COVID-19 and Seafarers: Tax Shoals Ahead

The disruptions COVID-19 caused for the seafaring workforce have been well documented, and general guidance has been provided by the OECD, the IMF, and the United Nations, as well as via the Neptune Declaration on Seafarer Wellbeing and Crew Change and national legislation. The available guidance, to the extent each addresses tax matters, generally applies to cross-border workers but has not addressed the unique tax problems seafarers face during the time the vessels on which they were employed were anchored or docked during the COVID-19 pandemic. We encourage action by international organizations and nations to address the policy deficiencies that leave seafarers in untenable tax situations or have the potential to do so.

Background

With the advent of the COVID-19 pandemic, crew were stranded on ships throughout the world. Passenger ships were denied entry, and personnel were denied crew changes. Many vessels left service and anchored offshore or docked.¹ Crew were stranded on the vessels on which they worked, sometimes for months.

The precise number of seafarers affected is impossible to determine.² The situation was designated a humanitarian crisis.³

Nongovernmental Actions

More than 850 companies and organizations signed the Neptune Declaration, recognizing a shared responsibility to resolve the crew change crisis and learn from it.

The declaration describes actions that should be taken:

• recognize seafarers as key workers and give them priority access to COVID-19 vaccines;

• establish and implement gold standard health protocols based on best practices;

• increase collaboration between ship operators and charterers to facilitate crew changes; and

• ensure airlift capacity between key maritime hubs for seafarers.

As an agreement among operators, the declaration is primarily focused on actions operators can take without governmental intervention. Its suggestions for governmental action are limited to crew safety and movement and do not extend to addressing other consequences faced by crew, such as domestic taxation.

International Tax Recommendations

Some of the tax issues faced by workers unable to return home or to their usual places of employment have been addressed by the OECD in its guidance on the taxation of companies and individuals. The first publication was the “Secretariat Analysis of Tax Treaties and the Impact of the COVID-19 Crisis,” in which the OECD characterized the displacement of workers as a force majeure event and indicated that the degree of permanency required for a permanent establishment was not established by an employee being forced to work at home. Updated guidance on treaties and the pandemic issued in January 2021 provided additional information on national actions but was fundamentally the same.

Addressing individual employment income, the OECD expressed no reason to advocate a different interpretation of national laws or bilateral tax conventions, concluding that tax treaties, at least those based on the 2017 OECD model convention on income and capital, are adequate to avoid double taxation.

The U.N. Committee of Experts in International Tax Cooperation has not yet fully addressed the tax issues associated with COVID-19 worker displacement, but it has committed to finding gaps in national legislation and compiled a list of national and regional actions.⁴

The Problem

None of the declarations or work by international organizations focused on the potentially draconian tax consequences seafarers could face because of their unintended presence in various jurisdictions, compounded by the fact that the vessels on which they were employed were no longer engaged in transportation.⁵ The OECD’s focus on residency determinations does not address taxation of income at source, nor did the organization address situations of many seafarers in which no treaty is applicable.⁶

Mentioned in the updated OECD guidance are countries that through domestic legislation or administrative pronouncement have provided unilateral relief from a residency determination, but those countries are the minority.

This article examines several questions regarding the relief provided in Italy and the United States:

• For individuals subject to a treaty, does the broader exemption applicable to ship and aircraft crew under OECD model article 15(3) continue to apply, even though the vessel on which they were employed ceased to operate in international traffic? In the alternative, does the cessation of vessel operations move crew taxation into the general 183-day rule of model article 15(2)?

• If a treaty does not apply, do special national rules applicable to ships’ crew and the associated exemptions continue to apply, even with the changed circumstances resulting from the pandemic?

• If no treaty applies, how are source-based taxation principles applied to crew?

• What is the impact of national COVID-19 individual relief provisions for crew members?

OECD Model Article 15

The general rule for the taxation of employment income under article 15(2) of the OECD model convention is that income earned by a resident of a contracting state shall⁷ be taxable only in that state if:

• the recipient is present in the other contracting state for a period not exceeding 183 days in any 12-month period commencing or ending in the fiscal year concerned;

• the remuneration is paid by, or on behalf of, an employer who is not a resident of the other state; and

• the remuneration is not borne by the employer’s PE in the other state.

