Ship Registration: Law and Practice

Edward B Watt and Richard M F Coles

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CHAPTER 6 Factors influencing choice of flag

Introduction

6.1 In a modern context where, for the reasons discussed in earlier chapters, the ‘flag of convenience’ label no longer carries a stigma on safety and compliance grounds; and where the vast majority of commercial tonnage is now operated from open registries – one challenge for the owner of any newbuilding or vessel purchased on the secondary market may rather be the burden of choice. Competition for business among the leading open registers is significant and often based on non-price considerations in circumstances where the available tax advantages between flag States may be broadly comparable. 6.2 A commercial ship-owner, when making the decision where to flag his vessel, must yet still initially make the important choice in principle between (1) registering the vessel in a country with which he has some genuine connection by way of national or economic ties; or (2) entering her in an open registry which will accept the vessel regardless of the nationality of the persons beneficially interested in her or the country from which the vessel is effectively controlled. Alternatively, the ship-owner may seek to enjoy certain of the benefits of the open registry system whilst retaining links with a traditional maritime nation by entering the vessel in its second register, or through the mechanism of bareboat charter registration. Considerations local to a proposed specific employment in a certain region can also play a part. The factors influencing the choice of flag for merchant ships intending a global trade, after a decision in principle has been reached, will be predominantly economic and political. The factors influencing the choice of flag of vessels intended primarily for other uses – such as fishing or yachts – will be subject to different considerations, to be discussed in turn.

Economic factors

6.3 The registration of a vessel under the flag of one of the traditional maritime nations (for example, the UK, Japan, Norway, Spain or Sweden) generally implies subjecting the operation of the vessel to the fiscal regime in force in that country. In principle, no distinction is made in developed market economies between the taxation of shipping operations and that of other commercial undertakings.1 The countries which operate open

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registries in general levy no taxes on the profits arising from the operation of vessels under their flags, although they do require payment of initial registration fees and annual taxes thereafter based in each case on the tonnage of the vessel involved. Registration in an open registry does not, of course, ipso facto exempt an owner from taxation in the country in which he is domiciled for fiscal purposes. However, the use of certain offshore corporate or trust ownership structures permitted by an international register which is not based on any notion of ‘genuine link’ may make it virtually impossible to identify the true beneficiaries of the profits arising from the vessel’s operation or the capital gain, if any, on her sale.2 6.4 The theme has been taken up, in a more general context, by the OECD. This resulted in the setting up in 1998 of a Forum on Harmful Tax Practices, intended to support fair competition and to minimise tax-induced distortion of financial and investment flows among OECD member countries. In 2000, the OECD Council identified a number of potentially harmful preferential tax regimes which included the shipping registries and related practices of seven countries.3 An ambitious timetable of measures was proposed, starting with a plan to achieve international standards and moving on to compulsory disclosure of beneficial interests and to the exchange of tax information within the OECD. The criteria adopted for determining whether a tax regime is potentially harmful include:

(1) a regime imposing low or no taxes on relevant income;
(2) a regime which is ring-fenced from its domestic economy; and
(3) a regime lacking transparency, or with inadequate regulatory supervision or disclosure.

Significantly, none of the fiscal regimes investigated by the OECD Forum in connection with this mandate were determined to be harmful “in the context of the particularities of the shipping industry”.4 The concluding report of this project, published in 2006, identified the regimes in seven further flag States as potentially harmful and which were also determined not to be actually harmful upon further investigation.5

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