UK: What A Difference A Flag Makes - Choice Of Flag By Shipowner

Last Updated: 4 March 1998

Choosing the right flag

The choice of flag can have far reaching consequences for a shipowner. It involves a consideration of fiscal and corporate rules and regulations, often covering the laws of more than one country. It may even affect the ability of the shipowner to raise money.

These are some of the factors which a shipowner may need to consider when selecting a flag for one of his vessels. It may not be appropriate for all of a shipowner's vessels to fly the same flag: it may be preferable to hedge the risk of industrial action by seamen of one nationality, or political strife by dividing a fleet between several flags. Equally, it may be necessary for trading or regulatory reasons for vessels to fly a specific flag. In some countries shipowners may be able (by negotiation or under publicised rules or scales) to obtain rebates or reductions in tonnage taxes and/or registration fees if they register a substantial number and tonnage of vessels under that flag.

Not surprisingly, shipowners often wish their shipowning companies to be incorporated in a tax haven and be resident in the same tax haven. The laws of the corporate residence are clearly relevant in selecting the flag state as they may prohibit the registration of the shipowner's vessels under the laws of the proposed flag state. It is not sufficient merely that the laws of the flag state permit the shipowner to register his vessels under the laws of that flag state: any other laws to which the shipowner company is subject must also be satisfied.

The following are some of the principal factors which will influence a shipowner's choice of corporate residence and flag state. These are factors which must be considered under any legal system and, as can be seen, there is often a compromise between legal and fiscal advantage and practicality.

Eligibility:

Can the vessel be owned by a foreign non-resident company or does the flag state insist on a locally incorporated and/or resident company being the owner? Are there any particular requirements as to the nationality of the shareholders and/or the directors? For example, the Bahamas has no requirement as to Bahamian ownership or participation in ownership, whereas Liberia requires its ships to be owned by Liberian resident persons or companies, unless the shipowning company is a registered foreign maritime entity with a resident agent. In practice, however, status as a registered foreign maritime entity in Liberia is easily achieved and the standard application form for such status appoints The International Trust Company of Liberia as the entity's resident agent. In contrast, the United Kingdom Register requires the shipowning company to be a "qualified person" before they are eligible to register vessels under British flag. The definition of qualified persons includes bodies corporate incorporated in a European Economic

Area country and bodies corporate incorporated in any relevant British possession and having their principal place of business in the United Kingdom or in any such possession. The main territories falling within the definition of "relevant British possession" are Bermuda, the Cayman Islands, Gibraltar, any of the Channel Islands and the Isle of Man. Registration under British flag within the United Kingdom or such overseas territories can, therefore, be achieved by companies incorporated and having their principal place of business in a certain tax haven.

Taxes:

How will the profits of the shipowning company be subject to taxation under the laws of its residence and/or the flag state? Are there any withholding taxes payable on interest or other amounts payable to third parties by the shipowning company? Will the shipowner be responsible for paying social security contributions or administering tax collection arrangements in relation to crew members and/or their earnings? Owners also need to bear in mind the tax laws affecting any parent company. For example, might those laws deem or consider the profits of foreign incorporated ship owning subsidiaries to be taxable in the parent company jurisdiction or tax the parent company itself on profits of those subsidiaries? May they treat the foreign subsidiary as trading through a permanent establishment in the parent company's country and tax the subsidiary accordingly? If so, how and where should corporate residence be established and is there any double taxation agreement or reciprocal arrangement in place to mitigate any tax burden?

Fees:

What fees or tonnage taxes are payable initially and thereafter annually, in respect of the registration of the vessel? What are the costs of incorporating and maintaining the shipowning company? Some countries, for example, the United Kingdom, have modest registration fees, while others - particularly flags of convenience such as Liberia and Panama - have more significant charges on registration and additional annual fees, often based on the tonnage of the vessel.

Operational:

Are there any restrictions on the nationality or qualification of the officers and/or crew? Are there any trading restrictions due to the vessel's flag? What other political risks are associated with the flag state? One should not underestimate the value of a good network of consuls to assist with practical matters. The technical and/or management requirements of the flag are often of considerable importance, although perhaps in theory less so with the advent of ISM Code. Is the flag acceptable to charterers and insurers? Are there any "genuine link" connections (such as a requirement for local managements of the vessel) which need to be met to achieve the desired flag and are these consistent with the operational requirements of the owner and his charterers, any structured or cross border financing of the vessel and the overall tax planning of the owner's group?

Financial matters:

Is the flag acceptable to potential financiers and/or charterers? This is generally a matter of political risk and legal risk. For example, do the laws of the flag state grant adequate powers and remedies to mortgagees and other creditors, are there any laws of the state of incorporation which might add to the difficulty and expense of financing the ships (e.g. laws relating to fraudulent conveyance or transactions at an undervalue where shipowning subsidiaries are asked to give mortgages to secure obligations of affiliates) and how quick, reliable and costly will it be to take enforcement action (if necessary) in that country? This last question is particularly relevant to vessels which are employed on liner services and, in some circumstances, may well be considered in relation to each of the regular ports of call as well as the laws of the flag state. In syndicated financings, the underwriters may be concerned as to how marketable the flag is to potential syndicate members, having regard to these factors and the degree to which shipping bankers feel comfortable and familiar with that flag. Will the choice of a variety of flags and/or jurisdictions create additional legal expense if the ships are financed on a fleet basis.

Conclusion

Cost control continues for many owners to be the most important factor in determining the choice of flag. However, it is important to balance headline items of cost such as crewing and social security costs and registration costs against some of the other and perhaps less obvious factors mentioned above. National flags continue to fail to attract tonnage back to their registers, although the use of the so called offshore registers and other local measures (such as schemes for tax relief on equity investment in companies whose vessels fly the national flag) have to some extent mitigated this. The benefits that would have to be made available to the shipowning community are often seen by many as "concessions" which are either politically or economically unpalatable. Despite the even greater emphasis on matters of safety and pollution liability that we have seen in recent years, open registers continue to gain tonnage at the expense of national registers.

This note is intended to provide general information about some recent and anticipated developments which may be of interest. It is not intended to be comprehensive nor to provide any specific legal advice and should not be acted or relied upon as doing so. Professional advice appropriate to the specific situation should always be obtained.

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