Security Deposit Interest Ring-fenced Under Tonnage Tax

International accountant and shipping adviser Moore Stephens has welcomed a decision by the U.K. First Tax Tribunal that interest received on security deposits relating to loans taken out to buy ships within tonnage tax is not taxable.

HMRC had argued that the interest income was outside tonnage tax as it related to the purchase of ships by London-based bulk and chemical tanker operator Euroceanica (U.K.) Limited, which was not a trading activity for the purposes of the tonnage tax legislation. It had further maintained that the giving of a security deposit was not a ‘necessary and integral’ part of the activity of operating ships as it was not a mandatory or “necessary” part of ship financing. 

However, the First Tier Tax Tribunal, which hears appeals against decisions relating to tax made by Her Majesty’s Revenue and Customs (HMRC), ruled that the crucial issue was whether the funds from which the interest income arose were currently being used for the purposes of Euroceanica’s trading activities, and whether the interest arose from cash which was “at risk” in the company’s trade.

The tribunal decided that the giving of the security deposits in this case was a genuine commercial arrangement entered into by the shipowner in order to obtain better loan terms from the relevant banks. The security deposits should not be regarded as investments, said the tribunal, as the company was not interested in the rate of return on the deposits and would have preferred to use the cash to generate shipping income. The funds were being used for current purposes, namely to collateralize the financing of ships. The cash deposits were of a relatively short-term nature, even though interest was received on the deposits over a number of years.   

The tribunal concluded that the deposits were being actively employed in the trade. Therefore, the relevant interest income should be treated as trading income and within tonnage tax. 

Sue Bill, a tax partner with Moore Stephens, said, “Although HMRC may lodge an appeal, the decision provides some clarity on the contentious issue of the extent to which interest received by a tonnage tax company is within the tonnage tax ring-fence. It is slightly surprising that HMRC felt able to defend its position on this issue at tribunal, particularly given that it accepts that interest on security deposits for leases can be within tonnage tax provided that certain conditions are met. The tribunal commented that neither it nor HMRC was able to see any distinction, and that HMRC had been forced to argue that its guidance relating to leases must be incorrect. Although very good news for the taxpayer, this case does show that the HMRC guidance on tonnage tax is not always correct.”

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