For crew members, model article 15(3) provides a broader allocation of taxing rights:

Remuneration derived by a resident of a Contracting State in respect of an employment, as a member of the regular complement of a ship or aircraft, that is exercised aboard a ship or aircraft operated in international traffic, other than aboard a ship or aircraft operated solely within the other Contracting State, shall be taxable only in the first mentioned state.

Article 15(3) has some requirements that may not have been met while ships were (or are⁸) out of service during, or as a consequence of, the pandemic:

• Employment must be as a member of the ship’s regular complement. During the time ships were out of service, the employment contracts for some crew members lapsed, and how owners addressed that is unknown. It is possible, particularly for cruise vessels, that some crew members would not be classified as part of the regular complement while on board after their contracts ended.

• The employment must be exercised on board a vessel engaged in international traffic, defined in model article 3(1) as any transport by a ship or aircraft except when operated solely within a contracting state. Implicit in the definition and confirmed in the commentary is the concept that international traffic must involve the transport of passengers or cargo. A vessel that is out of service and not engaged in the transportation of goods or passengers is not engaged in international traffic. That requirement applies equally to a crew member’s income from employment and a vessel operator’s income from the operation of ships and aircraft.⁹

• The above requirement does not apply to vessels or aircraft operated solely within the other contracting state. If we accept that vessels not transporting goods or passengers are not being operated, then they are not operated solely within that state — even if anchored or docked there. Thus, this restriction would not apply.

Consequently, crew on board out-of-service vessels may be off contract and therefore not members of the regular complement of the ship’s crew or not employed on board a vessel engaged in international traffic. In either case, they are ineligible for the broader relief of OECD model article 15(3) and instead must rely on the generally applicable rule of article 15(2).¹⁰

If the vessel was laid up in the territorial waters of the shipping company’s country of residence, both the employment is exercised in, and the employer is a resident of, the other contracting state. The general limitation of article 15(2)(b) prevents a crew member from claiming any treaty benefits based on physical presence.

If the vessel was instead docked in a country other than that where the employer is resident, the 183-day rule of OECD article 15(2)(a) would potentially apply. That is, if a crew member was not present in the other country for more than 183 days, relief from that source country’s tax may be available. However, if the crew member remains on the vessel more than 183 days in that jurisdiction, the country where the services are performed may tax wages earned.

Those conclusions assume that the contracting countries have not enacted residency relief provisions, such as those suggested by the OECD, or implemented them in such a way that relief would be available for the crew member.

Italian Income Tax Analysis

Italy’s maritime employment tax ramifications and employer withholding obligations depend on the combination of several variables, such as employee and employer residence, existence of a tax treaty between Italy and the employee or employer’s country of residence that follows OECD model article 15(3), an Italian PE of the employer, the location and flag of the ship, and use of the ship in international traffic.

Italian Residents

Italy follows the worldwide taxation principle unless a specific treaty provision applies. If the special regimes mentioned below do not apply, employment income realized by Italian-resident individuals on board a ship is subject to tax in Italy under the ordinary progressive rates, irrespective of the ship’s location.

Nonresident Aliens

Nonresident employees are taxed in Italy on income sourced there. Under article 23 of the Corporate Income Tax Act, employment income is sourced in Italy if the employee performs his activity in Italian territory.

A ship’s location and flag might become relevant to identify the portion of income considered realized in Italy. Article 4 of Italy’s Navigation Code provides that Italian ships – that is, ships sailing under an Italian flag — on the high seas are considered state territory, and ships sailing under non-Italian flags are considered flag-state territory unless in Italian territorial waters. The income realized by Italian-resident individuals aboard those ships should therefore be considered foreign income.

Special Regimes

Article 5(5) of Law 88 of March 16, 2001, provides a special regime under which income derived by Italian citizens who are maritime employees working aboard ships flying under foreign flags for more than 183 days in a 12-month period is excluded from the Italian tax base, regardless of the location of the ships and the tax residences of the employer and employee.¹¹ Moreover, the employee is not subject to any tax return obligation in Italy. Accordingly, if the ship sails under the Italian flag, income from employment earned by nonresident employees would be deemed sourced to Italy and would be subject to Italian income tax at the ordinary rates (regardless of whether the ship is operating in Italy or abroad). By contrast, if the ship sails under a non-Italian flag, employment income would be treated as Italian-source only if the vessel sails in Italian territorial waters.

