16 August 2011 External T.I. 2009-0342101E5 - Operation of Ships

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: To clarify the CRA's published positions in E 9611145 on what constitutes the operation of ships. To provide some guidance on when the Non-Operating of Ships Activities of a shipping company such as Ship Leasing will be considered incidental to shipping company's Operation of Ships business. To provide comments on how the CRA's published positions apply with respect to the Sub-Time Chartering Out of ships when a shipping company follows a certain business model or commits a ship to a Pool Arrangement.

Position: See response

Reasons: See response

									August 16, 2011

	XXXXXXXXXX 							HEADQUARTERS
									Income Tax Rulings
									Directorate

									2009-034210

Meaning of "Operation of Ships" for the purposes of paragraph 81(1)(c) and subsection 250(6) of the Canadian Income Tax Act (footnote 1)

This is in response to your letter in which you request the Canada Revenue Agency (CRA) to clarify CRA's published positions regarding what constitutes "the operation of ships" in certain specified situations within the meaning of paragraph 81(1)(c) and subsection 250(6) of the Act and to clarify under what circumstances the CRA would consider revenue from Ship Leasing earned by a shipping company to be excluded from operation of ships revenue for purposes of the test in paragraph 250(6)(b). In addition, you requested the CRA's views on how its published positions on what constitutes "the operation of ships" within the meaning of paragraph 81(1)(c) and subsection 250(6) apply in the following circumstances.

• A shipping company carries on its business following a certain business model.
• A shipping company commits a ship it has under its control to a Pool Arrangement.

We apologize for the delay in responding to your letter.

Definitions

In this document, the following words or expressions have the following meaning:

"Bareboat Charter (Demise Charter)" is a Charterparty between the registered or legal owner of a ship or a disponent owner of a ship and the Bareboat Charterer (i.e. the person acquiring possession of the ship under the Charterparty), pursuant to which the owner or disponent owner transfers (demises) to the Bareboat Charterer possession of the ship and the right to trade it as he chooses for a specified period, on terms that the Bareboat Charterer will pay the Bareboat Charter hire, maintain and insure the ship and indemnify the owner against liabilities incurred by the ship. The contract is effectively a "dry lease" under which the Bareboat Charterer will employ the crew and be responsible for all Technical Management and Commercial Management of the ship and related expenses. For the period of the Charter, the Bareboat Charterer has the right to exploit the earning power of the ship as he chooses for that period (i.e. can Bareboat Charter Out the ship or can crew the ship and arrange for the transport of passengers or goods on the ship on his own account or can Charter out the crewed ship under a Time Charter or Voyage Time Charter.)

"Charterer" depending on the context in which it is used means an individual or company that acquires the possession of a ship under a Bareboat Charter, or acquires shipping services under a Time Charter or Voyage Time Charter or an individual or company who under a CoA or Voyage Transport Charter or some other contract arranges with a shipping company to have the shipping company transport on ships under its control passengers for the individual or company or goods belonging to the individual or company.

"Charterparty" depending on the context means a contract between the parties who enter into a Bareboat Charter, a Time Charter or a Voyage Time Charter or a CoA or a Voyage Transport Charter.

"Commercial Management" means the right to exploit the earning capacity of the ship. Commercial Management includes the management of the following types of services: negotiating and arranging Voyage Transport Charters or CoA's or Time Charters or Voyage Time Charters; liaison with shipping brokers; developing and maintaining customer relationships; monitoring market demand, availability of ships and anticipated future requirements for ships; ship scheduling; coordinating the acquisition of bunkers (marine fuel) for ships; and billing and collecting revenues.

"Contract of Affreightment (CoA)" is a Charterparty between a shipping company that owns ships, has Bareboat Chartered In ships or has Time Chartered In ships or has Voyage Time Chartered In ships and a Charterer (Customer) for the carriage of a specified quantity of particular goods owed by the Customer by more than one voyage between specified ports over a specified period, on the payment of Freight in respect of each voyage performed. A CoA typically does not identify the ships to be used (although it may require them to have specified characteristics), so that the shipping company has the right to use any ship(s) whose employment the shipping company is entitled to direct at the time for performance; whether as registered or legal owner, or Bareboat Charterer, or Time Charterer, or Voyage Time Charterer. Where the shipping company owns or is the Bareboat Charterer of the ship(s) involved, the shipping company retains possession of the ship(s) and all the Technical Management, including crewing and Commercial Management responsibilities of the ship(s). Where the shipping company is the Time Charterer or the Voyage Time Charterer of the ship(s) involved, the shipping company retains the Commercial Management responsibilities of the ship(s) (i.e. that shipping company's control over the ship(s)). Where the shipping company is the Time Charterer or Voyage Time Chaterter of the ship(s), the owner or Bareboat Charterer of the ship(s) continues to retain possession of the ship(s) and all the Technical Management, including crewing, responsibilities of the ship(s) and is obligated to operate the ship(s) as directed by the Time Charterer or Voyage Time Charterer of the ship(s) to fulfill the Time Charterer's or Voyage Time Charterer's obligations under the CoA.

