House of Commons - Transport

Select Committee on Transport Second Report

1 Introduction

1. The UK is a maritime nation but it is extremely easy to forget it: 95% of our trade is carried by sea and the shipping sector contributes more than £1 billion to the economy. But it is not just about shipping. A recent survey conducted on behalf of Maritime London, the promotional body for London's maritime services industry, found that London remains the global centre of the maritime services industry.[1] It identified 1,750 companies or organisations participating in maritime activities in London.

2. The long term decline of the shipping industry was accordingly a real threat to our prosperity. Tonnage tax was introduced in the Finance Act 2000 to try and revive the UK shipping industry and increase the number of UK-based seafarers. It is an alternative tax regime for shipping companies; rather than paying corporation tax on the actual commercial profits made in the year, a notional profit is computed on the basis of the number and size of the ships operated.

3. The new tax regime had widespread support. In May 1999, our predecessor committee, the Transport sub-committee of the Environment, Transport and Regional Affairs Select Committee, recommended the introduction of a tonnage tax with measures to boost the training of British seafarers, in the report of its inquiry into the future of UK shipping.[2] It was introduced following this report, recommendations of the Shipping Working Group, (a forum which contained representatives from the industry, trade unions and Government), and an inquiry into tonnage tax, conducted by Lord Alexander.[3]

4. As four years had elapsed since the introduction of tonnage tax the Committee decided that it was timely to examine the effect of the regime on the UK shipping register and the training and employment of UK-based seafarers.

5. On 23 June 2004 we took oral evidence from the Chamber of Shipping, the National Union of Marine Aviation and Shipping Transport Officers (NUMAST), the National Union of Rail, Maritime and Transport Workers (RMT), David Jamieson MP, Parliamentary Under-Secretary of State for Transport, the Department for Transport. (DfT), Ms Theresa Crossley, Divisional Manager, Shipping Policy, Department for Transport and Mr Philip Donlan, Business Tax Group, International Division, Inland Revenue. We also received 8 written memoranda of evidence. We are grateful to our Specialist Adviser, Professor James McConville, and all our witnesses for their help.

6. The key features of the tonnage tax regime introduced in the Finance Act 2000 were the following:

Eligibility: Qualifying ships must be seagoing and of at least 100 gross tons. Companies must be strategically and commercially managed within the UK.
Option to elect: Companies can choose to participate or remain in the standard corporation tax regime.
Window of entry: Elections to join the regime had to be made within 12 months of Royal Assent to the Finance Act 2000.
year election: Companies are normally expected to remain in the regime for at least 10 years.
Exiting the regime: Companies are discouraged from leaving the regime before their election expires.
Flag neutrality: Ships in tonnage tax do not have to be on the register of an EU member state.
Training: Companies in tonnage tax have a training obligation for cadets of UK or EEA nationality ordinarily resident in the UK.
Employment: Participating companies have to give consideration to employment and training opportunities for ratings.

7. When the new tax regime was introduced, the Government promised to review its effectiveness. The Treasury and the Department for Transport announced a joint review of the tonnage tax towards the end of 2002. Shortly after announcing the review the Government became aware that the EU maritime state aid guidelines were likely to be changed. When we took evidence we were told that the review was not expected until mid 2005, and was likely to be completed in stages.[4] It was, in fact, completed and published in December 2004.[5] It is hard to castigate the Government for completing its work ahead of schedule, but this inability to estimate the time needed for the review has been unhelpful.

8. The review considered the costs and benefits of the regime, the technical functioning of the regime, and the future of the regime, taking into account the new state aid guidelines.[6] The review proposes changes to the regime in response to new EU guidelines on state aid, which the Government intends to bring forward in the Finance Bill later this year. It also considers changes to the training requirement, including the possibility of introducing a requirement to employ cadets after their initial qualification. However, the Government makes no proposals for any such change and has asked the Shipping Task Force to consider the issue further.

