Clause 81 and Schedule 22 provide for an optional new ring-fenced regime for shipping companies known as "tonnage tax". Under a 10-year election into this regime a shipping company would work out its taxable profits based on the tonnage of the ships it operates, rather than by reference to its actual business results. This favourable new regime is being introduced to help deliver the Government's aim of encouraging the British shipping industry.

Clause 81 introduces tonnage tax. Details are to be found in Schedule 22.

Part I introduces the tonnage tax regime and sets out the rules for the calculation of tonnage tax profits.

Part II sets out the rules for making tonnage tax elections.

Part III defines qualifying companies, qualifying groups and qualifying ships.

Part IV sets out the minimum training obligation. All references to the Secretary of State are to the Secretary of State with responsibility for transport.

Part V sets out other requirements that must be met to ensure an election remains in force.

Part VI details the activities and income that qualify for tonnage tax.

Part VII deals with ring fencing issues, including transfer pricing and finance costs deductions.

Part VIII sets out the rules for chargeable gains and capital losses.

Part IX deals with capital allowances, including transitional rules for the first few years after entry into the regime.

Part X sets out restrictions on capital allowances that apply to finance lessors who lease ships to tonnage tax companies.

Part XI sets out rules for companies that operate on the UK sector of the continental shelf (which will mainly but not exclusively affect companies operating in the UK sector of the North Sea).

Part XII defines a group for tonnage tax purposes and sets out rules for changes to group structure caused by sales and acquisitions of companies.

Part XIII sets out rules for exit from tonnage tax.

Part XIV includes further definitions and explanations that do not fit comfortably into any other Part.

Part I introduces the tonnage tax regime and sets out the rules for the calculation of tonnage tax profits.

This is an introductory paragraph that summarises the concept of tonnage tax as an alternative method of calculating the taxable profits of qualifying shipping companies (paragraph 1(1)). It provides that the regime will only apply to qualifying companies or groups that elect into the regime (paragraph 1(2)) and meet other requirements (paragraph 1(3)). The election process and the other requirements are described in detail in Parts II, III, IV and V.

Paragraph 2(1) provides that a company (or group) that is subject to the tonnage tax rules is to be known as a tonnage tax company (or tonnage tax group). Some further definitions are given in paragraph 2(2).

The basic rule that a tonnage tax company's tonnage tax profits are taxed instead of the normal measure of profits calculated by reference to its actual income and expenses is introduced in paragraph 3(1). The normal measure of profits so replaced is known in Schedule 22 as the "relevant shipping profits" and this concept is covered in more detail in Part VI. The tonnage tax profits themselves are calculated by reference to the tonnage of the ships operated by the company (see paragraph 4). Paragraph 3(2) provides that the term relevant shipping profits also covers losses.

A tonnage tax company's taxable profits for the purposes of corporation tax will therefore be made up of its tonnage tax profits plus all other profits (if any) that are not relevant shipping profits. Normal corporation tax rates and all the normal corporation tax self-assessment rules regarding matters such as tax returns and tax payments will apply, as will normal rules for such matters as Inland Revenue enquiries into elections and returns.

Paragraph 4 explains how to calculate a company's tonnage tax profits (paragraph 4(1)). The rules set out a fixed profit per day per 100 net tons (on a sliding scale starting at £0.60 per 100 tons per day for the first 1,000 tons and finishing at £0.15 per 100 tons per day for tons over 25,000 (paragraph 4(2)). The practical effect of this is that smaller ships will on average be charged to a higher rate of tonnage tax profits than larger ships.

In applying these rules, a separate calculation must be done for each qualifying ship operated by the company. A company's total tonnage tax profits will be the sum of the fixed profits for each individual qualifying ship. Tonnage tax profits are chargeable regardless of the use to which the ship is put. Thus there are no reductions for ships that are idle or that are out of action through repair and maintenance. However, a new ship will not be subject to tonnage tax until it has been launched and is ready for use.

It can be seen that tonnage tax profits are entirely predictable and can be calculated in advance, so enabling a tonnage tax company accurately to budget for its tax liabilities.

This paragraph provides that where two or more parties share the operation of an entire ship (for instance under a joint venture agreement), then each will only be charged a proportionate share of the tonnage tax profits for that ship (paragraph 5(1)). However, where two or more parties are each treated as operating the entire ship (for instance where one company charters a ship to another company), then each party will have a full charge to tonnage tax profits on that ship (paragraph 5(2)).

This paragraph defines "tonnage", with the aim of ensuring that different companies are assessed consistently to tonnage tax profits under paragraph 4 above. The definition draws on the various national and international tonnage conventions that are used in practice to calculate tonnage. The general rule is that international conventions should be followed to determine tonnage for vessels of 24 metres in length or more, whilst local regulations will apply to other ships (paragraph 6(1)). In practice, if a ship does not fall exactly into one of the specified categories, then a sensible alternative will be accepted. Paragraph 6(2) requires a ship to have a certificate to validate the tonnage, whilst paragraph 6(3) provides a further definition.

Tonnage tax is an optional regime and a company or group must actively elect into it. Part II sets out the rules for making a tonnage tax election and for when such an election is to take effect.

Paragraph 7 provides that only a qualifying single company or a qualifying group may make a tonnage tax election. These elections are respectively known as company elections and group elections (paragraph 7(1)). A group election applies to all qualifying companies within the group (paragraph 7(2)). Thus it will not be possible for a group to pick and choose which qualifying companies partake in tonnage tax - it is an 'all or nothing' election. A group election that does not include all qualifying companies will not be valid.

A single company is defined at paragraph 137 and a group is defined at paragraph 114.

This paragraph provides that an election must be made by notice to the Inland Revenue ((paragraph 8(1)) and that it must be supported by such information as the Inland Revenue may require (paragraph 8(2)). Full details of the required supporting information will be set out in an Inland Revenue Statement of Practice. This will be mainly administrative detail such as company names and tax references. However it will also include the requirement to give full details of the group structure where a group election is in point.

The Inland Revenue will not usually formally accept an election, but will issue an acknowledgement. A company or group that wants reassurance that their election is valid should take part in the non-statutory clearance procedure that will be operated by the Inland Revenue for groups or companies wishing to make a tonnage tax election. This clearance procedure will enable the treatment under tonnage tax of some of the more complex aspects of companies’ affairs to be decided in advance. Provided that there is full and frank disclosure of all relevant facts, any decision made will be binding on the companies concerned and on the Inland Revenue, until there is a change in those facts or a change in the tonnage tax rules or a general change in their application.

This paragraph provides that a single company election must be made by that single company (paragraph 9(1)) and a group election must be made jointly by all the qualifying companies in the group (paragraph 9(2)). Tonnage tax is a long-term commitment and it is important that each company individually signs up to it.

This paragraph sets the rules for when a tonnage tax election can be made.

For existing qualifying companies there is a 'window of opportunity' to make an election, of twelve months starting from the date of Royal Assent to Finance Bill 2000 (the "initial period"), as set out in sub-paragraph (1). So if, for example, Finance Bill 2000 became law on 1 August 2000, then all elections for existing qualifying companies would have to be made by 31 July 2001.