"Disponent Owner" of a ship is a person who has commercial control over a ship's operation without owning the ship. For the purpose of this document, the disponent owner of the ship is the person (i.e. the shipping company) who has Bareboat Chartered In the ship. For the remainder of this document, any use of the term "owner" will include "disponent owner" unless a contrary meaning is indicated.

"Freight" means a sum of money paid to a shipping company which is a ship owner, a Bareboat Charterer, a Time Charterer or a Voyage Time Charterer by a Charterer (Customer) in exchange for the transporting of the Customer's passengers or goods, on a ship or ships under the shipping company's control.

"International Traffic" is international traffic as defined for the purpose of subsection 250(6) (i.e. the definition of international traffic in subsection 248(1) as modified by subparagraph 250(6)(a)(i)).

"Operation of Ships" is the operation of ships under its control by a shipping company in the transport of passengers or goods on such ships on its own account.

"Pool Arrangement" is an agreement between a number of shipping companies (Pool Members), who have the right (because they own the ship(s), have Bareboat Chartered In the ship(s) or have Time Chartered In the ship(s) or have Voyage Time Chartered In the ship(s) each of them commits to the Pool Arrangement) to exploit the earning capacity of similar ships, to co-operate in the Commercial Management of the ships committed to the Pool Arrangement. Various legal structures may be adopted. A Pool Arrangement provides the opportunity to achieve better operating efficiencies, through increased ship utilization and better access to markets, routes and potential customers and shared risks.

"Ship Leasing" includes both the Bareboat Chartering Out of ships and the Sub-Time Chartering Out of ships or any combination of those 2 activities.

"Sub-Time Charter Out" is a Time Charter or Voyage Time Charter entered into by shipping company to Charter out a ship which the shipping company had Time Chartered In or Voyage Time Chartered In.

"Technical Management" is the management of the operation of the ship. This includes the management of the hiring of the crew and duties related to crew management (see definition of Vessel Manning below), of logistics related to operations, as well as of service and maintenance operations and of all areas of technical support.

"Time Charter" is a Charterparty for services made between the registered or legal owner of a ship and the Time Charterer (i.e. the person who is acquiring the services). Pursuant to the contract the owner does not transfer possession of the ship but is responsible for crewing the ship and promises to operate the ship as ordered by the Charterer for a defined period in exchange for the payment of Time Charter hire and for bunkers used by the ship. The overall effect is that for the period of the Charter the owner remains responsible for Technical Management including the crewing of the ship, but transfers to the Time Charterer the Commercial Management. The Time Charterer for the period of the Charter has the right to exploit the earning capacity of the ship (e.g. can arrange for the transport of passengers or goods on the ship on its own account or can Sub-Time Charter Out the ship under a Time Charter or Voyage Time Charter). A Time Charter can also be a Charterparty between a shipping company that is Sub-Time Chartering Out the ship and a new Time Charterer who is the Time Charterer under the Charterparty. In such a case the owner continues to have possession of the ship and to be responsible for the Technical Management of the ship including crewing the ship but must now operate the ship as ordered by the new Time Charterer. The shipping company which is Sub-Time Chartering Out the ship transfers the Commercial Management of the ship including the right to exploit the earning power of the ship (i.e. its control over the ship) to the new Time Charterer.

"Vessel Manning" includes the recruitment of suitable officers, ratings and cadets; dealing with all matters relating to the training, certification, discipline, occupational health and safety and welfare of crew; dealing with crew travel arrangements, payroll administration and all other matters relating to the proper manning of vessels.

"Voyage Charter" when referred to in information relating to the shipping industry depending on the context in which it is used can be either a Voyage Time Charter or a Voyage Transport Charter. To avoid confusion, where appropriate the terms "Voyage Time Charter" and "Voyage Transport Charter" are used elsewhere in this document.

