry and cargo shipping industry to claim exemption from U.S. federal income tax. If Section 883 were repealed, then the “United States source shipping income” of a vessel operator would generally be subject to a four percent gross basis tax (that is, without deductions). A vessel operator’s United States source shipping income would be equal to fifty percent of the income derived from a voyage that began or ended in the United States. However, liner and cruise operators with a fixed place of business in the United States would be subject to tax on their net income which is effectively connected to their U.S. place of business at the normal corporate tax rate of 21%.
The repeal of Section 883 would require Congressional action, the prospects of which are uncertain. However, short of a repeal of Section 883, there are other potential administrative avenues that could be utilized by the Administration to limit the availability of the Section 883 exemption.
Section 883 is only available to those vessel operators organized in a qualified foreign country. A qualified foreign country is one which (i) has entered into an exchange of diplomatic notes with the United States providing for a reciprocal exemption from tax on international shipping income for U.S. corporations or (ii) provides an exemption from tax for income derived from the international operation of ships or aircraft, either by statute, decree, income tax convention, or otherwise or generally imposes no tax on income. The United States has entered into an exchange of diplomatic notes with a number of foreign countries, including the Bahamas, Panama, Liberia and the Marshall Islands which form the basis of treating those countries as qualified foreign countries. The United States government could terminate those diplomatic notes and therefore potentially cause those foreign countries to no longer be qualified foreign countries. There is precedent for such a move. In 2020, the United States terminated its exchange of diplomatic notes for shipping income with Hong Kong. Countries which provide for a statutory exemption in their internal law for international shipping income, such as Bermuda and the Cayman Islands, would not be affected by such an action. In addition, exemptions available under formal income tax treaties would not be affected by such an action, although the U.S. government could seek to renegotiate such treaties.
It is too early to tell whether the comments by Secretary Lutnick reflect a policy initiative by the Administration. That said, the industry should be closely monitoring any further moves in this area. If there are any concrete steps towards repealing or limiting Section 883, then international shipping companies should consider steps which would mitigate the imposition of any additional U.S. taxation.