For a company or group that does not qualify at the date of Royal Assent but becomes qualifying in the future (perhaps through acquiring a qualifying shipping business), then the window of opportunity will be the twelve months starting from the day on which it first qualifies, under sub-paragraphs (2) and (3).

Sub-paragraph (4) mentions specific rules in Part XII that deal with changes to group structure. Some of the Part XII rules override the normal rules set out above to allow a further twelve month opportunity for a group to make an election after the initial period has expired.

There is an additional requirement in sub-paragraph (3) that a group may not elect after the initial period if it is "substantially the same" as a group that qualified at Royal Assent. This requirement is designed to prevent a group that failed to elect in the initial period creating a new window by making small changes to its group structure and claiming that the resultant revised group did not exist as a qualifying group at Royal Assent.

The 'window of opportunity' to make an election has been made deliberately short with the full agreement of shipping industry representative bodies. The aim is to prevent or minimise the tax planning opportunities that could otherwise arise in the run-up to the new regime.

This paragraph gives the Treasury power to provide for further windows of opportunity in the future (paragraph 11(1)) and to make any consequential amendments to the legislation that may be needed to make these further windows work (paragraph 11(2)). The shipping industry requested that a new window of opportunity should be provided ten years after the first window. This would be similar to other European tonnage tax regimes, such as the one in the Netherlands. However, the Government prefers this flexible approach under which it can provide for new windows at any time.

This paragraph sets out the detailed rules for when an election takes effect.

The general rules as set out in sub-paragraphs (1) and (2) are that:

for elections made during the initial period, the election will take effect from the beginning of the accounting period in which it is made (so could apply before the date of the election). However, if this is an accounting period starting before 1 January 2000, then it will take effect from the beginning of the next accounting period.

for elections made after the initial period, the election will take effect from the date on which the company or group became a qualifying company or group. A new accounting period will start on this date (see paragraph 52).

Under sub-paragraphs (3) and (4), a company or group that elects during the initial period may apply instead for the election to take effect from the beginning of the following accounting period or the beginning of the previous accounting period (subject to 1 January 2000 being the earliest possible start date). It is anticipated that a large number of electing groups and companies will apply for one of these options.

An application for the next accounting period is likely to happen where a group needs to reorganise its activities to optimise the number of activities that qualify for tonnage tax, or where it has already undertaken transactions in the current accounting period that are not compatible with tonnage tax.

An application for the previous accounting period is likely to happen where a group does not have sufficient time to elect before an accounting period ends, but wishes the regime to commence from the earliest opportunity.

In exceptional circumstances, a company or group will be able to apply under sub-paragraph (4) for the election to take effect from the beginning of the second accounting period after the election is made. The Inland Revenue will accept that "exceptional circumstances" exist only when it is commercially not possible for the company/group election to take effect at an earlier date. This could be because contractual arrangements cannot be renegotiated in time, or because unusually complex restructuring is needed that will take more than one accounting period to complete. It is anticipated that this further extension will apply to only a few companies or groups, if any.

Sub-paragraph 5 provides that for group elections where companies in the group have different accounting periods from one another, the election will take effect for each company by reference to its own accounting period during which the group election is made.

For example, if a company has a 31 December year-end then tonnage tax would normally first apply:

This paragraph sets out the rules for when a tonnage tax election finishes:

The general rule given in sub-paragraph (1) as follows:

Unless it is renewed (see paragraph 15, explained at paragraph (48) below), an election will last for ten years and will end ten years from the date that the election first takes effect.

It is possible that a group will contain companies that came into tonnage tax at different times, perhaps through having different accounting period ends or through sales and acquisitions from other tonnage tax groups. In such a case, the election will end at the same time for all group companies with the end date being ten years from the date that the group election first took effect for any company in the group.

Under sub-paragraphs (2) and (3) an election will cease to have effect before ten years have passed if the company or group ceases to qualify for tonnage tax, if the company or group is excluded under the rules in Part V, or if the company or group leaves tonnage tax through the operation of the rules on group structure changes in Part XII.

Once an election has finished the company or group will return to the normal corporation tax procedures for calculating taxable profits. A new accounting period will start on this date (see paragraph 52).

Paragraph 14 effectively provides that the tonnage tax rules only apply whilst a tonnage tax election is in force.

This paragraph sets out the rules for renewal elections. A qualifying company or group may renew its tonnage tax election at any time (paragraph 15(1)), provided that it has not been issued with a certificate of non-compliance with the training obligation under paragraph 32 (paragraph 15(2)). A renewal election follows the same rules as those for an initial election, in that it must be jointly made, meet Inland Revenue information requirements and have effect for ten years (paragraph 15(3)). A renewal election will supersede any existing election and under the general rule in paragraph 12 will take effect from the beginning of the accounting period in which it is made (paragraph 15(4)). A company or group may choose to renew its election every year if it wishes to do so.

The tonnage tax regime can only apply to qualifying companies, qualifying groups and qualifying ships. Part III defines these terms.

This paragraph defines a qualifying company and a qualifying group.

A qualifying company is one that is subject to corporation tax in the UK, operates (see paragraph 18) qualifying ships (see paragraph 19), and has the strategic and commercial management of those ships in the UK (paragraph 16(1)).

A qualifying group is a group that contains one or more qualifying companies (paragraph 16(2)).

UK ‘strategic and commercial management’ is a requirement of the European Commission’s Community guidelines of State aid to maritime transport. Full details of this test will be set out in an Inland Revenue Statement of Practice. This is expected to include a 'menu' of the different management activities that can be carried out in respect of a ship, such as negotiating charters, managing the bunkers and provisioning, taking bookings for cargo or passengers, personnel management and technical management. In order to qualify a company must be able to demonstrate that enough of these activities are carried out in the UK to satisfy the test. A company will not have to carry out all its ship management activities in the UK, nor will it have to be UK flagged or operate in UK waters. This test is not the same as the normal tests for tax residence.

This paragraph provides for a company to remain within tonnage tax during a period when it temporarily ceases to operate any qualifying ships (paragraph 17(1)), perhaps for instance if its only ship should be lost at sea. A company in these circumstances that wishes to remain within tonnage tax must give notice to the Inland Revenue within the time limit described in paragraph 17(3)

A company that takes advantage of this provision will calculate its tonnage tax profits as though it still operated the same ship(s) as immediately prior to the temporary cessation (paragraph 17(2)). The training obligation (see Part IV) will continue to apply. The paragraph applies until the company starts to operate ships again or until it decides that it is not going to operate ships again (paragraph 17(4)). The Inland Revenue will generally presume that a cessation of more than three months is permanent, unless there is evidence to the contrary.

This paragraph is aimed at a single company, which would otherwise be excluded from tonnage tax for ten years under the rule in paragraph 131. A group company would not be so excluded, although it may also choose to take advantage of this provision.

Paragraph 18 defines what is meant by operating a ship:

A company will be regarded as operating a ship if it owns the ship or charters-in the ship (paragraph 18(1)).

A company will not be regarded as operating a ship that it part charters-in. This restriction is aimed at slot charters and similar, where the charterer-in is effectively hiring space on a ship (paragraph 18(2)). A charter of part of a ship is not the same as the shared charter of a whole ship (see paragraph 5), which count as shared operation.

A company will also be regarded as operating a ship that it charters-out, subject to restrictions on bareboat charters-out (paragraph 18(3)). More details are given at paragraph (56)-(57) below.