"Voyage Time Charter" is a Charterparty which is in effect a Time Charter for a voyage or voyages. Where the Charterparty is between the owner of a ship and the Voyage Time Charterer, the owner does not transfer possession of the ship but is responsible for crewing the ship and promises to operate the ship as ordered by the Charterer, for a period of the Charter. The overall effect is that for the period of the Voyage Time Charter the owner remains responsible for Technical Management including the crewing of the ship, but transfers to the Voyage Time Charterer the Commercial Management of the ship. The Voyage Time Charterer for the period of the Voyage Time Charter has the right to exploit the earning capacity of the ship (i.e. can arrange for transport of passengers or goods on the ship on its own account or can Sub-Time Charter Out the ship under a Voyage Time Charter). A Voyage Time Charter can also be a Charterparty between a shipping company that is Sub-Time Chartering Out the ship and a New Charterer who is the Voyage Time Charterer under the Charterparty. In such a case the owner of the ship continues to have possession of the ship and be responsible for the Technical Management including the crewing of the ship but must now operate the ship as ordered by the New Charterer. The shipping company which is Sub-Time Chartering Out the ship for the period of the Charter transfers the Commercial Management of the ship including the right to exploit the earning power of the ship (i.e. its control over to the ship) to the New Charterer.

"Voyage Transport Charter" is a Charterparty between a shipping company which has the right to exploit the earning capacity of the ship (because the shipping company is the owner of the ship, the Bareboat Charterer of the ship, the Time Charterer of the Ship or the Voyage Time Charterer of the ship) and a Charterer (Customer), to carry the Customer's passengers or goods on the ship on a particular voyage for an agreed sum (e.g. Freight). Where the shipping company is the owner or a Bareboat Charterer of the ship, the shipping company retains possession of the ship and all the Technical Management, including crewing and the Commercial Management responsibilities of the ship. Where the shipping company is a Time Charterer or a Voyage Time Charterer of the ship, the shipping company retains the Commercial Management responsibilities of the ship (i.e. that shipping company's control over the ship). Where the shipping company is a Time Charterer or a Voyage Time Charter of the ship the owner or the Bareboat Charterer of the ship continues to retain possession of the ship and all the Technical Management, including crewing, responsibilities of the ship and is obligated to operate the ship as directed by the Time Charterer or the Voyage Time Charterer of the ship to fulfill the Time Charterer's or the Voyage Time Charterer's obligations under the Voyage Transport Charter.

Our Comments

The following comments are general in nature. The determination of the application paragraph 81(1)(c) and subsection 250(6) to particular case can only be made after a thorough consideration of all of the relevant facts pertaining to that situation.

The CRA's published position (E 9611145), as it relates to what constitutes the "operation of ships" within the meaning of subsection 250(6), was first set out in CRA Document E 9126695 and subsequently reiterated in several CRA documents with the latest being E 9611145.

The positions in E 9611145, several of which are not addressed in this document, have not changed. The definitions in this document and the following comments only provide an expanded explanation of those positions as they relate to what constitutes the operation of ships in situations A to H below and whether or not gross revenue from Ship Leasing and other activities that are not operation of ship activities in certain circumstances can nevertheless be considered to be gross revenue from the operation of ships. In addition, as requested, comments are included below on how the positions in E 9611145 apply where a shipping company follows a certain business model or where a shipping company commits a ship to a Pool Arrangement.

Background

In summary, where the conditions of that provision are met, the purpose of subsection 250(6) is to allow a shipping company to manage its operation of ships in International Traffic from Canada (i.e. have its central management and control located in Canada) but to be taxed in Canada as a non-resident of Canada. Paragraph 81(1)(c), if the conditions of that provision are met, provides that non-residents are not taxed in Canada on their income earned in Canada from the operation of ships in International Traffic. (footnote 2)

In our view the meaning of the term "operation of ships" as used in subsection 250(6) and paragraph 81(1)(c) is the same both provisions. Therefore, guidance on what constitutes the operation of ships within of subsection 250(6) can be found in the Supreme Court of Canada case "Furness Withy and Company Limited" (footnote 3) (Furness Withy).

A summary of the Court's analysis in Furness Withy of the meaning of the words "operated by him" in section 10(1)(c) (footnote 4) of the Income Tax Act RSC 1952 and "from operating ships" in Article V of the United Kingdom of Great Britain and Northern Ireland; Statutes of Canada 1946, is that in the context in which they are used in each of those provisions those words refer to the operation ships only by the non-resident. This conclusion is confirmed by the following holdings in the case.

1. That neither Section 10(1)(c) of the Income Tax Act nor Article V of the Tax Convention exempts earnings of the appellant from managing or agency or stevedoring services which it renders in Canada to other corporations.

2. That the appellant is entitled to exemption under these provisions in respect of the portions of the amounts treated as income by the Minister, which arose from entries of charges made by the branches for "agency" and stevedoring services to ships which were owned or chartered by the appellant and were operated in its own service.