The decline of the UK shipping industry

9. The steady decline of the UK shipping industry had been a source of concern long before the Independent inquiry into tonnage tax. The decline was highlighted in a series of reports in the late 1980s and 1990s warning of the adverse effects of the forecast demise of the shipping industry and the loss of skilled UK seafarers.[7] Over the years former governments introduced measures to assist the shipping industry:

Wage cost support: Foreign earnings deduction for seafarers in the 1970s provided tax relief to seafarers working mainly overseas.
Training support: The government assistance for training (GAFT) scheme was introduced in 1988 and the Development of Certificated Seafarers (DOCS) scheme was introduced in 1993. These two schemes together were superseded by the Support for Maritime Training (SMarT) scheme in 1998/99.
Investment incentive: Roll-over tax relief, introduced in 1994, helped ship owners replace ageing tonnage.

Other deregulatory measures were taken including the reorganisation of pilotage and the rewriting of much secondary shipping legislation in a more accessible format.

10. Although these measures slowed the decline of the UK fleet they were insufficient to maintain a stable pool of UK seafarers or to arrest the trend to flag out to low cost shipping registers. In 1997 the new Government set up a Shipping Working Group to examine ways to arrest this decline and promote UK shipping. The Government drew on the report of this group for its December 1998 shipping White Paper, British Shipping: Charting a new course.

11. The White Paper summarised the decline of the UK shipping industry. It made grim reading. The size of the UK-owned trading fleet, of vessels of over 500 gross tonnes, had fallen from a peak of 50.8 million tonnes deadweight (dwt) in 1975 to 10.8 million dwt in 1997. The proportion of the UK-owned trading fleet registered in the UK was only 20%: until the 1970s it had been almost unknown for UK-owned ships to be registered outside the UK. Between 1980 and 1997 the number of British officers and ratings had fallen by 78% and 65% respectively.

The need for UK shipping and UK-based officers

12. The White Paper was clear that the UK needed its shipping industry and associated maritime skills for a number of reasons:

trade;

the sustainable environment which sea transport offered;

national security; and

support for the UK's leadership in many associated international businesses.

13. It was not simply that the United Kingdom needed a merchant fleet; shore-based industries also needed personnel with skills acquired through training at sea in the merchant navy.[8] Neither third-party training nor the employment of foreign ex-seafarers was considered likely to offset the shortage of British seafarers to fill the shore-based jobs in the UK maritime-related sector which needed seafaring experience. The shortage of maritime skills was expected to be particularly damaging to London's standing as a centre for marine insurance, protection and indemnity; ship broking; ship classification; and maritime law and arbitration.

Costs to the Treasury and benefits to ship owners

14. Lord Alexander said that "the tonnage rate is generally set so that notional profits, and hence actual corporation tax paid, are minimal."[9] As tonnage tax is optional a shipping company or group could choose to remain within the normal corporation tax regime or elect into tonnage tax, depending on which best suited its interests. According to Trinity House, the value to a ship owner of tonnage tax compared to the alternative fiscal regime is impossible to assess.[10] The tax circumstances of tonnage tax companies vary considerably and in the case of multi-national companies may be spread over several countries. However they were of the opinion that the impressive number of ships entered into the tonnage tax regime indicated a significant financial benefit to the ship owner.

15. The Treasury Review gave the latest estimates of the Exchequer cost of tonnage tax as follows:[11]

£m

2000-01 (Actual) 4.5

2001-02 (Actual) 37.8

2002-03 (Actual) 9.1

2003-04 (Actual) 10.0

The estimates compare the actual corporation tax yield under tonnage tax with an estimate of the tax yield which would have arisen had the tonnage tax not been introduced. We were assured by Mr Philip Donlan, Business Tax Group, International Division, Inland Revenue, that the costs of the scheme to the Inland Revenue were as anticipated when it was introduced.[12]