Bareboat charters-out are only allowed in three circumstances:

they are allowed without restriction if the charter is to another tonnage tax company in the same tonnage tax group (Paragraph 18(4)); or

they are allowed where the company has short-term surplus capacity (for instance through a temporary downturn in the market) and the ship is bareboat chartered-out for a term of up to three years (Paragraph 18(5));or

they are allowed where the charter is to a Government department (Paragraph 18(6)).

The reason for the restriction on bareboat charters-out is that tonnage tax is a regime for ship operating companies. A bareboat charter-out effectively hands over full control of the ship to the charterer-in and the ship therefore cannot generally be regarded as being operated by the tonnage tax company.

Two examples illustrating how the ship operation rules work are given below:

Suppose a company owns ships A, B and C and charters-in D and E. It bareboat charters-out B for a five year term and because of a temporary slump in bookings, it bareboat charters-out E for a one year term. It also bareboat charters-out A for a one year term, but this was because it was offered a particularly good deal on the charter fee, rather than because it couldn't use the ship itself. It will be regarded as operating C, D and E.

Suppose tonnage tax company X enters into a joint venture with non-tonnage tax company Y. Together they jointly charter in a ship. X will be regarded as sharing in the operation of the ship and under paragraph 5, will only be charged to a proportion of the applicable tonnage tax profit.

This paragraph defines a qualifying ship. There is a three-stage test to determine whether a ship is qualifying.

Under paragraphs 19(1), 19(3) and 19(4), the first test is that the ship must be 100 tons or more gross tonnage, it must not be excluded under paragraph 20 and it must be certificated for navigation at sea under whichever international conventions apply to it. Further guidance on some of these issues will be given in an Inland Revenue Statement of Practice.

Also under paragraph 19(1), the second test is that the ship must be used for one or more of four purposes. These are 1) the carriage of passengers; 2) the carriage of cargo; 3) towage, salvage or other marine assistance; or 4) the provision of transport for services that are necessarily provided at sea. The first three of these are self-explanatory. The fourth is aimed at ships such as diving support vessels and cable layers. These ships will be qualifying ships, but as explained in Part VI, only the income relating to the navigation element of their shipping trade will be within tonnage tax.

Under paragraph 19(2), the third test is that the main purpose of the ship is not to provide goods and services that could equally well be and commonly are provided on land. Thus for example, floating offices, casinos and supermarkets will not be qualifying ships.

As these rules are framed in terms of the actual use of the ship, a company that charters out vessels will need to consider the end use by the charterer in determining whether a ship is qualifying.

Paragraph 20(1) defines categories of ship that are excluded from being qualifying ships. These include fishing vessels, pleasure craft, harbour or river ferries, offshore installations such as oil-rigs and tankers dedicated to a particular oil field. Paragraphs 20(2) to 20(6) provide more detailed guidance.

The Inland Revenue accepts that a commercially operated cruise liner will be a qualifying ship under the carriage of passengers condition in paragraph 19 and will not be excluded under paragraph 20(1)(b) as a "pleasure craft", even though it is operated primarily for the recreation of its passengers. The pleasure craft exclusion will be interpreted so as to exclude a vessel that is chartered as a whole by its passengers (for instance a holiday yacht) but not to exclude a vessel that has individual fare paying passengers. Chartered "as a whole" will include charter by a passenger alone, or by passengers acting together or by a third party acting on behalf of one or more of the passengers.

A ship that makes inland waterway journeys at the beginning or end of sea crossings will be a qualifying vessel and will not need to apportion profits between the sea and inland stages.

This paragraph gives the Treasury powers to make orders excluding other types of ship from being qualifying ships. This power is aimed at new types of vessels that are not in common usage at the time of Royal Assent, but which become common at some time in the future. The Government does not intend to use this power to exclude vessels that are qualifying ships at the time of Royal Assent.

This paragraph allows a ship a thirty-day annual grace period for use as an excluded vessel. This relief is designed to accommodate short-term changes of use, for instance, a cruise ship being hired as a conference venue. It does not mean that a normally excluded ship can have up to thirty days a year within tonnage tax.

The tonnage tax regime imposes an obligation on participating companies to commit themselves to the training of seafarers. This aspect of the regime will be administered (at the time that this Bill is published) by the Department for the Environment, Transport and the Regions (DETR) on behalf of the Secretary of State for the Environment, Transport and the Regions.

This paragraph introduces the concept of the tonnage tax 'minimum training obligation'. In order for a tonnage tax initial or renewal election to be made, a company or group must make a commitment for the training of seafarers.

This paragraph gives the Secretary of State the power to make regulations regarding the training obligation for a tonnage tax company or group. These regulations (along with other Regulations mentioned in this Part) will be published in draft before this Bill passes into law. They are likely to specify:

A minimum training obligation to recruit and train one officer trainee per year for every 15 officer posts entered on the Safe Manning Certificates/Safe Manning Documents for all vessels entered in the tonnage tax regime, adjusted to include back-up crew provision. The term 'officer trainee' includes defined categories of trainee undertaking a course of training approved by the Merchant Navy Training Board and leading to the first certificate of competency.

A minimum training obligation in respect of ratings in that companies should review annually the feasibility of adopting each of the ratings employment and development options agreed by the Ratings Task Force, a tripartite (industry/unions/government) group chaired by the Chamber of Shipping.

That any trainee must be ordinarily resident in the UK and be either a UK national, a national of another European Economic Area (EEA) State or a British citizen from the Channel Islands or Isle of Man.

Paragraph 25 introduces the concept of the training commitment. This is explained in more detail at paragraphs 26 to 28(explained in paragraphs (73) to (81) below).

Paragraph 26 provides that a company or group that intends to elect into tonnage tax must make an initial training commitment and obtain a certificate from the Secretary of State approving this. The initial training commitment will be the first instalment of the training commitment described under paragraph 27 (explained at paragraphs (74) to (77) below). A tonnage tax election could be made without such a certificate, but there would be little point in so doing, as the election could never be effective.

Paragraph 27 gives the Secretary of State the power to make regulations regarding the ongoing training commitment. These regulations are likely to say that to implement the minimum training obligation, companies or groups will be asked to produce a training commitment setting out their specific training obligation and how it is to be met. They will also be asked to submit periodic returns (see paragraph 30, explained at paragraphs (83) and (84) below).

The training commitment is to be produced before election into tonnage tax and on an annual basis thereafter. It will be subject to approval by the Secretary of State.

Training commitments (annual and initial) should be reviewed formally by the company at board level and submitted to the Secretary of State. 1 October has been chosen as an appropriate reference date for the annual training commitment as it fits well with the normal recruitment/training cycle. The annual training commitment should be submitted for approval each year before 1 October. An annual commitment may not be needed in the first year of tonnage tax, depending on the date of the initial commitment.

A certificate will be issued once the Secretary of State is satisfied with the commitment made. It is an offence not to comply with requirements under these regulations. Offences are discussed in more detail in paragraph 35 (explained at paragraphs (91) and (92) below).

