A Taxing Time – The Perils of Yacht Ownership in the EU
Posted Dec. 2, 2011, 9:54 a.m.
By Alex McBarnet and Adrian Jones
“In this world nothing can be said to be certain, except death and taxes.” (Benjamin Franklin)
Yachts are often referred to as very expensive toys but even those used purely for private/pleasure purposes are almost always owned by bodies corporate (limited companies, partnerships, etc). There are three principle reasons for this: legal liability, operational management and fiscal efficiency. Yachts can generate potentially huge legal liabilities that may exceed or not be covered by insurance. The responsibility for these liabilities lies with the owner and any and all other assets of the owner may be at risk. Using an entity with limited liability and limited assets as the owner of the yacht helps to protect the actual individual behind the yacht, often referred to as the ultimate beneficial owner (UBO). Large yachts are also very complex and time consuming assets to operate; they may be in business, they have their own workforces (the crew) and they have to meet a myriad of rules and regulations. Obviously there are numerous agencies that can manage these issues for the UBO but each may take care of only part of the picture. An ownership vehicle can be used to coordinate all of these issues and bring them under one roof. And finally, yachts are high value assets that may incur large tax liabilities. Questions such as jurisdiction of ownership and use have a large impact on what taxes may be due and corporate ownership may help make the yacht more fiscally efficient.
On the 1st January 1993 the single market of the European Union came into effect. This put an end to the common practice of sailing yachts from one European country to another every six months or less and thereby benefiting from the then temporary importation rules. Pre-1993 very few yachts had been subject to value added tax (VAT) in any EU member state but on the 1st January 1993 this changed for many if not most of them. The desire to avoid this new VAT cost spurred a great deal of activity in the tax planning community and a new sector of the yacht industry was effectively born.
Many yachts that were in the EU at the start of the Single Market, and were built pre-1985, were automatically VAT paid. Other owners simply decided to pay any VAT due at that time. Where yachts became subject to VAT much thinking went into how to minimise this new tax burden. Businesses are able to register themselves for VAT and thereafter reclaim VAT on much of their business expenditure. Treating yachts as commercial assets, rather than private assets, was therefore a logical step. Of course yachts had been used in business before 1993, but now owners that had previously wanted to use the yacht for private purposes only were beginning to see the advantages of business use.
There are two principle types of commercial activity that yachts engage in: charter and leasing. Under a charter structure a company owned, or at least beneficially owned by the end client would set up and register for VAT in an EU member state. The yacht would be offered for commercial charter and, in theory at least, VAT would be applicable on the charter fees. Benefits of this type of structure included recovery of VAT on the acquisition of the yacht, recovery of VAT on many of the ongoing costs of operating and maintaining the yacht and in many circumstances duty free fuel as well.
Lease structures were fundamentally different in that the yacht would be acquired by a lease company independently of the client. The yacht would then be leased to the client and could benefit from certain VAT advantages dependent on the type of lease used. The three main yachts leases that developed after 1993 were operating leases, cross-border leases and so called French, Italian and Maltese leases. The lease company itself was in business and therefore could reclaim VAT on the acquisition of the yacht but as the yacht would ordinarily be used privately by the lessee recovery of VAT on ongoing costs and duty free fuel were not available.
Operating leases were the most simple of the leases. The yacht would be bought by the lease company and then leased to the client on a long-term basis, usually twenty years. Whilst VAT would have been recovered on the purchase of the yacht it would be charged on the lease instalment payments, however, this meant that the VAT cost was spread over a twenty year period instead of being a one-off up-front cost. The tax advantage was the deferment of VAT.
The cross-border lease was somewhat more complicated and utilised the differences in financial legislation between different EU member states. By offering the yacht lease from an EU member state whose VAT legislation was based on one set of principles and commencing the lease in a member state whose VAT legislation was based on a different set of principles, it was possible to create an arbitrage on the VAT normally due on the lease instalment payments. Effectively it appeared to be impossible to pay VAT on the lease instalments either in the country where the lease was offered or in the country where it commenced. The tax advantage of this was obvious.
The French, Italian and Maltese leases were based on the principles of EU VAT law that state that VAT should be due on the lease of a yacht only when that yacht is in EU territorial water. The governments of these three countries offered concessions to pre-calculate the amount of time that a yacht was deemed to spend outside of EU territorial waters and thereby remove the VAT liability on a portion of the cost of the lease. A certain amount of VAT would still be due as the yachts were considered to spend some of their time in EU waters but the total cost of VAT to the client would be greatly reduced.