Therefore, based on Furness Withy

i. when a shipping company uses ships under its control in the transportation of passengers or goods on its own account, the shipping company is engaged in the operation of ships within the meaning of paragraph 81(1)(c) and within the meaning of subsection 250(6);

ii. when a shipping company carries out Technical Management and Commercial Management of, or the stevedoring services to, ships which are under the shipping company's control and used by it in the transport of passengers or goods on its own account, such activities are part of the shipping company's operation of ships activities; and

iii. when a shipping company carries out Technical Management and Commercial Management of, or the stevedoring services to, ships for persons other than the shipping company, such activities are not part of the shipping company's operation of ship activities.

Except for in situation C, in order to determine if the shipping company is operating the ship in situations A to H as set out below, it is necessary to consider the impact of a Charterparty on the Charterer under the Charterparty and depending on whether it is a Bareboat Charter, a Time Charter or Voyage Time Charter, as the case be, on the owner of the ship, the Bareboat Charterer of the ship, the Time Charterer of the ship or Voyage Time Charterer of the ship.

Consequences of a Bareboat Charter

In a Bareboat Charter the shipping company which is the owner of the ship in exchange for a hire fee, for the period of the Charter, turns over possession of the ship to the Bareboat Charterer (i.e. the person who Bareboat Chartered In the ship under the Charterparty) for the period of the Charter. Therefore, for the period of the Bareboat Charter such owner of the ship is not operating the ship.

The Bareboat Charterer is responsible for all the Technical Management and Commercial Management of the ship for the period of the Charter and has the right to exploit the earning power of the ship as he chooses for that period (i.e. can Bareboat Charter Out the ship or can crew the ship and arrange for the transport of passengers or goods on the ship on his own account for example under a CoA or Voyage Transport Charter or can crew the ship and Charter it out under a Time Charter or Voyage Time Charter.)

Consequences of a Time Charter or a Voyage Time Charter

As can be determined from their definitions, although the period of the Charter may be different, a Time Charter and Voyage Time Charter otherwise have the same impact for the period of the Charter. Therefore, for the purpose of this analysis the reference to Time Charter covers both a Time Charter and Voyage Time Charter.

First consider a Time Charter which is a Charterparty between owner of the ship and the Time Charterer (i.e. the person who Time Chartered In the ship under the Charterparty). In this case the owner of the ship does not give up possession of the ship but promises to operate the ship as ordered by the person who Time Chartered In the ship. The owner of the ship remains responsible for the Technical Management of the ship which includes the crew and crew management with related tasks. The Commercial Management of the ship is transferred to the person who Time Chartered In the ship, who for the period of the Time Charter has the right to exploit the earning power of the ship (e.g. can arrange for the transport of passengers or goods on the ship on its own account for example under a CoA or Voyage Transport Charter or can Sub-Time Charter Out the ship under a Time Charter or Voyage Time Charter.) Both the owner that is responsible for the Technical Management of the ship and Time Charterer that is responsible for the Commercial Management of the ship would be operating that same ship at the same time.

Often there is a series of Time Charters involving a particular ship where the Time Charter described above between the owner of the ship and the Time Charterer (i.e. the shipping company that Time Chartered In the ship from the owner of the ship), which is the first Time Charter in the series, is followed by a subsequent Time Charter or Time Charters between persons who are Time Charterers because they Time Chartered In the ship and new Time Charterers. Where there is such a subsequent Time Charter, the owner continues to have possession of the ship and to be responsible for the Technical Management of the ship including crewing the ship but must now operate the ship as ordered by the new Time Charterer. For the period of this Time Charter the shipping company which is Sub-Time Chartering Out the ship transfers the Commercial Management and the right to exploit the earning power of the ship (i.e. its control over the ship) to the new Time Charterer. Therefore, for that period the shipping company which Sub-Time Chartered Out the ship is not operating the ship.

For the period of this Time Charter the new Time Charterer is responsible for the Commercial Management of the Ship and can exploit its earning power (e.g. arrange for the transport of passengers or goods on the ship on its own account for example under a CoA or Voyage Transport Charter). As a result, new Time Charterer is operating the ship, as is the owner who is responsible for the Technical Management of the ship.

The Situations

A. The shipping company owns a ship and under a Bareboat Charter, Charters out the ship.

B. The shipping company Charters out a ship by way of a Bareboat Charter (could be a Sub-Bareboat Charter Out which the company has Bareboat Chartered In under a Bareboat Charter).

C. The shipping company owns a ship, crews it and arranges to transport passengers or goods on that ship on its own account (e.g. under a Voyage Transport Charter or a CoA).

D. The shipping company Charters in a ship under a Bareboat Charter, crews it and arranges to transport passengers or goods on that ship on its own account (e.g. under a Voyage Transport Charter or a CoA).