Paragraph 28 gives the Secretary of State the power to make regulations concerning the administration of the training commitment. Such regulations are likely to specify that the training commitment will be set out in standard format and include the following information:

numbers of officers, based on Safe Manning Certificates/Safe Manning Documents (adjusted for back-up crew provision), for all ships within the tonnage tax regime;

numbers of officers to be trained under the training commitment;

details of exceptional circumstances in substantiation of any request to make payment in lieu of officer training;

numbers of UK, EEA, Channel Islands and Isle of Man ratings serving on vessels within the tonnage tax regime;

details of proposed actions to increase EEA ratings’ employment and development (as per the options agreed by the Ratings Task Force), and the numbers of ratings involved in each.

On receipt of the training commitment, the Secretary of State will check that it meets the criteria for the scheme and, if so will formally approve it. The Secretary of State may consult the Merchant Navy Training Board in considering the training commitment, but will retain sole approval authority.

The Secretary of State will aim to agree the training commitment within 4 weeks of receipt.

Should the Secretary of State disagree with the training commitment, then the regulations are likely to provide for the two parties to have a further 4 weeks to reach agreement. Should agreement not be reached, then the Secretary of State will set the training commitment for the year. Either during this procedure or within 30 days of the training commitment having been set, the company may request the opinion of the Maritime Training Trust (which is an independent body being set up by the industry and maritime trades unions). Should the Maritime Training Trust find that a different level of training is appropriate, then the Secretary of State will normally agree an adjustment to the training commitment for the following year. However, the final decision on whether and how to amend the Training Commitment will rest with the Secretary of State.

Paragraph 29 gives the Secretary of State the power to make regulations concerning payments in lieu of training. Such regulations are likely to specify that:

Where the company is unable either to provide in-house training or to contract-out seafarer training, the training commitment shall be discharged through a Payment In Lieu Of Training (PILOT) to the Maritime Training Trust. In these circumstances, the company’s training commitment should explain the practical reasons for its planned use of PILOT.

Liability for PILOT may also arise through a failure to meet the training commitment and/or by a company incurring an additional training obligation during the period covered by the training commitment through fleet expansion etc.

PILOT will be assessed three times a year on a net basis at the end of standard 4-month periods.

The level of the PILOT charge for FY 2000/2001 is to be set at £500 per cadet per month and will be index-linked to the Treasury annual GDP deflator.

PILOT will include a further element to cover the Maritime Training Trust's overhead costs, and it is planned to set this element initially at £50 per month per PILOT cadet. This amount will be reviewed annually

Paragraph 30 gives the Secretary of State the power to make regulations setting out how compliance with the training commitment is to be monitored. These regulations are likely to include:

A requirement that companies submit the training commitment to the Secretary of State, with a copy for the Maritime Training Trust;

thrice-annual end of period adjustment returns showing officer and rating training performance compared with the training commitment and any PILOT payable.

An end of period adjustment is a retrospective net adjustment made three times a year to determine any additional training obligation (compared with the training commitment) which has arisen as a result of changes in the fleet during the preceding 4-month period. End of period adjustments (and any associated PILOT) will be made three times a year in February, June and October.

Paragraph 31 gives the Secretary of State the power to make regulations setting higher rates of payment in lieu of training if a company or group fails to meet its training commitment. These higher rates are expected to be triggered by a failure to achieve 50% of the approved training commitment over successive years. These surcharges are likely to comprise, respectively, 50% of the ‘base’ PILOT rate in the second year and 100% of the ‘base’ PILOT rate in the third consecutive year and in any subsequent consecutive years in which 50% of the approved training commitment is not achieved.

Paragraph 32 gives the Secretary of State the power to make regulations concerning the issue of a certificate of non-compliance with the training commitment.

Such regulations are likely to provide that should a company or group remain in default of its training commitment obligations over three successive years, then the Secretary of State will issue a notice of non-compliance, rendering that company ineligible to make a renewal election into the tonnage tax regime. The general rule would be that the company would then have to leave the regime at the end of its current election period.

Paragraph 33 gives the Secretary of State the power to make regulations concerning the administration of certificates of non-compliance. Such regulations are likely to provide that if, during the current election period, the company was able satisfactorily to demonstrate a commitment to meet its future minimum training obligations, then the Secretary of State would have discretion to cancel the non-compliance notice. Subject to obtaining a certificate of approval for its training commitment, the company would then again be eligible to seek renewal of its election into the tonnage tax regime.

The Secretary of State would be entitled to consult the Merchant Navy Training Board or the Maritime Training Trust (or any other training body specified in the regulations) in considering whether to cancel a non-compliance notice, but it is not currently intended that the regulations should require him to do so.

Paragraph 34(1) enables the Secretary of State and the Inland Revenue to communicate with each other with respect to matters relevant to tonnage tax. This power will be used only for matters relating to the compliance or otherwise of groups and companies with the training obligations set out in Part IV. The general corporation tax affairs of tonnage tax companies and groups will not be disclosed. Similarly, the information sharing power in paragraph 34(2) between the Secretary of State and training bodies will only be used to share information relevant to this Part.

Paragraph 35 discusses offences. An individual (who could be a company director or the company secretary or some employee of the company) acting on behalf of the company and who gives information which he knows or has reasonable cause to believe is false in a material particular will be committing an offence. In some circumstances the company itself could also be criminally liable. This would depend on whether the individual could be classed as "the directing mind of the company" in the particular circumstances.

It is necessary to make certain acts or omissions a criminal offence because there is no sanction of expulsion from the tonnage tax regime in respect of the training commitment and nor is it appropriate for the Secretary of State to seek legal recourse on the basis of fraudulent declaration by a company.

Paragraph 36 provides general information about the regulations to be made under this Part. This includes the power for the regulations to retrospectively cover the period between the regulations coming into force and the tonnage tax rules starting to take effect on 1 January 2000. This is likely to be a gap of at least seven months.

Part V sets out other requirements that must be met to avoid penalties or to ensure that an election remains in force. These include rules as to the acceptable level of charters-in and some anti-avoidance rules.

This paragraph sets out details of an additional test that must usually be met for a company or group to be allowed to remain within tonnage tax. The requirement is that no more than 75% of a company or group’s qualifying tonnage can be chartered-in (paragraph 37(1)).

Bareboat charters do not count as charters-in for the purposes of this test, but time charters, voyage charters and any other similar types of charter will be caught. Where a tonnage tax group is involved, then the 75% test applies to all the tonnage tax companies taken as a whole and not to any individual company in the group (paragraph 37(2)). Charters between tonnage tax companies in the same group can therefore be ignored. The test applies on an average basis, so that companies or groups that have seasonal fluctuations in the pattern of their charters-in are not prejudiced. Paragraph 37(4) signposts further details of how the 75% test affects the tonnage tax election, given in paragraphs 38 to 40 (explained at paragraphs (99) to (103) below).

The reason for the restriction on charters-in is that tonnage tax is a regime for ship operating companies. A time or voyage charter leaves much of the operational control of the ship in the hands of the charterer-out and the ship therefore cannot be fully regarded as being operated by the tonnage tax company. Under this rule it is possible for a group to bareboat charter-in 100% of its tonnage, but it may only time charter-in (or similar) a maximum of 75% of its tonnage on average.

Two examples illustrating how the 75% test works are given below:

Suppose a tonnage tax group consists of companies X and Y. X owns a 1,000 ton ship A and time-charters it out to Y. Y also time charters-in a 1,000 ton ship B from outside the group. The chartered-in percentage for the group as a whole is 1,000/2,000 = 50%. Ship A is only counted once despite being operated by both companies.

