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Matheson Structured Finance Update: Ship leasing through Ireland
Ireland continually strives to enhance its offering as one of the world’s leading jurisdictions through which to structure financing transactions. A relatively recent enhancement has been the introduction of a new tax regime for Irish ship leasing businesses. The new regime offers significant flexibility to shipping operators and to international investors seeking a tailored exposure to the shipping industry.
Irish shipping businesses are generally subject to “tonnage tax”, which ensures that ship operating businesses located in Ireland only pay tax on a profit based on the tonnage of their vessels. Combined with Ireland’s corporation tax rate of 12.5%, this results in a very competitive effective tax rate for shipping businesses located in Ireland.
A number of conditions need to be satisfied to obtain the benefit of the tonnage tax regime. The regime is only available to Irish tax resident companies who carry on a business in Ireland of operating ships. In addition, the “strategic and commercial management” of the ships must be carried on in Ireland. Typically, this requires experienced management to be employed in Ireland by the Irish company to take decisions in relation to significant capital expenditures and disposals, the award of major contracts, route planning, bunker management and numerous other operational issues.
For companies that do not wish to establish a major physical presence in Ireland, the new tax regime offers an alternative tax efficient option. The ship owning company can now be established as an Irish special purpose company (frequently referred to as a “section 110” company). This regime permits companies to acquire and hold “qualifying assets”, such as shipping assets, on a tax-neutral basis. Investors typically make their investment in the section 110 company by subscribing for (or acquiring) bonds or making bilateral loans and can earn a return in the form of conventional interest payments or profit-participating interest payments (for which the section 110 company obtains a full tax deduction).
There are a number of general conditions to be satisfied before an Irish company can elect to use the section 110 regime. The main conditions are as follows.
- Irish resident - The company must be Irish tax resident
- Arm’s length dealings - The company must enter into all transactions (other than in relation to payment of profit-participating interest) on an arm’s length basis
- EUR 10 million - The company’s first transaction must relate to qualifying assets having a market value of at least EUR 10 million
- Business activities - The company may only carry on a business of holding and/or managing qualifying assets (such as, for example, shipping assets, containers, shares, bonds and other financial assets or commodities)
Investors commonly invest in section 110 companies by subscribing for (or acquiring) bonds which are listed on a recognised stock exchange. Under the Irish tax rules, listing the bonds enables (in most circumstances) the bonds to be held by an unrestricted investor base without any Irish interest withholding taxes arising.
Unlisted Bonds and Loans
If an investor makes its investment by subscribing for (or acquiring) unlisted bonds or making bilateral loans, the investor must confirm that it is resident in the EU (excluding Ireland) or in a country with which Ireland has a tax treaty and that it will pay tax in the normal way on income it receives from the Irish company (for example, without the benefit of a participation exemption or notional deduction) or that it is a tax-exempt entity (for example, a pension fund, UCITS fund or a QIF fund).
Possible Transaction Structure
An Irish lessor elects to be treated for Irish tax purposes as a section 110 company. The lessor can issue tranches of bonds, issuing highly rated senior bonds to investors on the capital markets and subordinated profit-participating bonds to the “sponsor” of the issuance programme. Using the finance obtained the Irish lessor acquires and leases-out shipping assets. The lease payments are guaranteed by a financial institution or government backed agency, potentially allowing the bonds issued to investors on the capital markets to qualify for a high credit rating.
The lease revenues are used to pay a return, in the form of an interest payment to senior bondholders, with any profits remaining in the lessor being paid out on the subordinated bonds to the sponsor. All interest payments would be treated as tax deductible expenses of the lessor.
The advantages of a lessor electing to use the above structure include:
- The lessor can qualify as a section 110 company
- Ireland has a wide tax treaty network
- The transfer of bonds issued by the lessor is not subject to Irish transfer taxes
- It is capital efficient, for regulatory capital purposes, for regulated entities, including credit institutions, to hold highly rated bonds instead of loan funding
- Credit risk involved in lending for the purchase of shipping assets is removed. The Irish lessor is an “orphan” company, independent from the sponsor, in the event of the insolvency of the sponsor
The extension of the section 110 regime to ship leasing transactions offers an alternative option to shipping businesses looking to establish, expand or restructure their operations. Viewed from another perspective, it offers a flexible investment platform for capital markets investors to make shipping-related investments.