E. The shipping company owns a ship, crews it and Charters it out by way of a Time Charter or a Voyage Time Charter.

F. The shipping company Charters in a ship under a Bareboat Charter, crews it and Charters it out by way of a Time Charter or a Voyage Time Charter.

G. A shipping company Charters in a ship under a Time Charter or Voyage Time Charter (i.e. the ship is "Time Chartered In" as that term is defined above) and arranges to transport passengers or goods on that ship on its own account (e.g. under a Voyage Transport Charter or a CoA).

H. A shipping company under a Time Charter or Voyage Time Charter Charters out a ship that it has Time Chartered In (i.e. the ship is "Sub-Time Chartered Out" as that term is defined above).

A & B The Shipping Company Is Not Operating the Ship

Based on the analysis of the impact of a Bareboat Charter, as possession of the ship is given up by the shipping company, in the circumstances set out in situations A and B, for the period of the Bareboat Charter, the shipping company is not operating the ship it owned and Bareboat Chartered Out or the ship which it Bareboat Chartered In and in turn Bareboat Chartered Out on its own account, as contemplated in Furness Withy. Therefore, in situations A and B the shipping company is not operating the ship within the meaning of subsection 250(6).

C & D The Shipping Company Is Operating the Ship

In situation C it is clear that the shipping company is operating a ship in the transport of passengers or goods on its own account as contemplated in the decision in Furness Withy and in situation D considering the impact of a Bareboat Charter it is clear that the shipping company is operating a ship it has Bareboat Chartered In for the transport of passengers or goods on its own account as contemplated in Furness Withy. Therefore, in both situations C and D the shipping company is operating the ship within the meaning of subsection 250(6).

E & F The Shipping Company is Operating the Ship

As set out in the analysis of the impact of Time Charter or Voyage Time Charter, under a Time Charter or Voyage Time Charter entered into by a shipping company that is the owner of the ship, the shipping company retains possession of the ship, is responsible for the Technical Management of the ship including its crew and must operate the ship at the direction of the Time Charterer. Therefore, in situation E, as contemplated in Furness Withy, the shipping company is operating a ship it owns on its own account and in situation F, as contemplated in Furness Withy, the shipping company is operating a ship it Bareboat Chartered In on its own account. It follows that in both situations E and F the shipping company is operating the ship within the meaning of subsection 250(6).

As the contractual obligations of the shipping company under the first Time Charter in the series will continue for the period of that Time Charter, the shipping company that is the owner of the ship will continue to be considered to be operating the ship no matter how many times the ship is Sub-Time Chartered Out by the first Time Charterer or by other persons by whom it is Sub-Time Chartered Out.

G The Shipping Company is Operating The Ship

As set out in the analysis of the impact of a Time Charter on the person who Time Chartered In the ship, that person has the responsibility for the Commercial Management of the ship and has the right to exploit the earning power of the ship (e.g. can arrange for the transport passengers or goods on the ship on its own account for example under a CoA or a Voyage Transport Charter) In this regard, the owner of the ship must operate the ship under the direction of the person who Time Chartered In the ship in order to fulfill the obligations of that person under a CoA or Voyage Transport Charter. Therefore, in situation G the shipping company is operating a ship Time Chartered In by it in the transport of passengers or goods on its own account as contemplated in the decision in Furness Withy. It follows that in situation G the shipping company is operating the ship within the meaning of subsection 250(6).

H The Shipping Company Is Not Operating The Ship.

As can be seen from the impact of a Time Charter, a shipping company that Sub-Time Charters Out a ship which it had Time Chartered In, transfers its control over that ship (i.e. the Commercial Management of the ship and right to exploit the earning power of the ship by arranging for the transport of passengers or goods on its own account) to the new Time Charterer (i.e. the person Time Chartering In the ship under the Charterparty by which the shipping company is Sub-Time Chartering Out the ship). Therefore, for the period of the Sub-Time Charter Out, in situation H the shipping company is not operating the ship as contemplated in Furness Withy. It follows that in situation H the shipping company is not operating the ship within the meaning of subsection 250(6).

In the situations above where the shipping company is operating the ship, it does not matter if the shipping company has entered into an agreement with another company (whether a third party or a related company) to provide services to the shipping company for the Technical Management, including Vessel Manning of the ship and/or for the Commercial Management of the ship, the shipping company still will be considered to be operating the ship. However, the provision of such services by the other company to the shipping company does not constitute the operation of ships by the other company.

The Gross Revenue Test

Paragraphs 1 to 5 below are taken from E 9611145.

