If You Need Further Information Regarding This Presentation Or How the Final Section 883

SEWARD & KISSEL LLP

NOTICE TO INTERTANKO MEMBERS: Please be advised that the following presentation made by James C. Cofer, Esq. in Athens, Greece on January 20, 2004 represents the state of U.S. federal income tax law, regulations, administrative interpretation and court rulings as of January 20, 2004. The presentation does not reflect subsequent changes, some of which may apply retroactively. Please be further advised that this presentation does not constitute legal advice. You are urged to consult your own tax advisors regarding the particular federal, foreign, state and local tax considerations applicable to your specific circumstances.

If you need further information regarding this presentation or how the Final Section 883 Regulations applies or impacts your particular U.S. tax position, please contact either Derick W. Betts, Jr. at (212) 574-1662/[email protected] or James C. Cofer at (212) 574-1688/[email protected] of Seward & Kissel LLP, 1 Battery Park Plaza, New York, New York 10004.

INTERTANKO Presentation Athens, Greece January 20, 2004

I. Introduction and History

Good afternoon. My name is Jim Cofer and I am an attorney with Seward & Kissel LLP in New York. I would like to thank the INTERTANKO Hellenic Forum and the Union of Greek Shipowners for inviting me to speak today.

I’m here to discuss the recently finalized regulations under Section 883 of the U.S. tax code as well as other recent developments in U.S. tax law which may impact your companies.

My presentation today will have five parts: First, I will review briefly the history of Section 883. Second, I will give you a general overview of the final regulations under Section 883. Third, I will point out some specific issues in the final regulations that particularly impact the members of INTERTANKO. Fourth, I will explain the taxation of a foreign corporation when Section 883 is not available. Finally, I’m going to briefly discuss the recent reduction in U.S. tax rates on dividends paid by certain foreign corporations.

The current version of Section 883 was enacted as part of the Tax Reform Act of 1986, which was the first comprehensive revision of the U.S. Internal Revenue Code in 32 years. Prior to the revision of Section 883, taxation of international shipping companies was “flag-based,” meaning that in order to be exempt from tax, a corporation’s vessels merely had to be registered in a country which provided a reciprocal exemption from income tax to U.S. corporations.

In revising Section 883, the Congress was evidencing concern that the rise in flags of convenience had eroded the U.S. tax base by allowing corporations

The actual text of Section 883 is rather sparse and therefore there was an obvious need for the IRS to provide regulatory guidance. The first regulatory guidance was issued by the IRS in 2000 in the form of proposed regulations. The industry provided extensive comments on these regulations and, in 2002, the IRS withdrew the 2000 proposed regulations and issued reproposed regulations, which were a significant improvement, although they still contained flaws. The industry provided additional comments on the 2002 reproposed regulations and in August 2003, the IRS issued final regulations under Section 883, which are effective for tax years of foreign corporations beginning on or after September 25, 2003.

II. Basic Structure of the Final Regulations

A. Introduction—Tests

Before delving into their substance, let me say that the Final Regulations are a significant improvement on the proposed regulations and the reproposed regulations. Although we as representatives of the shipping industry did not get everything we wanted in the final regulations, the IRS was willing to listen to us and to modify its thinking on a variety of issues.

The final regulations provide, in general, that “qualified income” of a “qualified foreign corporation” from the “international operation of ships” is exempt from U.S. federal income tax. So, to break that down, there are three requirements for exemption under Section 883:

(1) The earning of “qualified income,”

(2) Being a “qualified foreign corporation,” and

(3) Engaging in the “international operation of ships.”

Let me break down each of those requirements for you.

B. Qualified Income

First, what is “qualified income”?

Qualified income is income derived from the international operation of ships or certain incidental activities, which is the subject of an equivalent exemption from the foreign country in which the foreign corporation is organized. In other words, Section 883 operates on a concept of reciprocity. A category of income, for example, bareboat charter income, is exempt from U.S. tax under Section 883 only if the country in which the foreign corporation is organized provides a reciprocal exemption from tax to U.S. corporations. This reciprocal exemption may be provided by internal law, an exchange of diplomatic notes or

C. Qualified Foreign Corporation

Second, what is a “qualified foreign corporation”?