Suppose a company owns ship A, time charters-in B, C and D and bareboat charters-in E. For six months of each year it also time charters-in F, G, H and I. All ships are 1,000 tons. For six months of each year it will charter-in 3,000/5,000 = 60% of its tonnage. For the other six months it will charter-in 7,000/9,000 = 78% of its tonnage. It will meet the test on average over the year.

Paragraph 38 provides that a group or company must meet the 75% test in its first tonnage tax accounting period. If it does not do this, then its tonnage tax election is void and the normal corporation tax rules will apply in respect of that period. The company or group may then find that it has missed the window of opportunity to make another election.

This paragraph provides that where a single company exceeds the 75% test in each of two consecutive accounting periods, then the Inland Revenue may issue a notice excluding the company from tonnage tax (paragraph 39(1)). Under such a notice exclusion will take effect from the start of the next accounting period or from such later period as may be specified (paragraph 39(2)).

The exclusion is discretionary and depending on the circumstances a company may be allowed to remain within tonnage tax even after failing the test. For instance, if a company can demonstrate that the excessive charters-in were only to last for a short period, that there were good commercial reasons why the test was failed and that the test will be passed in subsequent accounting periods, then it may have a good case for asking the Inland Revenue to exercise discretion. Exclusion may also be prevented when it is thought that a company has intentionally failed the 75% test in order to engineer an early exit from tonnage tax.

This paragraph provides that where a group exceeds the 75% test in each of two consecutive accounting periods, then the Inland Revenue may issue a notice excluding the group from tonnage tax (paragraph 40(1)). Discretion will be applied in a similar manner for groups as for single companies (see paragraph (101) above).

Where group companies have different accounting period ends, the provisions in paragraph 40 will have to be applied by reference to a common period across the whole group. Logically, for a group to fail the 75% test at least one company would have to fail the test on its own account. Where this happens, the test should then be extended across all companies in the group by reference to that company’s accounting dates. For example, suppose a tonnage tax group consists of companies X and Y. Y has accounting periods ending on 31 December each year. X has an annual accounting date of 31 May. Y charters in 79% of its tonnage during the year ended 31 December 2003. The XY group as whole will fail the 75% test if it charters-in more than 75% of its tonnage during the calendar year 2003. The second consecutive period for the purposes of paragraph 40 in this case would be the calendar year 2004.

This paragraph provides that, in order to remain within the tonnage tax regime, a company must not enter into any transaction or arrangement that is an abuse of the tonnage tax regime (paragraph 41(1)). Such a transaction or arrangement is one which results in the tonnage tax regime being applied so that a tax advantage, or an artificial reduction in tonnage tax profits is obtained (paragraph 41(2)). The term "tax advantage" is further described in paragraph 41(3) and, broadly, is the increase in any relief from, or repayment of, or avoidance of a charge to, tax.

Paragraph 41(4) provides specifically that entering into a finance lease is not to be regarded as an abuse of the tonnage tax regime simply because the lessor can obtain capital allowances. Certain terms are also defined.

This paragraph provides that, where a tonnage tax company has entered into an abusive transaction or arrangement under paragraph 41, the Inland Revenue may issue a notice excluding the company or group from the tonnage tax regime (paragraphs 42(1) and 42(5)). The effect of issuing such a notice will be that the company’s or group’s tonnage tax election ceases to be in force from the beginning of the accounting period in which the transaction or arrangement was entered into (paragraph 42(2) and (3)).

In the case of a group, where accounting periods may differ between the group companies, the date on which the tonnage tax election ceases to have effect will be specified in the notice issued by the Inland Revenue, but will not be earlier than the beginning of the earliest accounting period in which any member of the group entered into the transaction or arrangement (paragraph 42(3)).

Paragraph 42(4) provides that the exit charge rules in respect of capital gains and balancing charges (in paragraphs 129 and 130) will apply where a company’s tonnage tax election has ceased to be effective because of a notice issued under this paragraph.

The rules in paragraphs 41 and 42 are aimed at significant cases of abuse and will not be used to attack minor errors in the computations or genuine misunderstandings. Nor will they be used to attack any bona-fide pre-election restructuring that is required to enable a group to opt for the regime, for instance the divisionalisation of shipping and non-shipping activities.

This paragraph sets out the appeals procedure for notices issued under paragraphs 39, 40 or 42. A company (or group companies jointly) may appeal to the Special Commissioners within 30 days of the notice being issued.

Part VI details the activities and income that qualify to be included within "relevant shipping profits" and therefore to be replaced by tonnage tax profits within a company's corporation tax computations.

This paragraph explains the meaning of "relevant shipping profits". These are, broadly speaking, a shipping company's commercial profits or losses that are replaced in its corporation tax computations by tonnage tax profits. Relevant shipping profits includes its relevant shipping income - being income from tonnage tax activities (see paragraphs 45 to 48), some dividends from overseas subsidiaries (see paragraph 49) and a limited amount of other income (see paragraph 50) - and some chargeable gains (see Part VIII).

Paragraph 45(1) explains that tonnage tax activities consist of core qualifying activities (see paragraph 46), qualifying secondary activities up to a permitted level (see paragraph 47) and incidental activities (see paragraph 48). Activities that give rise to investment income, such as owning shares or holding bank deposits, can never be tonnage tax activities (paragraph 45(2)).

This paragraph defines a tonnage tax company's core qualifying activities. These are the activities carried out as part of the operation of its own ships (eg the carriage of cargo or passengers) plus other activities that are necessary and integral to ship operation (eg crewing, provisioning, route-planning etc) (paragraph 46(1)). It does not include ship operation services carried out for other group companies or for third parties (although these may be qualifying secondary activities in paragraph 47). It also does not include any services necessarily provided at sea (see paragraph 19(1)(d)). Profits arising from such services will not be part of relevant shipping profits and must be split out and taxed under normal rules.

This paragraph gives the Inland Revenue the power to make regulations to determine what the qualifying secondary activities are and how the permitted levels of these activities are to be set. These regulations will be published in draft as soon as they are available and are expected to:

provide an overriding rule such that to qualify as a secondary activity, any activity carried on by a tonnage tax company must be related to a core activity that it (or another tonnage tax company in the same tonnage tax group) carries on. For example, an activity that may be qualifying secondary for a container ship operator, would not be qualifying secondary for a cruise line operator, unless the cruise line operator undertakes this activity in respect of a container vessel operated by another company in the same tonnage tax group.

list the activities that will wholly or partly qualify as secondary activities. This is expected to include: connected services bought in by the tonnage tax company at arm’s length prices; administrative and financial services (customs, VAT, document charges, transit insurance etc) directly related to the customers’ use of qualifying ships; some activities connected with loading and unloading a ship; other services that are customarily provided by a passenger or cargo ship operator as part of its services to its customers; the provision of services to third parties only to the extent that these services are provided using surplus capacity from provision of the same services to the tonnage tax group’s own qualifying vessels, and (in comparison to those necessary support activities) are only carried on at a minimal level.