1. "Where assets are risked or employed in the corporation's integrated shipping business the income therefrom would generally be considered to be from the operation of ships. There may be situations where the intended use of a vessel can not be fulfilled due to economic or other events that could not be reasonably foreseen. For example, with respect to the sub-leasing of ships, where a ship is Time Chartered In for the purpose of being used by the lessee in its integrated shipping business, and due to subsequent events the vessel can not be so used, revenue from Sub-Time Chartering Out the vessel on a temporary basis would normally be considered to be from the operation of ships, provided that the vessel is returned to its intended use as soon as is reasonable in the circumstances. The sub-leased vessel would still be considered risked or employed in the corporation's integrated shipping business. While, in these circumstances, the sub-leasingrevenue would be considered from the operation of ships, in any case where the sub-Time Chartering activity constitutes a separate business the revenue therefrom would not be considered to be from the operation of ships."

2. "Where a ship is owned or Bareboat Chartered In by a corporation and such ship is Bareboat Chartered Out or Sub-Bareboat Chartered Out, as the case may be, revenue therefrom will not normally be considered to be from the operation of ships. Where, however, the corporation's leasing activities do not constitute a separate business and the ship was originally acquired or Bareboat Chartered In to be used in its integrated shipping business to transport passengers or goods and, due to subsequent events, the ship can not be so used and is Bareboat Chartered Out or sub-Bareboat Chartered Out on a temporary basis, provided the vessel is to be returned to its intended use as soon as is reasonable in the circumstances, the revenue therefrom would be considered to be from the operation of ships. Again, the vessel would still be considered risked or employed in the corporation's integrated shipping business."

3. "Gross revenue of an integrated shipping business from Bareboat Chartering Out or Sub-Time Chartering Out a vessel, that is included in the gross revenue from the operation of ships in accordance with the above comments, provided the vessel was acquired to be used in International Traffic, will be "qualifying gross revenue" for purposes of paragraph 250(6)(b)."

4. "A company that owns and operates a ship can be regarded as being involved in a number of discrete activities: raising capital and debt financing; overseeing new construction, acquisitions and dispositions; crewing and catering; performing repairs and maintenance; arranging insurance; marketing; negotiating charters; arranging voyages and soliciting passengers or cargo; and stevedoring. All of these activities are appropriately characterized as constituting the operation of ships when undertaken as part of an integrated business that is carried on in the same corporation for its own account. In our view, it was not intended that any of these activities would be so viewed when undertaken separately. For example, none of a bank that lends money to acquire ships, a shipbuilder, a seamen's employment agency, a shipping insurance company, a cruise line travel agent, or a dockside cargo handling firm is intended to be treated as being in the business of operating ships."

5. "There can, of course, be situations in which a corporation is engaged in more than one business, and it would not be surprising to find a company that, for example, operated its own line of ships while also running a cargo handling operation for other ship owners. If, in fact, that cargo handling operation had developed to a stage where it was beyond any reasonable requirements of the company's own ships, it would seem appropriate to treat it as a separate business and, in the context of the question at hand, to exclude those revenues arising in connection with cargo services provided to the other ship owners. If, however, the cargo handling facilities were established and used for the company's own ships, with its services being provided to others only on the odd occasion that the company did not require them for its own use, we would not regard the operation as a separate business and would not propose to exclude any of its revenues from the company's operation of ships."

The examples in paragraphs 1 and 2 above from E 9611145 set out specific circumstances where the Ship Leasing activities of a shipping company may be considered to pertain to or be incident to the activities that constitute the Operation of Ships with the result that the gross revenue from such Ship Leasing may be considered to be gross revenue from the Operation of Ships. In this regard with respect to the Sub-Time Chartering Out example in paragraph 1 above from E 9611145 the key factors are as follows.

a. The ship which is Sub-Time Chartered Out is at risk in the Operation of Ships business of the shipping company.

b. The ship that is Sub-Time Chartered Out was initially Time Chartered In for the specific purpose of being used in its Operation of Ships business by the shipping company.

c. The Sub-Time Chartering Out of a ship resulted from a change in the intended use of the ship brought about by on unforeseen events occurring subsequent to the time the ship was Time Chartered In by the shipping company.

d. The ship is Sub-Time Chartered Out on a temporary basis and will be returned to the shipping company's Operation of Ships business as soon as is reasonable in the circumstances.

In addition, the last sentence of paragraph 5 above from E 9611145 provides an example where non-Operation of Ships activities performed by the shipping company for other persons may be considered to pertain to or to be incident the Operation of Ships business and the gross revenue earned from such non-Operation of Ship activities may be considered to be gross revenue from the Operation of Ships.