A “qualified foreign corporation” is a corporation which satisfies two tests: “country of organization test” and the “stock ownership test.”

First, the country of organization test…which is fairly simple.

A foreign corporation will satisfy the country of organization test if it is organized in a “qualified foreign country,” which is a country that grants an equivalent exemption from tax to U.S. corporations with respect to a category of income. This is a further illustration of the reciprocity concept. The IRS has published a non-exclusive list of countries which are qualified foreign countries.

Second, the stock ownership test…which is not so simple.

The stock ownership test can be satisfied by meeting one of three alternative tests: (1) the qualified shareholder stock ownership test, (2) the publicly-traded test, or (3) the CFC ownership test.

The Qualified Shareholder Stock Ownership Test…

A foreign corporation will satisfy the qualified shareholder stock ownership test if more than 50% of the value of its outstanding shares is owned for at least half the number of days in the foreign corporation’s taxable year by a qualified shareholder—meaning an individual resident of a “qualified foreign country” or an entity such as a publicly traded corporation, foreign government or pension fund. It is important to note that a qualified shareholder does not have to be resident in the same foreign country in which the foreign corporation is organized. So, for example, the common structure in which a Liberian corporation is wholly owned by non-Liberians remains permissible.

Obviously, a publicly-traded corporation will not know the identities of most of its shareholders. Therefore, the regulations contain the Publicly-Traded Test.

A foreign corporation will satisfy the publicly-traded test if its stock is primarily and regularly traded on an established securities market, either in the United States or in a qualified foreign country. However, there is a very important exception to the publicly-traded test, known as the closely-held exception. The closely-held exception provides that a class of stock of a foreign corporation will not satisfy the publicly traded test if 5% shareholders (by vote and value) of the foreign corporation own 50% or more of the vote and value of such class of stock on more than half the days of the taxable year, unless the

I think an example will help illustrate the closely-held exception:

Assume FC, a corporation organized in Liberia, which is a qualified jurisdiction, has one class of stock which is primarily and regularly traded on a qualified stock exchange in the United States. On January 1, 2004, FC has three 5% shareholders: USP, a United States person, who owns 6% of FC’s stock and two U.S. based hedge funds, HF1 and HF2, that own 25% and 15%, respectively, of FC’s stock. The combined ownership of the three shareholders is 46%.

On June 1, 2004, HF3, a U.S. based hedge fund, acquires 5% of FC. So, now FC is 51% owned 5% shareholders and FC will be retroactively denied the benefit of the Publicly-Traded Test for 2004 unless either (1) it can convince one of its 5% shareholders to reduce its stock holdings prior to December 1, 2004, or (2) it can identify sufficient qualified shareholders in the closely-held block to reduce the ownership of the closely-held block below 50 percent. As a practical matter, it will be impossible to identify sufficient qualified shareholders in the closely-held block because USP is a non-qualified shareholder and HF1, HF2 and HF3 are unlikely to identify their ultimate beneficial owners and even if they do, most of these investors are likely to be U.S. persons since each of the hedge funds is a U.S. based entity.

If FC fails to rectify its ownership situation by December 1, 2004, it will lose its Section 883 exemption from U.S. federal income tax for the entire year.

I must add that although this closely-held rule may be problematic, it is a big improvement from the proposed regulations and reproposed regulations, which would have disqualified a class of stock of a foreign corporation from the publicly-traded test if at any time during the taxable year 50% or more of such class was owned by five percent shareholders. This would have eliminated the opportunity which exists in the above example to reduce the holdings of a shareholder below 5 percent to avoid the application of the closely held exception.

The CFC ownership test applies to foreign corporations which are controlled by U.S. shareholders and I will not discuss it in detail.

