US Tax Consequences of the Jones Act Waiver

On April 24, U.S. Customs and Border Protection extended a limited waiver of the Jones Act that had originally been granted on March 19. As a result of the waiver, non-U.S. flagged vessels are permitted to transport certain specified energy and other products between two U.S. ports (U.S. Voyages) until Aug. 16. While the waiver creates commercial opportunities for operators and owners of non-U.S. flagged vessels (Foreign Operators and Owners), transportation income from U.S. Voyages could trigger U.S. income for Foreign Operators and Owners, as well as withholding taxes for their lessees and customers, that would not ordinarily apply to voyages between a U.S. port and a non-U.S. port (Cross-Border Voyages).

Transportation income is defined broadly and includes (1) income from transporting passengers or property by vessel or aircraft (or by containers or related equipment); (2) income from hiring or leasing a vessel, a container or aircraft; and (3) income from the performance of certain services on board a vessel or aircraft.

Cross-Border Voyages

A Foreign Operator and Owner’s transportation income from Cross-Border Voyages is not subject to U.S. withholding tax. Instead, it is generally subject to a 2% tax on the gross amount of transportation income attributable to the voyage. Frequently, Foreign Operators are exempt from this tax under an applicable treaty or the Internal Revenue Code’s reciprocal exemption (which applies if the Foreign Operator’s country of residence provides U.S. persons an equivalent exemption).

In limited circumstances, a Foreign Operator and Owner’s transportation income from Cross-Border Voyages may be effectively connected to a U.S. trade or business (ECI). This occurs if the owner or operator has a fixed place of business in the U.S. involved in earning the transportation income and at least 90% of its U.S.-source gross transportation income is attributable to regularly scheduled transportation or that fixed place of business. If the transportation income is ECI, the Foreign Operator is subject to U.S. federal net income tax on that income in essentially the same manner as a U.S. person, along with branch profits tax for non-U.S. corporate owners or operators.

U.S. Voyages

In contrast to Cross-Border Voyages, transportation income received by a non-U.S. person attributable to a U.S. Voyage is generally subject to a 30% gross-basis withholding tax unless (1) the recipient is eligible for a reduction or elimination of withholding under an applicable U.S. tax treaty or (2) the transportation income is ECI and not exempt under a treaty, in which case it is subject to U.S. tax on a net income basis.

Foreign Owners and Operators that have heretofore used their vessels exclusively for non-U.S. voyages or Cross-Border Voyages should be sensitive to the potential for material U.S. taxes if their vessels are used for U.S. Voyages. In addition to the potential 30% withholding tax, income from U.S. Voyages could be ECI if attributable to a business in the United States, even if the heightened ECI requirements applicable to transportation income from Cross-Border Voyages are not met.

Takeaways

Given the magnitude of this potential tax, Foreign Owners and Operators considering U.S. Voyages in light of the suspension of the Jones Act, as well as their lessees and other customers that may have withholding obligations, should consider how tax risk is allocated under their various shipping agreements and consult their tax advisers regarding their tax status and exposure. For example, many vessel leases require lessees to gross up the lessor for any withholding taxes triggered by voyages. In such a case, lessees should consider this gross-up obligation, as well as any withholding taxes or potential income tax on ECI they earn directly, in considering whether to undertake a U.S. Voyage. Lessors under leases that do not include a gross-up should consider their options for limiting lessee activity that could trigger additional U.S. tax during the period that the Jones Act is suspended. Lessors and operators looking for alternative solutions (including potential structural solutions) may contact any of the lawyers listed.

For more information on the subject of this advisory or Hughes Hubbard’s tax practice, please contact any of the listed lawyers.