Article last updated: October 22, 2012
This letter summarizes some of the basic rules, restrictions and penalties associated with Capital Construction Funds.
The Capital Construction Fund (“CCF”) program is designed to encourage owners of U.S. flagged vessels to accumulate sufficient capital to acquire additional U.S. flagged vessels by offering tax incentives to do so. Once your application is approved, you will enter into a formal CCF agreement with the Maritime Administration.
United States citizens who operate U.S. flagged vessels are entitled to make deposits into a CCF. The maximum amount that may be contributed is the income attributable to the operation of “Eligible Agreement Vessels”, on one’s taxable income, together with the amount of depreciation allowed as a deduction on Eligible Agreement Vessels, the net proceeds from the sale or disposition of Eligible Agreement Vessels and the earnings from the investments in a CCF. Income from “Qualified Agreement Vessels (defined later) may also be deposited into a CCF. Deposits may be made up to the above limits, but CCF holders generally must make the minimum contributions provided in the CCF agreement. Unless a waiver is obtained from the Maritime Administration to make a lesser contribution, penalties can be imposed. If you foresee the inability to meet a minimum deposit, you should contact the Maritime Administration and seek a waiver as they may be willing to do so with proper notice.
Vessel owners are entitled to an income tax deduction for the amount deposited into a CCF attributable to income from Eligible Agreement vessels. Deposits may be made into the fund up to the due date of the owner’s income tax return for the taxable year to which the deposit relates (including extensions), except that when one who sells an Eligible Agreement vessel desires to deposit the sales proceeds into his Capital Construction Fund, you are supposed to notify MARAD within ten days after the sale of the vessel. This notification should include a description of the transaction, name of the transferee, the proceeds to be realized, and whether the proceeds will be deposited into your Capital Construction Fund.
Deposits into a CCF are segregated into three separate accounts which must be maintained for bookkeeping purposes, an ordinary income account, a capital gain account and a capital account.
If a deposit is made from an amount that would otherwise have been taxed at ordinary income tax rates, it is credited to the ordinary income account. This includes contributions to a CCF out of ordinary income, short term capital gains, interest and other ordinary income earned on assets held in the CCF.
The capital gain account represents deposits that would otherwise be taxed at capital gains tax rates, such as gain from the sale of a vessel, the receipt of insurance proceeds resulting from the destruction of a vessel and long term capital gains earned on fund deposits. The capital account represents deposits from non-taxable sources such as depreciation.
Deposits into a CCF may be subject to self-employment tax even if they are not subject to income tax. CCF deposits are an alternative minimum tax preference item for “C” corporations. Certain states may also tax certain CCF contributions.
“Qualified Withdrawals” can be made from a CCF for the acquisition and re-construction of United States flagged vessels and to satisfy acquisition indebtedness in connection therewith. Vessels acquired with Qualified Withdrawals are called “Qualified Agreement Vessels” and are subject to numerous restrictions. Within thirty (30) days after the execution of a contract to acquire a Qualified Agreement Vessel a copy of the contract must be submitted to the Maritime Administration. Vessel reconstruction expenses must generally exceed $1 million and be of the nature that would be capitalized under the Internal Revenue Code to Qualified Withdrawals.
There are special rules with regard to CCF qualified withdrawals to related parties. Qualified withdrawals may not be made until a construction contract is executed and after a vessel is listed on Schedule B of the CCF Agreement. However, a CCF account holder may reimburse its general funds for expenditures applicable to the construction, reconstruction or acquisition of a vessel which occurred prior to the date of the contract if the reimbursements are made within 120 days from the date of the contract. A party may also reimburse its general funds for expenditures which could have initially been paid by a qualified withdrawal if the reimbursements are made within 120 days of such expenditure. Further, a party may reimburse its general funds for expenditures made prior to the time that a CCF agreement or amendment is entered into but after the party has made application therefor if the expenses would otherwise qualify as qualified withdrawals. A CCF account holder may not prepay indebtedness by using a qualified withdrawal without the written consent of the Maritime Administration.
Withdrawals from a CCF for other purposes are called Non-Qualified Withdrawals and are effectively subject to penalties. Prior permission must be obtained from the Maritime Administration before a Non-Qualified Withdrawal can be made.
Qualified Withdrawals from a CCF are tax free. They are deemed to be made first from the capital account, until its balance is zero, then from the capital gain account, and then from the ordinary income account.
