Published in WorkBoat Magazine – December 2006
Business is good in the marine industry. And when business is good vessel owners are always looking for ways to reduce their tax bills.
A good source for this comes from the tax collector itself ó the federal government. The U.S. Maritime Administration has two great programs that vessel owners can tap into to limit their tax burden ó the Capital Construction Fund and the Construction Reserve Fund. They’re not tax shelters. Instead, the government-sponsored programs offer significant tax-deferral opportunities.
The programs have a purpose beyond tax relief. It’s to ensure that there is an active U.S.-flag fleet available during times of war or other national emergencies and also that there will be enough U.S. shipyards to build additional vessels if they are needed during wartime.
The CCF program also seeks to level the playing field. When it comes to the construction and replacement of vessels, operators of U.S.-flag vessels are at a competitive disadvantage with foreign-flag operators whose vessels are registered in countries that do not tax shipping income. The CCF program helps reduce this advantage this through its tax-deferral privileges.
Another goal of the program is to assist in the modernization and expansion of vessels used in the noncontiguous domestic and Great Lakes trades.
CCF vessels must be U.S. built and documented under U.S. laws for operation in the nation’s foreign, Great Lakes, or noncontiguous domestic trade. Participants must meet U.S. citizenship requirements.
Under the CCF program, a vessel owner may defer taxes not only on a vessel’s sales proceeds, but also on all net operating profits attributable to an eligible vessel and for earnings on funds deposited in a CCF account. In addition, CCF deposits can be used for the acquisition of new vessels, for the acquisition and reconstruction of used vessels, and for the payment of acquisition debt on these vessels. Deposits in a CCF may be held for up to 25 years. Withdrawals are tax-free.
“The Capital Construction Fund program gives companies in the marine industry an enormous advantage over competitors who do not use the program,” said Wayne Babin, a certified public accountant with Pepperman, Emboulas, Schwartz & Todaro LLC, Metairie, La. “In such a cyclical industry as oil-and-gas services, companies can reduce debt service and increase daily cash flow when day rates decline. This enables companies to more efficiently meet monthly note payments during down markets. The CCF program also gives companies the ability to expand their fleet while using monies ordinarily used to pay income taxes to construct and pay debt on [CCF] vessels.”
But there are a few strings attached. Substantial trading restrictions are placed on CCF vessels. Specifically, new vessels must operate in the U.S. foreign or non-contiguous domestic trade for 20 years after they are constructed. For used vessels it’s 10 years. In essence, vessels must travel between a U.S. and a foreign port (or an offshore point in the Gulf of Mexico such as an oil rig) and back. There is a daily penalty for CCF-built vessels that trade between two U.S. ports. There is also a hefty penalty for funds withdrawn from the CCFs that are not used for the purchase of a new or used U.S.-flagged vessel.
Also with a CCF, the new vessel’s cost basis is reduced by the amount of the CCF deposits for which taxes are deferred. Thus, a CCF-built vessel will have a smaller depreciation deduction.
The Construction Reserve Fund offers fewer tax-deferral opportunities than the CCF program but has fewer strings attached.
In a CRF, a vessel owner can defer income taxes due from the sale of one or more vessels by reinvesting the net proceeds in a new vessel. If all of the net proceeds are deposited, no tax is due in the vessel’s sale year. The deposit must generally be obligated under a contract for the construction or acquisition of a new vessel within three years from the date of a CRF deposit. Withdrawals for the construction or acquisition of new vessels are tax-free.
New vessels built under a CRF must be U.S. flagged. There are no restrictions on the operation of a vessel under the CRF program. Profits from vessel operations and earnings on funds may be deposited in a CRF but are subject to tax in the year earned. CRF deposits must be used for the construction or acquisition of new vessels. Like a CCF, the cost basis of a new vessel is reduced by the CRF deposits for which taxes were deferred. Thus, the depreciation deduction is lower.
CCF and CRF deposits can be used to pay the deposit or full price of a vessel. Both can also be used to pay a first preferred mortgage or other acquisition debt. For example, an owner can sell a vessel for $2 million, apply the entire amount as a down payment on a $10 million vessel, and use subsequent qualified CCF or CRF deposits to pay off the ship mortgage on a tax-deferred basis. Effectively, a vessel owner obtains a tax deduction not just for the interest portion of the debt but also for the principal.
Each program has strings attached. But for vessel operators who plan on being in the marine industry for the long haul, the benefits typically far outweigh the costs.
Leon Rittenberg III is a New Orleans-based transactional and tax attorney. He can be reached at firstname.lastname@example.org .
OPTIONS FOR FUNDING A NEW VESSEL
The tax savings associated with a CCF can be substantial. Here are two examples:
CAPITAL CONSTRUCTION FUND BENEFICIARIES
Companies that have utilized the CCF or CRF program touch most sectors of the U.S. maritime industry. They include:
Thus, vessels constructed, reconstructed, or acquired under the CCF program include:
Source: U.S. Maritime Administration