The distinction between Operation of Ship activities and non-Operation of Ships activities is required for the purpose of applying the gross revenue test in paragraph 250(6)(b) of the Act. For the purpose of the gross revenue test, where a shipping company's activities do not consist solely of the Operation of Ships activities, to the extent that its other activities do not pertain to or are not incident to its Operation of Ships activities, the gross revenue from the other activities will not be considered from the Operation of Ships.

An analysis of the gross revenue streams of the shipping company by type for the year will indicate whether or not the shipping company carried out only Operation of Ships activities or carried out a combination of Operation of Ships activities and non-Operation of Ships activities. If the shipping company has carried out a combination of the two types of activities an analysis will have to be made to determine whether or not any of the non-Operation of Ships activities of the shipping company pertain to or are incident to the shipping company's Operation of Ships activities. Such a determination is a question of fact which can only be carried out with full knowledge of all the relevant facts. While in the very specific circumstances set out in the examples in paragraphs 1, 2, and 5 above from E 9611145, the CRA's position is that the gross revenue resulting from those particular non-Operation of Ships activities may be considered to be gross revenue from the Operation of Ships, the CRA does not have any predetermined thresholds for determining whether non-Operation of Ships activities of a shipping company pertain to or are incident to the shipping company's Operation of Ships activities. In this regard, paragraphs 5 and 6 of IT 73R6 "Small Business Deduction" set out what in our view are key factors that should be considered to determine if income from a leased ship pertains to or is incident to the Operation of Ship Activities of a company.

The Business Model

The business model provided in your letter of September 16, 2009 can be described as follows:

The example is of a shipping company whose business involves the Commercial Management of a large fleet of ships, all of which are Time Chartered In. For legal purposes, some of the ships are owned by separate related entities and Time Chartered to the company on long term Time Charters. Other ships are Time Chartered In from third parties. Under the business model adopted by the company, all of its ships are managed as one fleet and are considered by the company to be part of a single business. All of the ships are potentially available for use under Voyage Transport Charters, CoA's, short term Time Charters, or longer term Time Charters. It is very unlikely that for any ship a Sub-time Charter Out would be on the same terms, or for the same duration, as the Time Charter in. No particular ship is designated for a particular use and, over the life of any ship, the company's intention may at times be to employ the ship under Voyage Transport Charters or CoAs and at another times under a Time Charter. It is possible that, during periods of economic uncertainty when there are fewer opportunities to fix Voyage Transport Charters at favourable rates, the company's intention will be to employ its ships by entering into longer term Time Charters whenever an appropriate opportunity arises.

The company's approach to deciding whether or not it employs a ship under a Time Charter is governed by a variety of complex economic and commercial factors. These include the following:

• Balancing overall business risk by having some exposure to predictable cash flows in the fixed rate Charter market, as well as to less predictable but potentially higher returns from the variable rate market.
• Reducing business risk by employing a higher percentage of ships in the fixed rate market when market conditions for a particular type of ship are poor.
• Balancing the certainty of obtaining higher than market returns on the fixed market in the shorter term against the potential future loss of returns if the spot market improves. This may mean that the company decides to employ a ship on a longer term Time Charter even though there are still opportunities available to enter into Voyage Transport Charters.
• Maintaining a certain minimum level of cash flow from longer term fixed business to help maintain a constant level of dividend payments.
• Meeting customer requirements for longer term Time Charters to develop an important strategic customer relationship.

The business model above describes a shipping company whose business activities are a combination of the Operation of Ships activities and Ship Leasing. As discussed above, for the gross revenue earned by the shipping company from its Ship Leasing activities to be considered to be gross revenue from the Operation of Ships, the Ship Leasing activities would have to pertain to or be incident to the Operation of Ships activities. For the following reasons, based on the above description of the business model it appears that a shipping company following that business model would not be able establish that its Ship Leasing activities pertain to or are incident to its Operation of Ships activities.

• The example set out in paragraph 1 above from E 9611145 does not apply to the Ship Leasing activities which would be carried out by a shipping company following the business model. In this regard consider the following.

a. There is no indication that a ship which is Sub-Time Chartered Out is at risk in the Operation of Ships by the shipping company.

b. The ships that are Sub-Time Chartered Out are not initially Time Chartered In for the specific purpose of being used in the Operation of Ships by the shipping company.

c. The Sub-Time Chartering Out of a ship does not result in a change in the intended use of the ship brought about by unforeseen events occurring subsequent to the time the ship was Time Chartered In by the shipping company.

d. There is no indication that a ship which is Sub-Time Chartered Out is Sub-Time Chartered Out on a temporary basis or that it will be used in the Operation of Ships by the shipping company when the period of Sub-Time Charter Out expires.

