On August 19, the United States State Department announced in a brief statement that it had notified the Hong Kong authorities of the “suspension or termination of three bilateral agreements” pursuant to Executive Order 13936. The U.S. – Hong Kong Shipping Agreement1 (the Agreement) is one the agreements referenced in the State Department’s announcement. The brief State Department announcement does not provide any additional guidance regarding implementation of the termination or suspension.
The cancellation of the Agreement could have immediate U.S. income tax ramifications for international shipping companies or foreign individuals, who had previously enjoyed the exemption offered by the Agreement. I.R.C. section 887(a) imposes a 4% tax on any nonresident alien individual’s or foreign corporation’s United States source gross transportation income for such taxable year. I.R.C. section 863(c)(1) defines U.S. source transportation income as:
- All transportation income attributable to transportation which begins and ends in the United States.2
- For income attributable to transportation which either begins or ends in the United States, 50% of such income is U.S. source income.3
I.R.C. section 883 provides an exemption to the tax imposed by I.R.C. section 887(a), if the following conditions are met:
- Gross income derived by a corporation organized in a foreign country from the international operation of a ship or ships if such foreign country grants an equivalent exemption to corporations organized in the United States.4
- Fifty percent or more of the value of the stock of such corporation is owned by individuals who are residents of such foreign country or another foreign country meeting the requirements.5
Before its cancellation, the Agreement provided the equivalent exemption to corporations organized in the U.S. by the Hong Kong government. Therefore, many foreign shipping companies with U.S. source shipping income could claim an exemption under the Agreement, if they otherwise qualified for benefits under the Agreement.
With the cancellation of the Agreement, many of the foreign shipping companies that had enjoyed the exemption under I.R.C. section 883 may be subject to the U.S. transportation income tax and may be subject to the net basis tax that applies to foreign corporations doing business in the United States. Thus, such companies may now be subject to U.S. income tax on their shipping income and may have estimated tax obligations that they never had before, and other U.S. tax filing and payment obligations.
Taxpayers who formerly relied on the Agreement to exempt their shipping income from U.S. tax may wish to consider whether they qualify for benefits under another international agreement so as to qualify for the reciprocal exemption. For example, the US-China Transportation Treaty (the US-China Treaty) exempts certain transportation income and may provide a basis to claim an exemption under the reciprocal exemption rules. While residents of Hong Kong are not generally eligible to claim benefits under the US-China Treaty, under certain circumstances it may be possible for them to do so where the Hong Kong company is essentially Chinese owned. However, whether an international shipping company or a foreign individual is within the parties covered by the US-China Treaty is a complex question and should be determined by thoroughly analyzing all relevant laws (including the Code and any relevant treaty) and applying those laws to the specific facts at hand. In some cases, it may be advisable to obtain an interpretation of these laws from the U.S. Competent Authority (the IRS), who is charged with interpreting and administering international tax treaties.
1Agreement Constituted by Exchange of Notes between the Government of the United States of America and the Government of Hong Kong for Double Taxation Relief in respect of Income from International Operation of Ships