TTM06510 - Relevant Shipping Profits: Relevant shipping income

Certain interest etc

As described in TTM06500, investment income cannot be ‘relevant shipping income’. The fact that the recipient of interest carries on a trade does not of itself displace the general rule that the income should be brought to account for tax under its normal head of charge.

However certain interest etc may be included in relevant shipping income - but only if it would fall to be treated as trading income under the normal corporation tax rules.

For accounting periods beginning on or after 1 October 2002, the types of income which may come within this rule include:

• anything giving rise to a credit that would fall to be brought into account for the purposes of Chapter II of Part IV of the Finance Act 1996 (loan relationships);
• any exchange gain under Chapter II of Part II of the Finance Act 1993(exchange gains and losses); and
• any profit on a qualifying contract under Chapter II of Part IV of the Finance Act 1994 (interest rate and currency contracts).

There are limited circumstances, as mentioned in BIM40805, in which interest may be regarded as a trade receipt and such interest may be included in relevant shipping income

Trade receipt

The conditions to be satisfied before we accept that interest income should be treated as trading income are described in BIM40805 onwards.

The general test is that interest will normally rank as trade receipts only where it is an integral part of the business operations to employ capital to produce such income, for example, in the case of banks and other financial concerns. (See Nuclear Electric Plc v Bradley [1996] 68TC670 where the House of Lords approved the reasoning in an earlier Court of Session case, Bank Line Ltd v CIR [1974] 49TC307; and, by way of contrast, Liverpool and London and Globe Insurance Co v Bennett [1913] 6TC327.)

In the Bank Line case (which related to the treatment of interest on a ship replacement fund), Lord Avonside commented:

“Income becomes a trading receipt when it arises from capital actively employed and at risk in the business because it is required for its support or, perhaps, to attract customers looking to the credit of the business. Trading income is ‘the fruit’ of the capital employed in the business in the present and active sense………Turning to the present case it is found as a fact that the capital sum in issue was created for the purpose of replacement of ships as an when they became obsolete. In my opinion it is absolutely clear that the retained monies were not employed in the business carried on by the appellants. Of course the appellants could not carry on business without ships and for that reason they set up a capital fund with which to purchase new vessels as and when existing vessels became obsolete. That fund, in truth, far from being employed in the carrying on of the business, was created by withdrawing money from the business. Naturally, it has been put out to earn interest and does so, but that interest cannot be looked upon in the circumstances as 'trading receipts'."

Interest on an investment

Interest on an investment may be treated as trading income if:

the investment is for a short term, and

it is an integral feature of the trading activity to make such an investment, and

the funds deposited can be regarded as continuing to be employed in the business and to form part of the current working capital.

Investments made in the course of banking, insurance and other financial trades will normally meet these conditions. See for example the London and Liverpool and Globe Insurance case.

Investments by non-financial concerns are unlikely to meet these conditions if for example they:

endure from one period of account to another, or

represent capital even if it is only temporarily surplus to requirements, or

although short term, represent part of a series of deposits which together constitute a long term setting aside of part of the capital.

Interest on working capital

Where interest is received on balances required in the company’s trade as working capital, then that income will normally form part of the company’s ‘relevant shipping income’, but only to the extent that the balances did not exceed the amount genuinely needed for working capital.

‘Working capital’ of a company may be defined as:

the funds held on a day-to-day basis to meet its revenue expenditure obligations as they fall due.

• Reasonable assumptions about the receipt of trading income and payment of expenditure must be made in arriving at the working capital required so that, for example, the working capital requirement in respect of a ship which is chartered-out on the spot market may be higher than that for a ship which is chartered-out on a long term charter (in order to provide for the potential loss of charterhire income caused by market fluctuations).

Working capital, by its nature, must be held in liquid or near-liquid form. HMRC does not accept that interest on term deposits or other long-term investments can be relevant shipping income.

Interest and forex gains and losses on deposits integral to leases

As part of the arrangements for obtaining loan finance, a shipping company may be obliged to make a deposit on which interest arises. This most commonly occurs in cases where the finance is being provided by means of a finance lease and the lender requires a defeasance deposit (see TTM10100) because it is not prepared to take on the whole of the underlying risk.

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Leases

HMRC may accept that interest on deposits which are integral to leases falls to be treated as relevant shipping income if the following conditions are met:

• The underlying lease was entered into in order to finance the acquisition of a tonnage tax asset, or to provide working capital for use in the tonnage tax trade
• The lender would not have entered into the lease if the deposit had not been made
• The amount of the deposit does not exceed the amount required to secure the lease
• The amount of the deposit and the rate of interest are determined by commercial rather than tax considerations
• The deposit was not made as part of a scheme or arrangement to facilitate the artificial avoidance of tax.

HMRC will not accept that these conditions are satisfied by a defeasance deposit which has the effect of removing more than 50% of the non compliance risk which would otherwise have fallen directly or indirectly on the lessor.

Sale and leaseback.

A sale and leaseback transaction will satisfy the first condition above if it was entered into to provide working capital. You may therefore accept that interest on a deposit made as an integral part of such a transaction will fall to be included in relevant shipping profits if the other conditions are satisfied.

Loans

Security deposits linked to loans are uncommon and are unlikely to have been made as an integral part of the business of a ship operator. HMRC does not accept that interest on a security deposit to secure a loan to the shipping company is relevant shipping income.

(This text has been withheld because of exemptions in the Freedom of Information Act 2000)

Interest that does fall to be treated as trading income will be a relevant shipping profit within para 44(2)(b) schedule 22 FA 2000.

Examples

See TTM06520 for some illustrations as to what may come within relevant shipping income, and what may not.

References