U.S. tax planning for the international transportation of goods by containers.

• Author: Rubinger, Jeffrey L.
• Position: Tax Law

The U.S. marine transportation system handles large volumes of domestic and international freight in support of the economic activities in the United States. As a vital part of that system, the U.S. container ports handle cargo and are major sources of employment, revenue, and taxes for businesses or communities where they are located. According to recent statistics, in the first half of 2010, U.S. container ports handled a total of 110 million metric tons of containerized cargo, 17 percent higher than the 95 million metric tons handled in the same period in 2009. (1) As a result, today, one container in every 11 that is engaged in global trade is either bound for or originates in the United States, accounting for nine percent of worldwide container traffic. (2) Furthermore, changes in containerized export and import volumes has also led to an increase in the number of "intermodal" shipping containers transported by rail (up 12 percent from 2009) and the demand for trucking services (up 8 percent from 2009). (3)

With these numbers growing steadily during the past 15 years, the U.S. federal income tax implications to U.S. companies engaged in the international transportation of goods by containers has become increasingly significant. This article discusses potential U.S. federal income tax considerations that may be available to certain companies involved in this industry as a result of income tax treaties that contain favorable international transportation provisions and the entity classification regulations (i.e., "check-the-box" regulations). (4)

Taxation of U.S. and Foreign Companies, in General

A U.S. company that directly conducts business operations abroad will generally be subject to U.S. federal income tax on its worldwide income, regardless of the source of such income, but may receive a foreign tax credit for all or a portion of the foreign tax paid in other jurisdictions on that same income. (5) In contrast, foreign (i.e., non-U.S.) companies are subject to U.S. federal income tax on a much more limited basis. Foreign companies are taxed only on income that either 1) is effectively connected with a U.S. trade or business (ECI), or 2) is classified as U.S. source fixed, determinable, annual, or periodical (FDAP). FDAP income is subject to a 30 percent withholding tax that is imposed on a foreign person's gross income (subject to reduction or elimination by an applicable income tax treaty). (6) ECI is subject to tax on a net basis at the graduated tax rates generally applicable to U.S. persons. (7)

Taxation of International Transportation Income, in General

A number of code provisions specifically address various aspects of income arising from international transportation activities. Section 883(a) excludes income from the international operation of ships or aircraft from the gross income of certain foreign corporations that grant to the United States an equivalent exemption. For this purpose, a foreign corporation is considered to be "engaged in the operation of ships or aircraft" only when it is an owner or lessee of one or more entire ships or aircraft. (8) Thus, this provision applies to a fairly narrowly defined segment of the international transportation industry.

Under [section] 863(c), income attributable to transportation (transportation income) that begins or ends in the United States is treated as being 50 percent from U.S. sources. Moreover, foreign corporations will be subject to a four percent tax on their U.S.-source gross transportation income under [section] 887, provided such income is not ECI. (9) The term "United States source gross transportation income" means any gross income--without reduction for any deductions or losses --that is transportation income (as defined in [section] 863(c)(3)) to the extent such income is treated as arising from sources within the United States under [section] 863(c)(2)(A). (10)

For purposes of these provisions, the term "transportation income" means any income derived from, or in connection with 1) the use (or hiring or leasing for use) of any vessel or aircraft, or 2) the performance of services directly related to the use of any vessel or aircraft. (11) The statute provides that the term "vessel or aircraft" includes any container used in connection with a vessel or aircraft, (12) but the term "transportation income" does not include income from the disposition of vessels, containers, or aircraft. (13)

The Internal Revenue Service clarified that the term "income derived from or in connection with ... the use (or hiring or leasing for use) of any vessel or aircraft" means: 1) income derived from transporting passengers or property by vessel or aircraft; 2) income derived from hiring or leasing a vessel or aircraft for use in the transportation of passengers or property on the vessel or aircraft; and 3) income derived by an operator of vessels or aircraft from the rental or use of containers and related equipment (container-related income) in connection with, or incidental to, the transportation of cargo on such vessels or aircraft by the operator. (14) The IRS also clarified that "persons other than an operator of a vessel or aircraft do not derive container related income. Such income is treated as rental income, not transportation income." (15)

Accordingly, the provisions discussed above are applicable only to persons that either own or operate entire ships or aircraft. None of the cited provisions apply to international transportation companies that, for example, own containers, and arrange to ship goods stored in those containers using third-party shipping or rail companies, but do not operate the actual ships or railcars on which the containers are transported (such as a nonvessel operating common carrier (NVOCC)). (16)

Tax Efficient Structuring for International Transportation Activities

* International Shipping Operations: Treaty with Austria--Assume a newly formed U.S. company (TransportCo.) plans to operate as described above by arranging for the transportation of goods stored in containers from the United States to various countries around the world by using third-party shipping or rail companies, but will not own or operate the actual ships or railcars on which the containers are transported. Also assume that TransportCo. will own the containers that are used to transport the goods, will issue its own bills of lading, and will be liable as a common carrier for the transportation of goods. Finally, assume that such company will be structured in the United States as a closely held pass-through entity (e.g...