This paragraph defines a tonnage tax company's qualifying incidental income. Shipping related income that is not core or qualifying secondary will be qualifying incidental income provided that it does not exceed 0.25% of turnover from core and permitted secondary activities in any one accounting period.

This is an 'all or nothing' test, so that if a company exceeds the permitted level of incidental income, then none of the income will qualify. For example, say a company has turnover from core activities of 1,000, turnover from qualifying secondary activities of 1,000 (of which only half falls within the permitted levels to be set in the Regulations) and non-qualifying turnover of 2,000. The incidentals limit would therefore be 0.25% x (1,000 + 500) = 3.75. If the company had shipping related incidental income of 3.5 then all of it would be qualifying incidental. However, if the company had shipping related incidental income of 4 then none of it would be qualifying incidental.

This test is aiming to relieve a company that has small amounts of other income from the burden of having to prepare its tax computations partly under tonnage tax rules and partly under normal rules. It is not intended to allow a company that has extensive non-qualifying activities to have a guaranteed proportion of income from those other activities within tonnage tax. Hence the 'all or nothing' approach. The term "shipping-related" will be interpreted broadly, otherwise the stated objective of relieving administrative burdens may not be achieved. However, the activities that generate the income must relate to qualifying shipping.

This paragraph provides for dividends received by a tonnage tax company from a non-UK resident company to be part of relevant shipping profits if certain conditions are met (paragraph 49(1)). These conditions are set out in paragraph 49(2) and provide that the non-resident company must:

operate qualifying ships;

have a simple majority of its voting power held directly or indirectly by one or more UK or other EC member state companies

meet the 75% test on chartered in tonnage (Paragraph 37) on average in each accounting period in respect of which the dividend is paid. The company must meet this test on its own account without regard to the rest of the group.

carry out only activities that generate relevant shipping income. This means, for example, that it cannot have other trades in addition to its qualifying shipping trade, it cannot have secondary activities in excess of the permitted levels and it cannot hold investments in non-qualifying companies;

pay the dividends out of profits earned whilst the tonnage company that receives the dividends was within tonnage tax. Dividends paid out of pre-tonnage tax profits will be subject to tax under the normal rules. A qualifying dividend that is credited in the accounts of a tonnage tax company will be accepted as being part of relevant shipping profits, even if the money is not actually received before the company ceases to be a tonnage tax company;

There is no requirement for all such non-resident companies to be directly held by the tonnage tax company. Dividends can be passed up through a chain of non-resident companies provided that all companies in the chain meet these tests. A company that does not meet these tests will break the chain for all other companies and prevent any of them from paying dividends under this rule.

Sub-paragraphs (3) and (4) provide definitions of terms used in the paragraph.

This paragraph provides that interest income, exchange gains and income arising from financial instruments will be part of relevant shipping profits as long as the income arises as part of the tonnage tax company's normal qualifying shipping trade. It would be relatively unusual for interest income to meet this condition and this would generally be expected to fall to be treated as investment income under paragraph 51. It will not be possible to offset interest receivable against interest payable unless the balances giving rise to such interest are themselves netted off one against the other and interest paid or received only on the balance. Income arising from speculative transactions will also usually fall to be treated as investment income under paragraph 51 but hedging transactions should normally be within paragraph 50.

This paragraph provides that investment income can never be part of relevant shipping profits, unless it meets the specific tests in paragraphs 49 and 50. Some examples (a non-exhaustive list) of types of investment income are given.

Part VII deals with ring fencing issues. Tonnage tax is designed to produce a minimum level of taxable profits, so that a tonnage tax company will always pay some level of tax. This Part contains rules to ensure that there are no offsets against tonnage tax profits, or against tax on those profits.

Relevant shipping profits are to be replaced by tonnage tax profits within a company's corporation tax computations. It is therefore important to ensure that only income and expenses that properly belong to the ship operation trade are included within relevant shipping profits, and that all other income and expenses are taxed under the normal corporation tax rules. This Part also includes rules on transfer pricing between connected tonnage tax and non tonnage tax companies and rules on the deductibility of interest and other finance costs.

Paragraph 52 provides that an accounting period will start or end on entry to or exit from tonnage tax. On an initial election, the general rule in paragraph 12 that the election takes effect from the start of the accounting period, means that normal accounting periods will apply. However, where an election is made after the initial period, or where a company enters or leaves tonnage tax through mergers and demergers (Part XII), then a new accounting period will be required.

This paragraph provides for a company's tonnage tax activities to be treated as a separate trade. This is to enable a clear distinction to be drawn between pre and post tonnage tax periods and between tonnage tax and non tonnage tax activities. There are many rules in the Taxes Acts that come into play when a trade starts or ends and to prevent these other rules applying, this paragraph also provides that existing trades do not stop/start on entry to or exit from tonnage tax.

Paragraph 54 sets out the rules for the interaction between the controlled foreign companies (CFC) legislation and tonnage tax. A CFC is a non-UK resident company that is controlled to a significant extent in the UK and is subject to a lower level of taxation. The aim of the CFC legislation is to prevent UK companies diverting income to tax havens and other preferential regimes. The rules work by requiring (subject to various exemptions) UK companies to pay tax (‘CFC tax’) equal to any tax that would otherwise be avoided.

A qualifying company that is a member of a tonnage tax group will automatically be a tonnage tax company. A CFC is deemed to be resident in the UK for the purposes of computing its chargeable profits, therefore, if it meets the qualifying company conditions and is a member of a tonnage tax group, it will calculate under tonnage tax rules its chargeable profits for the purposes of CFC tax. This method of calculating chargeable profits will follow regardless of whether any UK shareholder is itself a tonnage tax company.

Paragraph 54(1) provides that a tonnage tax company does not have to pay tax on the profits of a CFC if:

the CFC pays up its profits for an accounting period as a dividend; and

that dividend would qualify as relevant shipping income under paragraph 49.

Paragraph 54(2) to (4) sets out the detailed interactions between this Schedule and the CFC legislation

Paragraph 54(5) provides that a rule preventing a double charge to tax arising due to the interaction of the CFC rules and the transfer pricing rules in the normal regime is disapplied, because that double charge cannot arise where the transfer pricing rules are applied in a tonnage tax case.

Paragraph 55 provides for tonnage tax profits to be ring fenced from all the usual methods of relieving normal taxable profits. For instance it will not be possible to reduce tonnage tax profits by offsetting losses from other group companies or from other non-tonnage tax trades.

This paragraph provides that losses brought forward that relate to the qualifying shipping trade will be extinguished and will no longer be available for use.

This paragraph provides that tax on tonnage tax profits is to be ring fenced from all the usual methods of relieving tax on profits. For example, under sub-paragraph (2) it will not be possible to:

claim double taxation relief for foreign tax paid on shipping profits; or

offset unrelieved surplus advance corporation tax against tax liabilities arising on tonnage tax profits.

Sub-paragraphs (1) and (3) mean that the restrictions on offsets against tax liabilities on tonnage tax profits also apply to the apportioned profits of a CFC, where these have been calculated in accordance with tonnage tax rules (as will happen if, under the tonnage tax regime, the CFC is a member of a tonnage tax group). This restriction on offsets against apportioned CFC profits applies whether or not the company on which the apportionment is made is itself a tonnage tax company.

Sub-paragraph (4) provides that tonnage tax profits will be ignored for the purposes of shadow advance corporation tax calculations.

