Taxation of Ship Operation Activities
A ship operator provides services for the carriage of passengers and/or goods by operation of ships in sea transportation. Activities that the ship operator does not need to carry on for the purposes of its own operation of ships in sea transportation but which make a contribution relatively minor to such operation and are so closely related to such operation that the activities should not be regarded as a separate business or source of income of the ship operator should be considered to be incidental or ancillary to the operation of ships in sea transportation.
Sums derived by a ship operator from chartering a ship on a voyage charter or time charter fully equipped, crewed and supplied, which are regarded as directly connected with the ship operator’s ship operation in sea transportation, are assessed in accordance with the provisions in section 23B of the Inland Revenue Ordinance (IRO). Sums derived by a ship operator from chartering a ship on a bareboat charter basis, which is an incidental or ancillary activity of the ship operator engaged in operation of ships in sea transportation, are also assessed in accordance with the provisions in section 23B.
A person is a ship operator if the person has the capacity to perform the functions, undertake the risks and use assets of a carrier by sea of passengers and/or goods. If a ship operator charters ships on voyage charters and/or time charters that are fully equipped, crewed and supplied, such chartering activities are regarded as directly connected with the ship operator’s ship operation business. Sums derived by the ship operator from such chartering activities are assessed in accordance with the provisions in section 23B.
If the person merely offers ships for lease on time charters without performing the functions, undertaking the risks and using assets of a carrier by sea of passengers and/or goods, the person is a ship lessor. Sums derived by a qualifying ship lessor as defined in section 14P(2) from leasing ships on time charters are assessed in accordance with the provisions in section 14R.
The terms “bareboat charter” and “time charter” represent maritime concepts and are generally used in the maritime industry. The terms “finance lease” and “operating lease” represent accounting concepts and are normally applied to pure ship leasing activities. In practice, a bareboat charter may be an operating lease or a finance lease while an operating lease may be a time charter or bareboat charter.
There is no requirement on the length of term for a charterparty in section 23B. Sums derived by a ship operator from chartering ships on time charters that are fully equipped, crewed and supplied or on bareboat charters which are incidental or ancillary to the ship operator’s ship operation business, whether for exceeding one year or not, are assessed in accordance with the provisions in section 23B.
In general, the nature of a hedging instrument follows that of the hedged item. That is:
||If a hedging instrument is used to hedge against any risks associated with a hedged item of capital in nature, any gain or loss derived from the hedging instrument and the hedged item would be treated as capital gain or loss (i.e. neither taxable nor deductible).|
||If a hedging instrument is used to hedge against any risks associated with a hedged item of revenue in nature, any gain or loss derived from the hedging instrument and the hedged item would be treated as revenue gain or loss (i.e. either taxable or deductible).|
If a hedging instrument is used by a ship operator to hedge against risks relating to exposures on freight rates and bunker prices, which are faced by the ship operator in the ordinary course of its ship operation business, any resulting hedge gain or loss would be revenue in nature and is either taxable or deductible.
Given that sums derived by a ship operator from the international operation of Hong Kong registered ships are “exempt sums” under section 23B, the hedge gain or loss in relation to the “exempt sums” would not be taxed or allowed for deduction so long as the hedging is incidental or ancillary to the international operation of Hong Kong registered ships.
Each group company is a separate legal entity carrying out separate business activities. The nature of business activities of each group company has to be determined on its own facts and circumstances. If a group company is a ship lessor carrying out pure ship leasing activities, it would not be eligible for the exemption provided under section 23B. Section 23B would be applicable only to a ship operator carrying on a ship operation business, including incidental chartering activities.
Profits derived from sale of a capital asset are not subject to profits tax. Generally, a ship acquired by a ship operator for use in its ship operation business is a capital asset. If the ship operator financed the acquisition of the ship under a funding lease, all the risks and rewards incidental to ownership of the ship should have been substantially transferred to the ship operator at the inception of the lease. Though the ship was sold immediately after the transfer of legal title, the profits derived from the sale should be capital in nature and hence are not chargeable to profits tax.