• Based on the findings of the courts in interpreting the meaning of "pertains to or incident to" as set out in paragraphs 5 and 6 of IT 73R6, The Small Business Deduction, it appears that the Ship Leasing activities of a shipping company following the business model are not otherwise pertaining to or incident to the Operation of Ships activities of the shipping company. In this regard consider the following.

a. Ship Leasing by the shipping company of some of its ships does not appear to be dependent on or subordinate to the Operation of Ships activities of the shipping company.

b. The Operation of Ships activities of the shipping company do not appear to rely on any of the ships which are Sub-Time Chartered Out such that the Sub-Time Chartered Out ship is a back-up asset that could support the Operation of Ships activities of the shipping company on a regular basis or from time to time.

c. The ships that are Sub-Time Chartered Out by the shipping company do not appear to be necessary to sustain the Operation of Ships activities of the shipping company.

d. It does not appear that the ships that are Sub-Time Chartered Out were Time Chartered In to be employed and risked in the Operation of Ships activities of the shipping company to fulfil a requirement which had to be met by the Operation of Ships activities of the shipping company.

In summary for the purpose of the gross revenue test in paragraph 250(6)(b) it appears that a shipping company following the business model described above would be earning revenue from its Ship Leasing that does not qualify as revenue from the Operation of Ships.

Pool Arrangements

Pool Arrangements are a way of doing business in the shipping industry. A Pool Arrangement is an agreement between a number of shipping companies (Pool Members), who have the right (because they are owners of the ship(s) or have Bareboat Chartered In the ship(s) or have Time Chartered In the ship(s)), to exploit the earning capacity of similar ships by cooperating in the Commercial Management of all the ships committed to the Pool Arrangement. While various legal structures may be adopted for a Pool Arrangement, in general, under the agreement by which a Pool Member commits a ship to the Pool Arrangement, the ships are placed under the management of the Pool Manager who is responsible for the Commercial Management of the fleet of ships in the Pool Arrangement. The Pool Manager markets the ships in the Pool Arrangement as a single entity, negotiating Time Charters, Voyage Time Charters, Voyage Transport Charters and CoAs. The Pool Manager collects the earnings of the pool and distributes them to the individual Pool Members in accordance with the terms of the Pool Arrangement.

In the Pool Arrangement described above, the shipping service of the Pool Arrangement itself is performed by persons who own the ships and have crewed them or who have Bareboat Chartered In the ships and have crewed them. Therefore where the ship committed to the Pool Arrangement by the Pool Member is owned or Bareboat Chartered In and crewed by the Pool Member, the Pool Member is the person who provides the shipping service. Such Pool Member's gross revenue from the Pool Arrangement with respect to the ship will be gross revenue from the Operation of Ships. Where however, the Pool Member has Time Chartered In a ship, and commits that ship to the Pool Arrangement, it would generally be the owner of that ship or the person who Bareboat Chartered In that ship and crewed it (footnote 5) that performs the shipping service of the Pool Arrangement and not the Pool Member. Such Pool Member's gross revenue from the Pool Arrangement with respect to the ship will not be gross revenue from the Operation of Ships.

While we have not examined any actual Pool Arrangements, it is our understanding that certain other Pool Arrangements under which a shipping company commits a ship to a Pool Manager can create a principal/agency relationship between the shipping company and the Pool Manager. Where Operation of Ships activities (e.g. the Technical or Commercial Management of a ship) are carried on by Pool Manager as agent on behalf of Pool Member who is the principal in the arrangement, the gross revenue from such activities will be considered revenue from the Operation or Ships for the purposes of purposes of paragraph 250(6)(b) of the Act.

We trust that these comments will be of assistance to you.

Yours truly,

Olli Laurikainen, CA
Section Manager
for Division Director
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 Income Tax Act (Canada), R.S.C. 1985. c. 1 (5th Supp.) as amended. All statutory references herein are to Income Tax Act unless otherwise specified.
2 Actually for the purposes paragraph 81(1)(c) the term " international traffic" is defined in subsection 248(1) and in limited circumstances, involving the Great Lakes and the St. Lawrence River, international traffic as so defined can be broader than International Traffic as defined for the purpose subsection 250(6). That difference has no impact on the issues addressed in this document.
3 68 DTC 5033 SCC and 66 DTC 5358 ECC
4 Currently paragraph 81(1)(c).
5 This person could be the owner of the ship who entered into Time Charter with the Pool Member or where there has been a series of Time Charters involving the ship before it was Time Chartered In by the Pool Member, the owner of the ship that entered into the first Time Charter in the series. In either case the owner of the ship is responsible for the Technical Management of the ship and the gross revenue that person is earning from such Time Charters is gross revenue from the operation of ships.