16. The Chamber of Shipping said that an assessment of the impact on UK shipping turnover and the balance of payments was not yet possible as up-to-date figures were not yet available.[13] But there had been benefits to "corporate UK" in the form of enhanced shore-based establishments of existing UK shipping companies and new offices opened up by companies coming into the UK. David Jamieson MP, Parliamentary Under-Secretary of State for Transport, the Department for Transport. (DfT), also emphasised the benefits of having shipping companies based in the UK, but was unable to put a value on it:

"Those companies will then have a predisposition generally to buy British, if you like, to be buying the other services within the United Kingdom, but that is very difficult to put a yardstick against. The general feeling is that in fact in cost terms it has been very beneficial."[14]

17. The consensus is that the tonnage tax has helped shipping companies: the challenge is to ensure that changes to the regime bring the widest benefits possible to the United Kingdom as a whole.

Implications of revised EU maritime state aid guidelines

18. The European Commission's maritime state aid guidelines were designed to set the parameters within which state aid in the maritime sector would be approved. Tonnage tax schemes require EU state aid approval because they are schemes for financial intervention in a single, commercial market. The United Kingdom scheme was approved in July 2000 under the EU maritime state aid guidelines published in 1997. The Commission published revised maritime state aid guidelines in January 2004 with which EU Member States have to comply by 30 June 2005. Mr Donlan thought that the Government would only have to "tinker at the margins" of the tonnage tax as a result of the new guidelines.[15] However the revised guidelines make two changes which have a direct bearing on the UK tonnage tax scheme; the strengthening of the flag link and changes to the eligibility of certain vessels.

19. The Regulatory Impact Assessment suggested there were two possible approaches to the revised guidelines.[16] The first option was to introduce the minimum changes needed to comply with the revised guidelines:

Excluding port towage activities from the scope of the tonnage tax regime;
Ensuring that companies maintain the proportion of their fleet under the EU flag;
Requiring companies operating non EU flagged ships in tonnage tax to provide evidence of compliance with Community and international standards of health, safety and the environment, or working conditions.

20. The second would combine changes required to comply with the new guidelines with other alterations to the regime, including the extension of tonnage tax to include aggregate carriers and North Sea specialist vessels. Option 1 would generate a tax yield for the Exchequer of £5 million after three years. Option 2 would have benefits to shipping companies entering tonnage tax for the first time arising from a reduction of tax (matching a cost to the Exchequer) of £5 million per annum. The Government proposes to pursue Option 2. It is however regrettable that the RIA asserts that Option 2 could deliver more social benefits by suggesting that the inclusion of dredgers and North Sea vessels would lead to more cadet training. This benefit is likely to be marginal given that these sectors already offer substantial employment to UK officers and ratings.[17]

Flag neutrality

21. The UK currently has a derogation from the general principle that a ship operator granted state aid should be linked to the EU flag.[18] The new state aid guidelines impose conditions on retaining any state aid scheme which is not linked to EU flagging.[19] We heard that the new guidelines were likely to impose conditions of monitoring and a commitment not to exceed the current proportions of ships in the tonnage tax regime which are not flagged in the EU.[20] The Treasury Review outlined the circumstances under which a link will be required with a flag of a member state in new legislation:

With effect from the financial year starting on 1 April 2006, when a shipping operator within the tonnage tax adds a vessel to its fleet, that vessel must be flagged as a vessel of a Member State if all of the following conditions are met for tonnage tax benefits to be granted to that vessel:

The financial year must be specified as a period when the flagging requirements apply. The Government will specify a financial year if, in the preceding three calendar years, the proportion of vessels within the tonnage tax regime registered in any EU Member State has reduced.
Less than 60 per cent of the tonnage of the operator's fleet is already flagged under a Member State register.
The operator's fleet contains a lower proportion of EU Member State registered tonnage than during the first period when it entered tonnage tax. [21]

The Government assumed that the UK derogation on flagging would remain in place for the next six years until the end of the initial ten year tonnage tax regime, because the state aid guidelines were not due to be reviewed again for another six years.[22]