D. International Operation of Ships

Third, what is the “international operation of ships”?

The international operation of ships means the carriage of passengers or cargo on voyages that begin or end in the United States. The definition includes the carriage of passengers or cargo for hire, or the leasing out of a vessel under a time or voyage charter, space or slot charter or bareboat charter, provided the vessel is used to carry passengers or cargo for hire.

4 © 2004 SEWARD & KISSEL LLP These activities may be conducted directly by the foreign corporation or, as I’ll discuss in more detail later, through a joint venture, such as a pool, partnership, strategic alliance or joint operating agreement.

E. Substantiation

There are also procedural requirements to satisfy the Section 883 exemption. The final regulations require a foreign corporation to make filings with the IRS and to collect information regarding its shareholders.

First, a foreign corporation must file a U.S. Federal Income Tax Return— Form 1120F—which provides a reasonable estimate of its gross income in each category and identifies by name and address each ultimate 5% beneficial owner relied upon to satisfy the stock ownership test.

Second, a foreign corporation must obtain, prior to filing its U.S. tax return, ownership statements, signed under penalties of perjury, from every entity or person in its chain of ownership to substantiate its satisfaction of the stock ownership test. Such ownership statements must be made available to the IRS upon request.

This process is simpler for satisfaction of the publicly-traded test.

III. Specific Issues with Respect to INTERTANKO

Now, I want to move on to a few specific issues which may be of interest to your companies.

As I mentioned at the beginning of my presentation, the industry provided a large number of comments to the IRS on both the proposed and reproposed regulations. Seward & Kissel, on behalf of INTERTANKO, commented on the reproposed regulations in a letter to the IRS and Derick Betts of our firm testified at a public hearing in Washington D.C.

A bit of history here for a moment with regard to comments we made on behalf of INTERTANKO on the proposed regulations when they were issued in 2000—we were quite happy with the reproposed regulations because they modified the proposed regulations by including lightering operations within the definition of “international operation of ships,” which was obviously a critical issue. However, there were three issues which we felt needed to be addressed in comments to the IRS regarding the reproposed regulations, first, the treatment of joint ventures; second, the treatment of funds awaiting repatriation and third, the treatment of unladen backhaul voyages.

A. Joint Ventures

On joint ventures, the Reproposed Regulations provided that a foreign corporation would be considered to be engaged in the international operation of

5 © 2004 SEWARD & KISSEL LLP ships with respect to its participation in a joint venture if such joint venture was conducted through a fiscally transparent entity for example a partnership or LLC which itself would be considered to be engaged in the operation of ships or aircraft.

We were concerned that the IRS would interpret the regulations to require each transparent entity in a multi-tiered structure to be engaged in the international operation of ships, which was inconsistent with ordinary commercial practice. Therefore, we requested that the Reproposed Regulations make clear that only the transparent entity generating shipping income would be required to be engaged in the international operation of ships. The IRS accepted this comment.

To take a very simple example, assume Foreign Corporation 1 and Foreign Corporation 2 want to enter into a joint venture. They form a joint venture entity, which is fiscally transparent. The Joint Venture entity is merely a holding company which forms a wholly-owned operating entity engaged in the international operation of ships. Under the reproposed regulations, the income from the operating entity may not have been exempt from tax under Section 883 because the joint venture entity was merely a holding company not engaged in the international operation of ships. Under the final regulations, it is clear that the income generated by the operating entity will be exempt.

B. Repatriation of Funds

With respect to the repatriation of funds. Income derived from activities which are incidental to the international operation of ships is exempt from gross income under Section 883. Under the Reproposed Regulations, the temporary investment of working capital funds to be used in the international operation of ships by a foreign corporation was considered incidental but Treasury activity involving the investment of excess funds or funds awaiting repatriation, even if such funds were derived from the international operation of ships, was not considered incidental.