“The difference between tax avoidance and tax evasion is the thickness of a prison wall.” (Dennis Healey)
Governments have specifically targeted wealth and luxury items for tax and, in recent years, yachts have been no exception. Yachts, in fact, attract excessive treatment by the authorities (the notorious Matriculation Tax in Spain at 12% of the yacht value is a prime example). Yachts are generally bought with tax paid funds and many owners consider further taxation to be quite unwelcome. There is a growing “moral” pressure from governments for people to pay as much tax as possible but on the whole there is no obligation to pay more tax than is strictly required so tax planners have long advised on how to legitimately avoid or mitigate tax. Some people (albeit a small minority) have clearly overstepped the boundary of avoidance into evasion, however, it should be noted that given the complexity of the tax issues some infringements of tax law have been entirely inadvertent.
Some arrangements were quite obviously abusive, such as chartering a large yacht for one pound per day and therefore claiming that it was used in business, but others were not so clear cut. Many yachts were chartered exclusively to their own beneficial owners yet still qualified for full VAT recovery as though they were in business and cross-border leases made it possible for yachts to escape almost all VAT due. In the case of chartering only to the yacht’s own beneficial owner this was made possible through the consent, at the time, of the relevant tax authority and in the case of the cross-border lease this was, and remains, perfectly legal, although perhaps more in the letter rather than in the spirit of the law.
The concept of running a charter business whose sole purpose was to charter the yacht to its own beneficial owner has now been quashed. This was largely done by pressure being applied from other tax authorities who were not satisfied with such arrangements. The cross-border lease arrangements fell foul of heightened EU tax authorities’ interest, presumably inspired by the EU Commission. A number of EU countries acted jointly to investigate and challenge these leases. They were unhappy that the leases took advantage of an apparent gap in the law that allowed the largest element of the VAT cost of the lease to escape. Whilst the “VAT gap” may have been legitimate the frustration caused to clients by the tax authorities was sufficient to persuade most providers to close this particular ownership route.
Other types of lease arrangements have also been challenged. Operating leases are no longer offered over long-term periods and financial leases have come under close scrutiny. Where yachts gained VAT reductions based on assumed sailing outside of EU waters the actual amount of time spent outside of the EU is now being checked rather more thoroughly than before (many did not in fact leave EU waters at all). And attention has also been given to the level of finance in place; if little or indeed no finance has been in place within a financial lease then its very status as a financial lease can be called into question and thus any VAT advantages that it might have provided may be annulled. French, Italian and Maltese financial leases remain possible but certain conditions have been tightened, especially in Italy.
In France the EU Commission has looked to limit the application of a broad VAT exemption for which most commercial yachts qualify (commonly referred to as the French Exemption) and infraction proceedings have been initiated against France. Whilst the French Exemption is based on indicators required for “use on the high sea” as required by the EU VAT Directive the Commission does not deem these sufficient to warrant the almost complete exemption of VAT from most commercial yachts.
Spain, as previously mentioned, continues to impose Matriculation Tax on yachts. This may appear in many ways to be an additional form of VAT but Spain has been careful to make it a “special tax” rather than VAT as together with Spain’s standard rate of VAT the total rate of tax has always been 28% and thus above the upper VAT limit imposed by the EU. Greece has recently introduced new taxes on yachts in an attempt to exploit the rich.
A different world
Increased scrutiny, pressure on yacht-friendly jurisdictions by less friendly neighbours, EU Commission action, special and luxury taxes and the application of recent cases (such as Halifax Plc, Part Service srl) have all combined to both increase the level of tax EU yacht owners face and reduce their ability to mitigate them. Yacht owners would not be wrong in thinking that the Mediterranean is today a much less welcoming playground than in the past.
The future, however, is not all doom and gloom. Some of the rather fast and loose behaviour of the past may indeed no longer be possible but tax efficiency in yacht ownership is still possible. Yachts are still able to be operated as charter businesses so long as there is a clear and real intent to operate them along established business principles. And yachts can still be leased with VAT benefits based on non-EU use so long as the non-EU use can be evidenced.
Recent cases of yachts being arrested and taxes, penalties and interest being charged highlight the fact that yacht ownership can be fiscally perilous but with professional tax advice, proper planning, correct implementation and expert administration of ownership structures yacht ownership can and should remain a pleasure.
Alex McBarnet is Managing Director of United Marine and Aviation, part of United Trust
Adrian Jones, CTA is Director of BlackStar VAT Services, part of the BlackStar Group