Sub-paragraph (5) provides that the normal rules for determining the applicable corporation tax rates will still apply and a tonnage tax company will therefore, if applicable, still qualify for small company tax rates and marginal relief. It will also be able to reclaim or offset UK tax deducted at source from income received. It is expected that corporation tax on tonnage tax profits will qualify for double taxation relief under other countries' tax laws, but ultimately, this is a decision for those other countries.

This paragraph sets out the rules for the interaction between the transfer pricing and the tonnage tax legislation. In the normal UK tax regime, the transfer pricing legislation applies so that where the relevant control conditions are met, a provision (made by means of a transaction or series of transactions) between a UK taxpayer and a non-UK taxpayer is treated for tax purposes as if it had been made on arm's length terms. The aim is to prevent connected parties manipulating prices so as to minimise the tax payable in their respective countries.

The tonnage tax rules extend this principle so that arm's length pricing must also apply to a provision between a UK taxpayer and the ring fenced activities of a connected tonnage tax company

The aim of this transfer pricing rule is to prevent connected parties manipulating prices so as to maximise income within the tonnage tax ring fence and so minimise the taxable profits outside the ring fence. Taxable profits within the ring fence are of course fixed by reference to the tonnage of the ships operated and do not relate to commercial profits earned.

This paragraph extends the concepts discussed under paragraph 58, so that transfer pricing rules also apply where a tonnage tax company has non-tonnage tax activities (for instance, perhaps it also has a road haulage division) and it 'transacts with itself' across the ring-fence.

This paragraph provides for a tonnage tax company to give notice that it is a tonnage tax company to all parties that might be affected by the transfer pricing rules within paragraph 58 (broadly speaking this is all connected parties taxable in the UK with whom it has business dealings). It must do this within 90 days of becoming a tonnage tax company or making a tonnage tax election, whichever is later. The notice will assist recipients to complete their tax returns, as they will be unable to make any adjustments required to account for non arm's length transfer pricing unless they are aware that they are transacting with a tonnage tax company.

This paragraph sets out the rules for allocating finance costs between the tonnage tax and non-tonnage tax activities of a single company. The rules are designed to prevent a company arranging for its tonnage tax activities to be financed by non-tax deductible share capital, whilst its non-tonnage tax activities are financed by tax deductible debt.

The rules operate on the presumption that finance is fungible. In other words, that borrowings by a company serve to finance the activities of the company as a whole, even if they are initially earmarked for a particular project. A company is required to consider its activities as a whole and ensure that only a just and reasonable proportion of any finance costs incurred are treated as being tax deductible outside the tonnage tax ring fence. The just and reasonable calculation should take into account the fact that finance requirements differ from activity to activity. Shipping is generally a capital intensive activity due to the high cost of the assets and would usually be expected to absorb a large part of any finance raised. Further guidance will be given in an Inland Revenue Statement of Practice.

If the company has more than a just and reasonable proportion of its finance costs claimed as deductions against profits outside tonnage tax, then an addition to its taxable profits is made outside the tonnage tax ring fence.

This paragraph sets out the rules for allocating finance costs between the tonnage tax and non-tonnage tax activities of a tonnage tax group. Principles are very similar to those discussed under paragraph 61 for a single company. The fungibility principle is now extended to cover the activities of the UK taxpaying companies in the group as a whole. The just and reasonable calculation should also consider the activities of any companies that qualify to pay dividends under paragraph 49 and take into account any complex international financing structures that might distort the distribution of finance costs.

If the group has more than a just and reasonable proportion of its finance costs claimed as deductions against profits outside tonnage tax, then an addition to the taxable profits of tonnage tax companies within the group is made outside the tonnage tax ring fence. That addition is shared between the tonnage tax companies in the group in proportion to their tonnage tax profits.

This paragraph defines finance costs for the purposes of paragraphs 61 and 62. Broadly speaking, finance costs are all costs that would generally be considered to arise from debt finance and would, in total, be deductible under the normal corporation tax rules. It includes the obvious costs such as interest on a loan but also includes less straightforward costs such as exchange gains and losses arising on the translation of relevant foreign currency loans.

Part VIII sets out the rules for the interaction of tonnage tax with the normal rules for calculating and taxing chargeable gains and relieving capital losses. The normal capital gains rules will apply except where expressly altered in Part VIII.

This paragraph defines a tonnage tax asset as being an asset used wholly and exclusively for tonnage tax activities carried out by a tonnage tax company. An asset that is used partly for non-tonnage tax activities will not be a tonnage tax asset. However, if an asset has identifiable parts, one or more of which is used wholly and exclusively for tonnage tax activities, then that identifiable part of the asset would be a tonnage tax asset.

For example a two-storey building used for group administration, including the administration of non-tonnage tax companies, would not be a tonnage tax asset. However, if one floor of that building were used wholly and exclusively for the administration of tonnage tax activities, then that one floor would be a tonnage tax asset by virtue of paragraph 64(2).

Shares in another company and other investments can never be tonnage tax assets, as they are not used for tonnage tax activities (even though certain dividends received could be within relevant shipping profits).

Paragraph 65(1) provides that a gain or loss arising on a present or former tonnage tax asset will only be recognised to the extent that it relates to periods when the asset was not a tonnage tax asset.

Paragraph 65(3) provides that the gain or loss arising will be time-apportioned according to the time that the asset was used outside tonnage tax as a percentage of the total time that the asset was owned by the company (or within the group). This time apportionment of gains and losses applies even if at the time of the eventual disposal, the asset is no longer owned by a tonnage tax company.

Paragraph 65(4) defines a "third-party disposal" for the purposes of the calculation in paragraph 65(3). This will include a disposal out of trading stock.

For example, suppose an asset is bought at the start of year 5 of a tonnage tax election. It is transferred within the group to a non-tonnage tax company at the end of year 7 of the election. The election ends at the end of year 10 and is not renewed. The asset is sold at a gain to a third party one year later. The proportion of the gain that is chargeable is 4/7, since the asset was used as a tonnage tax asset for years 4, 5 and 6 out of the total 7 years of ownership within the group.

This paragraph confirms that tonnage tax has no impact on capital losses brought forward from a pre-tonnage tax period. Any such losses may be carried forward and used to offset any gains that may arise outside the tonnage tax ring fence. This is in accordance with the general principles for ring fencing the regime. Capital gains attributable to periods outside tonnage tax are fully chargeable therefore capital losses relating to non tonnage tax periods may be used against them. The same principle is applied in the case of trading losses by allowing only the trading losses relating to non tonnage tax activities to be carried forward and set against trading profits arising outside the ring-fence.

This paragraph describes how the normal roll-over relief rules interact with tonnage tax. The normal rules for chargeable gains allow, in some circumstances, for a gain on the sale of an asset to be rolled over against the purchase of a new asset, thus deferring the payment of any tax that would otherwise have been due.

This relief will only be available if the new asset is not a tonnage tax asset. Where such relief has been claimed in the past and the replacement asset (whose cost for tax purposes has been reduced by the rolled over gain) becomes a tonnage tax asset, for instance on the making of a tonnage tax election, then the relief already given is withdrawn. However, to avoid an immediate or prior year charge to tax, the previously rolled over gain is held over and will not become taxable until the replacement asset is disposed of.

