Will the cruise industry circumvent the minimum tax? – Part 1

The cruise industry is recovering from Covid-19. Royal Caribbean Cruises Ltd., a publicly traded Liberian company and the world’s second largest cruise ship operator, reported book income of approximately $2 billion in 2019. The company reported a book loss of $6 billion in 2020, a loss of $5 billion. financial accounting loss in 2021 and an annualized financial accounting loss of $3 billion in the first half of 2022. But in an 8-K filing from September 2022, Royal Caribbean said its bookings had exceeded 2019 levels since its Covid restrictions -19 were relaxed in August.

Section 883

Royal Caribbean’s 202110-K acknowledges that the company and several of its principal subsidiaries, which are also incorporated in Liberia, are, in the course of operating cruises between U.S. and foreign ports, engaged in a trade or business in the United States and derive US-source income. . The 10-K observes that Section 883 generally provides corporations with a statutory gross income exclusion and, in practice, provides an exemption from U.S. corporate income tax and U.S. corporate branch tax, for shipping income from foreign corporations whose country of incorporation provides the United States to incorporated shipowners with a reciprocal exemption.

Specifically, Section 883 provides that qualifying maritime income “shall not be included in the gross income of a foreign corporation and is exempt from tax under this [income tax] Subtitle.” Conversely, IRS Rev. Rul. 80-147 and Tres. Reg. 1.883-1(j) imply that expenses attributable to such exempt income are not deductible and cannot create a loss carryforward. net operating in the United States on non-exempt, non-delivery income actually tied.

The IRS, relying on an exchange of diplomatic notes between Liberia and the United States, concluded Reverend Rul. 2008-17 that Liberia is such a reciprocal country. Accordingly, for United States corporate income tax purposes, Royal Caribbean and its financially consolidated Liberian subsidiaries appear to have relatively little effectively United States-related income or losses from their maritime transport.

Royal Caribbean’s 10-K notes that Treasury regulations, namely Treas. Reg. 1.883-1(h)(2): Disqualifies certain income from the Section 883 tax exemption. Such disqualified income includes providing Miami city tours before or after cruises end.

Alternative Minimum Corporate Tax

Beginning in 2023, the Reducing Inflation Act of 2022 may impose a U.S. minimum corporate income tax on certain corporate groups with foreign parent corporations whose adjusted worldwide average financial statement income exceeds $1 billion.

However, the CAMT only applies in a limited way to those groups whose parents are foreigners. Section 56A(c) states that in determining the amount of AFSI of a foreign company, “the principles of Section 882 apply”. CAMT generally only applies to a group with a foreign parent company if the AFSI of the group is at least $100 million, taking into account the application of the limitation of section 56A (c) (4) foreign member companies of the group. A foreign parent group, even if it has a worldwide AFSI greater than $1 billion, must have a minimum of $100 million in AFSI to be subject to CAMT, excluding U.S. net income of foreign members of the excluded group under the principles of Section 882 and 56A(c)(4).

If a foreign-owned group, apparently including Royal Caribbean, has more than $1 billion in AFSI worldwide, it will not be subject to CAMT if the group’s income that is not exempt under Section 56A(c)(4), such as the non-exempt income described in Treas. Reg 1.883-1(h)(2), is less than $100 million. Even if such a group has $1 billion in AFSI worldwide and at least $100 million in AFSI limited to Section 56A(c)(4), CAMT’s AFSI tax base is limited. by Section 56A(c)(4).

The cruise industry faces some ambiguity about the interaction of Section 883 with Section 56A(c)(4). For example, many Royal Caribbean cruises sail from Fort Lauderdale, Miami, or Port Canaveral, Florida, to Nassau, Bahamas, and then return to Florida. Under Section 863(c)(3), 50% of passenger revenue from these cruises is treated as income effectively connected with a U.S. source described in Section 882. See TAM 9348001. However, Section 883 may exempt this 50% from US corporate income tax and branch profits tax. For purposes of the $100 million AFSI threshold and CAMT tax base if that $100 million is exceeded, would the AFSI include 100%, 50%, or none of this Florida-Bahamas cruise revenue?

Section 59(k)(2)(A) treats Section 56A(c)(4) as inapplicable to foreign-invested groups only to determine whether the global AFSI threshold of $1 billion is met, not to determine if the $100 million threshold has been met or, if so, what is CAMT’s tax base. Therefore, it appears that the IRS cannot include 100% of Royal Caribbean’s Florida-Bahamas round-trip passenger revenue in the AFSI to determine whether the $100 million threshold is met or, if so, what is the CAMT tax base.

When it comes to the inclusion of 50% of Royal Caribbean’s Florida-Bahamas return passenger revenue in the AFSI, the situation is less clear. As noted, Section 56A(c)(4) states that “in the case of a foreign corporation, to determine [AFSI], the principles of Article 882 apply. Some IRS rulings are unclear on the question, which was moot prior to the enactment of CAMT, of whether such reciprocally exempt shipping income should be considered effectively related income under the principles of section 882 but excludable under the independent application of s. 883, or as excludable from consideration under s. 882 in the first place. Compare Rev. Rule. 87-15—which states that “[a] part of [the shipping company’s] Income [is] actually connected with a trade or business in the United States…. Such income, however, is exempt from United States tax under the reciprocal shipment exemption of section 883(a)(1) “- with PLR 8129051, which says, “The IRS National Agency notes, without negative comment, that the shipping company concluded that its earnings were excluded from its “gross income under section 882(b) because of the “reciprocal exemption” provisions of section 883(a)(1)”.

Under the anti-cruise line view that Section 56A(c)(4) only incorporates the exceptions of Section 882 and not those of Section 883, the 50% of net passenger revenue qualifying as revenue actually connected could be included in the AFSI. In the short term, the application by section 59A of a three-year average to determine the applicable corporate status, and the allocation to companies affected by section 56A(d) of an unlimited carry-over of losses of post-2019 financial statements to offset up to 80% of current year AFSI, could reduce CAMT exposure to Royal Caribbean and other cruise lines, whose businesses have been harmed by Covid- 19 between 2020 and 2022. According to the cruise lines’ favorable opinion, section 56A(c)(4) also incorporates the exceptions of section 883, 0% would be included in the AFSI.

Some cruise lines, such as Royal Caribbean, have ship-owning subsidiaries that lease the ships to affiliated companies that operate the cruises. These vessel-owning subsidiaries apply Section 883 to avoid being subject to the otherwise applicable Section 887 gross transportation tax of 4% on their non-effectively connected US-source income. The analogous question arises whether such income is exempt from inclusion in the AFSI under Section 56A(c)(4). A further, analogous question arises whether any shipping or other income that is exempt from U.S. corporate income tax and U.S. transportation tax under a tax treaty is also excluded by the 56A(c)(4).

One source of optimism for the cruise industry is that of the former Treas. Reg. Sections 1.56-1(b)(6)(ii)(B) and 1.56(g)-1(m)(4), dealing with the repealed analogous alternative minimum tax on accounting income and adjusted tax preferences. of current earnings, the Treasury favorably excluded a foreign shipping company’s earnings attributable to its Section 883 or treaty earnings that were exempt from ordinary U.S. corporate income tax.

Part 2 of this article will examine whether the OECD second pillar minimum tax can apply to the income of cruise passengers.

This article does not necessarily reflect the views of Bloomberg Industry Group, Inc., publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Alan S. Lederman is a shareholder of Gunster, Yoakley & Stewart, PA in Fort Lauderdale, Florida.

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