We were concerned about the treatment of funds awaiting repatriation because as the United States is a major importer of foreign oil, payments for the transport of oil are often made to vessel operators in U.S. dollars at U.S. banks, and, given the time zone differences, these monies are often invested by the recipient on an overnight or over-the-weekend basis before being repatriated abroad.

In our comment letter to the IRS on behalf of INTERTANKO, we pointed out that such transport revenues should be characterized as part of a vessel operator’s working capital and, since the investment in U.S. banks is temporary, any interest thereon should be exempt from tax under Section 883. However, we pointed out that the interest on such revenues could be viewed under the regulations as income from the investment of “funds awaiting repatriation” and

Unfortunately, the IRS did not address this comment in the final regulations and the conflict between the language in the regulations remains. However, we believe that interest earned on amounts deposited in U.S. banks on an overnight or over-the-weekend basis while awaiting repatriation should in many cases be viewed as the temporary investment of working capital funds and therefore exempt from tax under Section 883 I must caution, though, that this view is not free from doubt and it may be challenged by the IRS.

C. Backhaul

With respect to backhaul voyages, we were concerned that under the Reproposed Regulations, the owner of a tanker under time charter would cease to be engaged in the shipping business within the meaning of Section 883 when the vessel, after discharging its oil cargoes at a U.S. port, goes unladen on “backhaul” to the Middle East to pick up another oil cargo for transport to the United States. In the context of the tanker trade, the backhaul is an essential and integral component of the business of transport of oil cargoes. In the absence of the backhaul leg, the vessel would cease to be able to carry any further cargoes.

Fortunately, the IRS was receptive to this comment and modified the final regulations accordingly. Under the final regulations, an unladen backhaul voyage will be treated as being part of the charter of ships for hire and will not effect qualification under Section 883.

IV. Consequences of Failure to Qualify

So, those are the final Section 883 regulations, but what happens when a foreign corporation fails to qualify for exemption under Section 883?

Such a foreign corporation will be subject to one of two alternative tax systems on its U.S. Source Transportation Income which includes 50% of gross income derived by vessel trading to or from U.S. ports and includes bareboat, time and voyage charter income and freights.

The taxation of a foreign shipping corporation not exempt under Section 883 depends on whether it is engaged in a trade or business in the Untied States within the meaning of the tax code. A foreign shipping corporation will be engaged in a U.S. trade or business taxpayer only if (1) such corporation has a fixed place of business in the United States involved in earning of U.S. source transportation income and (2) substantially all of its U.S. source transportation income is attributable to “regularly scheduled transportation” or to the U.S. fixed place of business in the case of leasing income.

A corporation which is engaged in a U.S. trade or business, will be subject to tax on its net U.S. source transportation income at an effective rate of 54.5%, combining the regular corporate income tax and the so-called branch-profits tax.

V. The Future

The final regulations under Section 883 are the result of a great deal of time and effort by people in the government and representatives of private industry. In general, this process turned out to be relatively cooperative, with the IRS willing to listen to the industry and the industry recognizing the concerns of the IRS. The final regulations are generally beneficial to the industry and a vast improvement compared to the first set of proposed regulations. In short, they are something we can work with.

VI. Developments Outside of Section 883

I wanted to comment on one additional development which may be of interest to your United States shareholders, and that is the recent reduction in the rate of U.S. income tax on dividends paid by corporations.

The Jobs and Growth Tax Relief Reconciliation Act of 2003 reduces the U.S. income tax rate on dividends received by an individual from a “qualified foreign corporation” to 15% through the 2008 tax year.

A foreign corporation will be a “qualified foreign corporation” if it is eligible for the benefits of a comprehensive income tax treaty with the United States, as determined by the Treasury Department, or if the dividend is paid by the foreign corporation on stock (including an ADR) which is readily tradable on an established securities market in the United States.

Eligibility for the 15% rate is subject to additional restrictions, which are quite technical, but you should certainly consult your tax advisors if you are considering paying dividends to U.S. shareholders.

Thank you for the opportunity to speak on these important issues.

***

99999.0014 #455498v3