The cruise industry is recovering from Covid-19. Royal Caribbean Cruises Ltd., a publicly traded Liberian company and the world’s second largest cruise ship operator, reported book income of approximately $2 billion in 2019. The company reported a book loss of $6 billion in 2020, a loss of $5 billion. financial accounting loss in 2021 and an annualized financial accounting loss of $3 billion in the first half of 2022. But in an 8-K filing from September 2022, Royal Caribbean said its bookings had exceeded 2019 levels since its Covid restrictions -19 were relaxed in August.
Royal Caribbean’s 202110-K acknowledges that the company and several of its principal subsidiaries, which are also incorporated in Liberia, are, in the course of operating cruises between U.S. and foreign ports, engaged in a trade or business in the United States and derive US-source income. . The 10-K observes that Section 883 generally provides corporations with a statutory exclusion from gross income and, in practice, provides exemption from United States corporate income tax and United States corporate branch tax, for maritime income foreign companies whose country of incorporation grants owners of American ships a reciprocal exemption.
Specifically, Section 883 provides that qualifying maritime income “shall not be included in the gross income of a foreign corporation and is exempt from tax under this [income tax] Subtitle.” Conversely, the IRS Rev. Rule. 80-147 and Treasures. Reg. 1.883-1(j) imply that expenses attributable to such exempt income are not deductible and cannot create a net operating loss carryforward in the United States on non-exempt, non-delivery related income actually related.
The IRS, based on an exchange of diplomatic notes between Liberia and the United States, concluded in Rev. Rule. 2008-17 that Liberia is such a reciprocal country. Accordingly, for United States corporate income tax purposes, Royal Caribbean and its financially consolidated Liberian subsidiaries appear to have relatively little effectively United States-related income or losses from their maritime transport.
Royal Caribbean’s 10-K notes that the Treasury Regulations, viz. Treasures. Reg. 1.883-1(h)(2)—disqualify certain income from the Section 883 tax exemption. Such disqualified income includes providing Miami city tours before or after cruises end.
Alternative Minimum Corporate Tax
Beginning in 2023, the Reducing Inflation Act of 2022 may impose a U.S. minimum corporate income tax on certain corporate groups with foreign parent corporations whose adjusted worldwide average financial statement income exceeds $1 billion.
However, the CAMT only applies in a limited way to those groups whose parents are foreigners. Section 56A(c) states that in determining the amount of a foreign company’s AFSI, “the principles of Section 882 apply”. CAMT generally only applies to a group with a foreign parent company if the AFSI of the group is at least $100 million, taking into account the application of the limitation of section 56A (c) (4) foreign member companies of the group. A group whose parent company is foreign, even if it has a global AFSI greater than $1 billion, must have a minimum of $100 million in AFSI to be subject to CAMT, excluding income U.S. net of foreign group members excluded under the principles of Section 882 and 56A(c)(4).
If a foreign-owned group, apparently including Royal Caribbean, has more than $1 billion in AFSI worldwide, it will not be subject to CAMT if the group’s income that is not exempt under Section 56A(c)(4), such as the non-exempt income described in Treas. Reg 1.883-1(h)(2), is less than $100 million. Even if such a group has $1 billion in AFSI worldwide and at least $100 million in AFSI limited to Section 56A(c)(4), CAMT’s AFSI tax base is limited. by Section 56A(c)(4).
The cruise industry faces some ambiguity about the interaction of Section 883 with Section 56A(c)(4). For example, many Royal Caribbean cruises sail from Fort Lauderdale, Miami, or Port Canaveral, Florida, to Nassau, Bahamas, and then return to Florida. Below Section 863(c)(3)50% of passenger revenue from these cruises is treated as effectively U.S. source revenue described in Section 882. See TAM 9348001. However, Section 883 may exempt this 50% from corporate income tax and US branch profits tax. For purposes of the $100 million AFSI threshold and CAMT tax base if that $100 million is exceeded, would the AFSI include 100%, 50%, or none of this Florida-Bahamas cruise revenue?
Section 59(k)(2)(A) treats Section 56A(c)(4) as inapplicable to foreign parent groups only to determine whether the $1 billion global AFSI threshold is met, not to determine whether the $100 million threshold is met reached or, if so, what is the CAMT tax base. Therefore, it appears that the IRS cannot include 100% of Royal Caribbean’s Florida-Bahamas round-trip passenger revenue in the AFSI to determine whether the $100 million threshold is met or, if so, what is the CAMT tax base.
When it comes to the inclusion of 50% of Royal Caribbean’s Florida-Bahamas return passenger revenue in the AFSI, the situation is less clear. As noted, Section 56A(c)(4) states that “in the case of a foreign corporation, to determine [AFSI], the principles of Article 882 apply. Some IRS rulings are unclear on the question, which was moot prior to the enactment of CAMT, of whether such reciprocally exempt shipping income should be considered effectively related income under the principles of section 882 but excludable under the independent application of s. 883, or as excludable from consideration under s. 882 in the first place. Compare Rev. Rule. 87-15-which states that “[a] part of [the shipping company’s] Income [is] actually connected with a trade or business in the United States. PLR 8129051in which the National Office of the IRS notes, without adverse comment, that the shipping company concluded that its earnings were excluded from its “gross income under section 882(b) because of the “cross-exemption” provisions “of Section 883(a)(1).”
Under the anti-cruise line view that Section 56A(c)(4) only incorporates the exceptions of Section 882 and not those of Section 883, the 50% of net passenger revenue qualifying as revenue actually connected could be included in the AFSI. In the short term, the application by section 59A of a three-year average to determine the applicable corporate status, and the allocation to companies affected by section 56A(d) of an unlimited carry-over of losses of post-2019 financial statements to offset up to 80% of current year AFSI, could reduce CAMT exposure to Royal Caribbean and other cruise lines, whose businesses have been harmed by Covid- 19 between 2020 and 2022. According to the cruise lines’ favorable opinion, section 56A(c)(4) also incorporates the exceptions of section 883, 0% would be included in the AFSI.
Some cruise lines, such as Royal Caribbean, have ship-owning subsidiaries that lease the ships to affiliated companies that operate the cruises. These vessel-owning subsidiaries apply Section 883 to avoid being subject to the otherwise applicable Section 887 gross transportation tax of 4% on their non-effectively connected US-source income. The analogous question arises whether such income is exempt from inclusion in the AFSI under Section 56A(c)(4). Another analogous question arises whether any shipping or other income that is exempt from US corporate income tax and US transportation tax under a tax treaty is also excluded by the 56A(c)(4).
One source of optimism for the cruise industry is that of the former Treas. Reg. Sections 1.56-1(b)(6)(ii)(B) and 1.56(g)-1(m)(4), dealing with the repealed analogous alternative minimum tax on accounting income and adjusted tax preferences. of current earnings, the Treasury favorably excluded a foreign shipping company’s earnings attributable to its Section 883 or treaty earnings that were exempt from ordinary U.S. corporate income tax.
This article does not necessarily reflect the views of Bloomberg Industry Group, Inc., publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Alan S. Lederman is a shareholder of Gunster, Yoakley & Stewart, PA in Fort Lauderdale, Florida.
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