Part IX of Schedule 22 deals with the capital allowance implications of tonnage tax for companies that elect into the regime. Under the normal Corporation Tax regime capital allowances are given in place of the depreciation of capital assets shown in a company’s commercial accounts. Under tonnage tax, capital allowances are not available and various rules are needed to deal with the transition into the new regime, the treatment of mixed use assets and the position on exit from tonnage tax.

Paragraph 68 explains the overall effect of a tonnage tax election upon the capital allowances position of a company. It provides that: an election into tonnage tax will not of itself give rise to any clawback of previously given capital allowances in the form of balancing charges; a company will not be able to claim capital allowances in respect of assets used for its tonnage tax business during the course of its election; and when it leaves tonnage tax, the company will be put back broadly in the same position it would have been had it remained in the normal Corporation Tax system throughout.

Paragraph 69 sets out how, when a company enters the regime, it should go about removing machinery and plant used for the purposes of its tonnage tax business from its existing capital allowances pools.

Until the point when it enters tonnage tax, it has been open to the company to claim capital allowances on all capital expenditure on machinery or plant used for any of its business purposes. The expenditure may have been written off in a general pool of expenditure on machinery or plant or in more limited pools, sometimes only containing expenditure on a single asset.

Paragraph 69(1) specifies that any unrelieved qualifying expenditure in these pools relating to assets to be used for the purposes of the company’s tonnage tax business should be taken from those pools and placed in a single new pool (the "tonnage tax pool").

Paragraph 69(2) defines ‘unrelieved qualifying expenditure’ as that which would otherwise have been carried forward for the purposes of calculating future capital allowances.

Paragraph 69(3) provides a formula for dividing up unrelieved qualifying expenditure in the company’s capital allowances pools between expenditure attributable to its tonnage tax assets and expenditure attributable to any other assets. The formula divides up the capital allowances pools by reference to the market value of the machinery and plant held by the company just before entry into tonnage tax. For some companies, or some kinds of asset, it may be that book value represents a reasonable approximation to market value. Where it can be shown that this is the case, the Inland Revenue will accept apportionment on the basis of book value for that company or that kind of asset, rather than insisting upon market valuations for every asset. However, where there is likely to be a significant disparity between the two values, the apportionment must be on the basis of market value.

Under the existing rules for capital allowances on ships, it is possible to postpone capital allowances claimed in respect of expenditure on ships and hold it to one side until needed. Paragraph 69(4) operates to make sure that any postponed but unused capital allowances are added back to the pool of unrelieved qualifying expenditure before any of it is allocated to the tonnage tax pool. Any such allowances written back cannot then be used in any other way.

As explained in Paragraph 70(1), paragraph 70 deals with the situation where, upon entry to the regime, a company has items of machinery or plant which will be used partly for the purposes of its tonnage tax business and partly for other purposes. 'Partly' covers both an asset that is continually shared between tonnage tax and non-tonnage tax trades (for instance a computer system) and assets are used part of the time for the tonnage tax trade and part of the time for other trades (for instance a car).

Paragraph 70(2) sets out that for the purposes of the computation of capital allowances on the part use of the asset outside the tonnage tax business, the asset will be treated under the normal rules for dealing with part non-business use of an asset, with the part use for the tonnage tax business being treated as if it were not qualifying business use. This means that capital allowances will only be available on mixed use assets to the extent that they are used for the purposes of qualifying business purposes other than tonnage tax business.

This paragraph operates to limit the capital allowances available in the pre-entry period on ships acquired shortly before entry into tonnage tax and disposed of shortly afterwards to the actual amount of depreciation suffered on those ships up to the point the company enters the tonnage tax regime. This limitation applies to ships bought in the 6 months preceding the company’s entry into the regime and disposed of less than 1 year after acquisition.

Under the existing system of capital allowances, where a ship is sold for more than its tax written down value, it may give rise to a balancing charge (a clawback of capital allowances given in excess of the actual depreciation suffered on the vessel). If this happens, a shipowner may (subject to certain conditions) claim a deferral of that balancing charge, and set it against expenditure on qualifying new shipping acquired during the following 6 years. Instead of repaying excess capital allowances on the disposal of the old ship, he will reduce the amount of capital allowances he can claim in respect of the new shipping. To the extent that there is insufficient expenditure in the following 6 years on qualifying new shipping, the deferred balancing charge is brought into the charge to tax ("reinstated") at the time of the disposal of the old ship. Paragraph 72 deals with the situation where, between deferring a balancing charge on the disposal of an old ship and acquiring qualifying new shipping, a company enters the tonnage tax regime.

Paragraph 72(2) ensures that for the purposes of considering whether there should be a reinstatement of the balancing charge, qualifying expenditure on new shipping after entry in tonnage tax will be taken into account provided the company was a qualifying company for the purposes of tonnage tax at the time the old ship was disposed of (or would have been so, had this Schedule been in force at that time).

Paragraph 72(3) ensures that, apart from the special provision in paragraph 72(2), the rules for deferral of balancing charges arising outside the tonnage tax regime continue to operate as normal, for example with the existing definition of qualifying new shipping and the existing time limits applying.

As explained in Paragraph 73(1), paragraph 73 deals with the situation where, whilst it is within the tonnage tax regime, a company acquires an item of machinery or plant to be used partly for the purposes of its tonnage tax business and partly for other purposes. In such a case, no capital allowances will be available to the extent that the asset is used for the purposes of the tonnage tax business. However, paragraph 73(2) ensures that capital allowances will be available in respect of the part use of the asset for a qualifying purpose outside the tonnage tax business.

Paragraph 74 stipulates that after entry into tonnage tax a company’s tonnage tax pool may not be increased by the addition of further expenditure due to a company starting to use other assets for the purposes of its tonnage tax trade (whether held before entry to the regime or acquired subsequently).

As explained in Paragraph 75(1), paragraph 75 deals with the situation where, whilst it is within the tonnage tax regime, a company starts to use partly for some other purpose an item of machinery or plant previously used solely for the purposes of its tonnage tax business.

Where the asset in question was acquired before the company’s entry to tonnage tax, paragraph 75(2) applies the normal capital allowances rules so that the company is treated as disposing of the asset at market value at the time of change of use. Subsequently the asset will be treated under the normal rules for dealing with part non-business use of an asset, as if acquired for market value as at the time of change of use, with the part use for the tonnage tax business being treated as if it were not qualifying business use.

Where the asset in question was acquired after the company’s entry to tonnage tax, paragraph 75(3) applies the normal capital allowances rules to treat the company as acquiring the asset outside its tonnage tax business at market value at the date of change of use. Subsequently the asset will be treated under the normal rules for dealing with part non-business use of an asset with the part use for the tonnage tax business being treated as if it were not qualifying business use.

As explained in Paragraph 76(1), this paragraph deals with the situation where, whilst it is within the tonnage tax regime, a company starts to use solely for the purposes of its tonnage tax business an item of machinery or plant previously used partly for its tonnage tax business and partly for some other purpose.

Paragraph 76(2) applies the normal capital allowances rules to the capital allowances computation of the company’s non tonnage tax business so that it is treated as disposing of the asset in question at market value at the time of the change. In computing any balancing adjustment the previous part use for