The portion of Qualified Withdrawals made from the ordinary income account and capital gain account reduces the income tax basis in the vessel acquired by the withdrawal on a dollar for dollar basis. The portion of Qualified Withdrawals made from the capital gain account is taxed at capital gains rates when the vessel constructed with CCF funds is sold. Acquisition indebtedness (vessel mortgages) cannot be prepaid with CCF funds without MARAD permission.
Qualified Agreement Vessels are vessels acquired with the aid of Qualified Withdrawals and must be constructed or re-constructed in the United States, must be documented under the laws of the United States and must be operated in United States, Foreign, Great Lakes or Non-Contiguous Domestic Trade and must be engaged primarily in the waterborne carriage of men, materials, goods or wares. The term “Non-Contiguous Domestic Trade” includes transportation between the contiguous 48 states and the insular territories. Platforms and oil rigs attached to the sea bed of the outer continental shelf, beyond the three mile limit, are included as “insular territories”. New Qualified Agreement Vessels must operate in this fashion for twenty (20) years from the date of acquisition. Used vessels must operate for ten (10) years from the date of acquisition.
The owner of a Qualified Agreement Vessel who sells the vessel within one year of acquisition may be subject to a penalty equal to interest on the amount of the gain on the sale of the vessel attributable to the basis reduction and can only be done with the prior written approval of the Maritime Administration.
Maritime Administration approval is required to sell, mortgage, refinance or otherwise dispose of a Qualified Agreement vessel. Proceeds received (money taken out) when a vessel is refinanced may need to be re-deposited into the CCF Fund.
The owner of a Qualified Agreement Vessel must notify the Maritime Administration within ten days of the sale of the vessel.
One difference between Eligible Agreement Vessels and Qualified Agreement Vessels is that Eligible Agreement Vessels can be operated in domestic trades on inland waterways, but Qualified Agreement Vessels cannot. The earnings from Qualified Agreement Vessels can also be deposited into a CCF even though not listed on schedule A to the CCF agreement.
The owner of a Qualified Agreement Vessel owes daily liquidated damages for each day that a Qualified Agreement Vessel is operated in violation of the geographic trading restrictions referred to above. The daily liquidated damage rate is based on a formula of the present value of the qualified withdrawals made to acquire that vessel plus the amount of any outstanding indebtedness on that vessel which may be paid in the future from a CCF, times thirty percent (30%), divided by the duration of the trading restrictions on the vessel.
Non-Qualified Withdrawals are subject to income tax to the extent that the CCF deposits were made from a taxpayer’s ordinary income and to the extent of the capital gain account of the fund. Non-Qualified Withdrawals are deemed to be made from the ordinary income account, then from the capital gain account. Simple interest is charged on the tax attributable to Non-Qualified Withdrawals from the year of deposit through the year of withdrawal.
Penalties can also be imposed for failure to fulfill a substantial obligation under the CCF Agreement.
Earnings on investments in a CCF are tax free. CCF’s are subject to detailed investment restrictions. In sum, no more than 60% of the value of the total assets of the fund can be invested in common or preferred stock of publicly traded companies. No more than 25% of the fund’s value can be invested in the security of one issuer. Funds cannot be invested in securities of entities related to the fund owner. Interest on debt instruments must either be issued by the United States Government or have obtained specified ratings from Standard and Poors or Moody’s rating services. Margin transactions are not permitted.
Each year a report must be filed with the Maritime Administration updating the schedules attached to your CCF application and containing other information, including Qualified Trade and Citizenship Affidavits.
A CCF may be terminated at any time upon mutual consent of the parties or upon completion of the objectives set forth on Schedule B unless modified to add future objectives. At termination, all remaining amounts in a CCF are treated as being withdrawn in a non-qualified withdrawal.
There are numerous other technical CCF rules. Please call me anytime to discuss your questions about the CCF program.
There are numerous other technical CCF rules. Please call me anytime to discuss your questions about the CCF program at 504-585-7845.
1 This summary is designed to provide general information. We are not rendering legal, accounting or other professional services. No portion of these materials may be used or relied upon or for encouraging participation in a CCF program for any purpose including, but not limited to, for the purposes of acquiring assets, taking a position on a tax return or avoiding penalties under the Internal Revenue Code. Before taking any position on a tax return, participants should consult with their own professional advisors and independently the tax and other consequences of any particular transaction or suggestion.
2 Eligible Agreement Vessels are vessels constructed in the United States and operated in United States, Foreign or Domestic Commerce, which means operated by and between two points in the United States, a point in the United States and in a point in a foreign country, two points in the same foreign country or points in two different foreign countries. You must notify the Maritime Administration within ten (10) days of the sale of an Eligible Agreement Vessel.