Aggregate carriers

22. Aggregate carriers were excluded from the original tonnage tax regime because the EU state aid guidelines for maritime transport did not allow them to be included; the new guidelines allow for their inclusion. The Department for Transport told us that the Inland Revenue would be advising Ministers on measures that would be needed to bring such vessels into tonnage tax.[23] The review confirmed that the Government will introduce legislation to allow self-propelled dredgers, possessing their own cargo hold and transporting extracted materials at sea, to be included in tonnage tax from 1 July 2005.[24] These vessels however must be flagged in an EU member state.[25]

Offshore specialist vessels

23. Currently offshore specialist vessels such as emergency response and rescue vessels, seismic survey and diving vessels are excluded from tonnage tax. The Government has received representations supporting the inclusion of these vessels in the regime. Mr Donlan said that the Inland Revenue was doing additional research into the costs and benefits of bringing these vessels into the tonnage tax regime.[26] The sector represents about 100 ships.[27] The majority of these ships are already on the UK register but are not able to benefit from the competitive advantages of the tonnage tax regime. The Committee was told that this sector offered a high level of employment to UK officers and ratings.[28] The Treasury Review states that the Government is persuaded that there is a case for relaxing the current restrictions imposed on ships operating within the North Sea oil sector from entering the tonnage tax regime. The Government intends therefore to legislate to allow emergency response and rescue vessels, and a number of multi-function vessels to enter tonnage tax.

24. It would be possible to bring the tonnage tax regime into compliance with the new state aid guidelines by making only minimal changes, which would benefit the Exchequer. It would be wrong to do so. We support the Government's approach, which will allow a wider range of vessels to qualify for the regime, and look forward to the inclusion of these changes in the next Finance Bill.

Tugs

25. As the result of a case in the European Court of Justice, the new EU maritime state aid guidelines provide that tugs will only be allowed to enter tonnage tax if more that 50% of their towage activity during a given year constitutes 'maritime transport'.[29] Seagoing harbour tugs can therefore no longer be included in such schemes. This is a blow for some one hundred tugs which are operating within UK tonnage tax. They are nearly all on the UK register, have all-UK crews and about 60 cadets in training.[30] The British Tugowners Association (BTA) is afraid that there will be a reduction in training places and that some of the tugs currently under tonnage tax will explore alternative economies in the operation of the fleet, such as flagging out.[31]

26. The BTA has been assured that the Government will seek legislative changes that will minimise damage to the industry. The Government has recognised that "there needs to be fair and appropriate arrangements for operators within tonnage tax that will be affected by the new rules for towage".[32] We welcome the Government's decision to ensure that the penalty for early exits from tonnage tax does not apply to tug operators who no longer qualify for inclusion in the tax.

Government support for shipping

27. It emerged during the evidence that some EU countries offer different support to their shipping industry within the state aid guidelines. For example it was suggested that some member states reduced national insurance contributions for seafarers.[33] We were told that in the Netherlands most of the training for the shipping industry took place within the state system.[34]

28. We were surprised that the Inland Revenue had not investigated how other Member States interpreted the state aid guidelines to provide support to their shipping industries[35] and that it had not carried out such an investigation during the course of the review. We recommend it does so now.

29. The Chamber of Shipping pointed out that the Government had not implemented or developed the "central issues" relating to seafarers' employment costs put to it jointly by the Chamber, NUMAST and RMT in the late 1990s.[36] We understand from NUMAST that these include the introduction of an employment grant in the short sea sector and simplification of the seafarers' foreign earnings deduction scheme.[37] We were told that some shipping companies lose all their cadets, once trained, because they go into the deep sea sector to take advantage of the foreign earnings deduction scheme.[38] Our predecessor Committee recommended in 1999 that the Government should consider as a matter of urgency "how to end the anomaly concerning the non-application of Foreign Earnings Deduction to British seafarers engaged in the short-sea and coastal trades".[39] It is vital that the UK maximises its support for the shipping industry within EU rules.