VAT problems when chartering in the EU

20 January 2015 • Written by Lisa Overing
VAT laws within the EU are not standardised. This means each country has its owns taxation laws and regulations.

VAT is the one constant that has haunted the yachting community in the European Union (EU) for years. Owners have long relied on the tax advice of yacht managers, brokers, customs agents and captains.

To be fair, most owners have managed to sail unhindered, but the reality was that there was much illegal sailing, be it on import VAT, illegal chartering or misuse of VAT-free fuel. But they were getting away with it and because of that people drew the conclusion 'we are doing it, no one is stopping us, it must be OK'.

With recent declarations from customs authorities on the amount of VAT they say is leaking from the system, plus the tightening of rules, the effective shutting down of imaginative leasing schemes, and a recent high profile VAT-linked yacht arrest, owners need to wake up to what they should be doing on VAT.

This is not necessarily a guide, but it should direct the yacht owner, manager or charter manager to seek clear tax and legal guidance.

The VAT problem

From a certain point of view the rules are simple: if you buy a yacht for your use and bring it into the EU you have to account for VAT in some way or other. At a basic level, you buy or you import into the EU, you pay VAT.

A yacht cannot be a little bit commercial and little bit private and operate in laissez faire way. There are strict rules. If a yacht looks private lots of personal effects on board and only the ultimate beneficial owner and his family directly or indirectly ever use it, the arrangement cannot benefit from tax advantages.

In the UK, the tax authorities use the phrase 'earnestly pursued' as a test for the operation of a valid yachting business for VAT purposes. That is, are you running a real chartering business or just going through the motions?

So what has precipitated the current tax hiatus? A significant minority of owners have or are perceived to have abused the system. Hundreds of millions of euros is potentially there for the taking in unpaid tax.

EU hunt for VAT dodgers

Customs authorities across the EU have been working together to prove that owners establish layers of sham companies which are used to charter their own yachts and are conducting investigations all over Europe, looking for the one person in the chain, from builder to captain to broker, who says the owner of a particular yacht is Mr or Ms X and not the company that is the registered owner. This is difficult to prove, but traps are being laid.

The current legal proceedings in Italy involving non-EU-flagged vessels are based on an alleged infringement of EU Custom Regulations and the lawfulness of the provision of yachting services in the EU. The tax authorities are disputing whether EU VAT-registered yachts flying, for example, UK overseas territories' flags can continue to provide services in EU waters, contrary to what is permitted as a consequence of any associated VAT registration. They argue that if you have a non-EU flag you cannot operate legally in the EU and all the tax breaks fall away.

Italian tax authorities say non-EU flags fall outside cabotage freedom and can't provide chartering services in the EU.

EU VAT inconsistencies

What it has exposed is the inconsistency between the rules set out in Regulation (EEC) 3577/92 of 7 December 1992 applying the principle of freedom to provide services to maritime transport within member states (the maritime cabotage regulation), and the rules set out in Regulation 2913/92, establishing the Community Custom Code and Council Directive 2006/112/EC of November 2006 on the common system of value-added tax.

Contrary to the interpretation given by the Italian tax authorities, I believe the view of the European Commission (EC) is that yacht chartering services fall outside the scope of the maritime cabotage regulations, meaning that EU VAT-registered commercial yachts, should be free to trade within EU waters provided it is carrying out a legitimate chartering business and VAT chargeable on acquisition, importation or earnings is duly accounted for in the EU, regardless of flag.

It appears that as a consequence of incorrectly applying the rules of the EU maritime cabotage regime to chartering yachts, the Italian tax authorities submit that non EU flags fall outside cabotage freedom and cannot provide chartering services in the EU. But a misapplication of the rules does not stop arrests happening.

You may win the case but it will be stuck in the Italian legal system for some time, and as the matter is criminal your yacht will be under arrest for as long as it takes. In the meantime, the yacht's operations will be scrutinised for illegality, even if the original reason for arrest may have been ill conceived.

Self-chartering

But can the ultimate beneficial owner charter his/her yacht? In principle, yes, but the 'earnestly pursued' test is paramount: is the chartering activity carried out from a business perspective or for pleasure and private enjoyment of the yacht?

To qualify as a commercially operated yacht the tax authorities would seek documentary evidence of an operational structure such as a yacht management company, a charter broker negotiating the charter contracts, accounting activity of the charter income, and expenditures along with invoices and a bank account for receiving chartering income.

Another basic indicator would be the frequency of the chartering activity and the charter fees paid by the charterers and eventually the beneficial owner, which should be reasonable and in line with market rates applicable to similar yachts of the same value.

If a yacht is chartered for only few weeks during a charter season the tax authorities may consider it a private/pleasure yacht attempting to take advantage of VAT relief and benefits of the commercial scheme.

Having said that, if the beneficial owner wishes to charter his/her yacht, all the above requirements should be considered and fully complied with to avoid the risk of tax liabilities. A genuine charter contract should be in place and the charter fee should be appropriate to the value of the yacht, full accounting evidence and records of the payment made by the beneficial owner to the owning company should be kept and reflect the cash flow of the chartering activity, and the duration of the charters undertaken by the beneficial owner should be of a limited time.

Do not assume that if you were legitimate in year one, two or three of your ownership you can drift a little on the detail. In the UK recently, owners were told if they did not comply with the commercial test they had to de-register as commercial. And if a yacht is in the EU on temporary importation, don't even think about chartering or letting your EU-based friends use your yacht.

Whatever happens, owners are well advised to conduct a tax audit of their yacht and how it is used. Contacting specialists like Moore Stephens or Baker Tilley in the Isle of Man should be the next thing you do.

Originally published: August 2010.

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