The Ministry of Finance clarified in Circular Letter 207 of November 16, 2000, that the 183-day period does not have to be continuous; it is sufficient that the worker performs her work abroad for a minimum of 183 days in any 12 months. Further, the period in question is informed by the employment contract, so a period could fall over two calendar years. In Ruling 134/2020, the Italian Revenue Agency clarified that despite the wording of article 5(5) of Law 88, the notion of Italian maritime employees is not limited to Italian national maritime workers but also extends to foreign nationals (both EU and non-EU) if they are tax resident in Italy. The taxpayers are also exempted from any obligation to indicate the aforementioned income in their tax return.¹²

Implications for the Employer

In a nutshell, the employer will have withholding tax obligations in Italy vis-à-vis the remuneration paid to the maritime employees if it has an Italian PE or it is considered a company resident in Italy for Italian tax purposes.

Under article 4(1) of Law Decree 457/1997, resident and nonresident persons deriving income from the use of ships registered in the Italian International Ship Registry that is subject to income tax in Italy are entitled to a tax credit equal to the personal income taxes due on the income of employed and self-employed maritime crew members. The credit should be used to offset the amount of withholding taxes on that employment and self-employment income. In March 2021 the Italian Revenue Agency issued Ruling 15/E, saying a nonresident person deriving income from the operation of registered ships is entitled to the credit only if it has a PE in Italy.

COVID-19 Relief

Although Italy has concluded specific agreements with neighbor countries to address the effects of COVID-19 on frontier workers,¹³ its tax law does not address the pandemic’s impact on the special regimes for maritime employees. It has issued administrative rulings on ordinary employment,¹⁴ but it is unclear how the days employees could not work aboard ships flying foreign flags because of sanitary restrictions should be treated. In accordance with Circular 207 — which specifies that the computation of the 183 days includes holidays, weekly rest periods, and other nonworking days, regardless of where they were actually spent — the answer should be that they are regarded as days worked aboard those ships.

That conclusion is also substantially aligned with the solutions proposed in the OECD secretariat analysis, which suggested that the effects of COVID-19 should be neutralized as much as possible — for instance, it suggested that in the short term, tax administrations and competent authorities should “consider a more normal period of time when assessing a person’s resident status.” The updated guidance endorsed that position, stating, “Tax administrations and competent authorities will have to consider a period where public health measures imposed or recommended by the government do not apply when assessing a person’s residence status” and that therefore, reference had to be made to the place where “the employment used to be exercised.”

The Italian Revenue Agency has clarified that those OECD documents are not binding on the interpretation of domestic tax law, but it did mention them in Ruling 458/2021¹⁵ as a source for interpreting tax treaties, saying they may be considered persuasive.

Takeaway

The measures taken by Italy in response to the COVID-19 pandemic do not provide certainty in preventing crew stranded on ships from becoming Italian tax residents or subject to tax on Italian-source income with all the related compliance burdens.

U.S. Income Tax Analysis

The U.S. rules that govern the taxation of non-U.S. citizens are divided into two categories — those affecting tax residents and those affecting nontax residents.

Unlike other jurisdictions that have specialized regimes for the taxation of crew members, U.S. tax law modifies the general rules for crew members in limited circumstances. Vessels in the United States that are out of service because of COVID-related trade restrictions create factual situations that the crew member exceptions were not designed to address and could render those modifications inapplicable.

The variables influencing U.S. taxation of maritime work and employer withholding tax ramifications depend on a combination of several variables, including the residence of the employee and employer, the existence of an income tax treaty between the employee’s country of residence and the United States, whether the payments to the employee constitute wages, and whether the work performed by the employee constitutes employment.

U.S. Residents

The United States taxes its citizens and residents on their worldwide income. Crew members are subject to the same rules because there is no special income tax regime specifically applicable for crew, but as noted, modifications and exclusions from the general rules may apply.

A U.S. resident is any individual that has been admitted as a lawful permanent resident or if he meets the substantial presence test.¹⁶ An individual satisfies that test if present in the United States at least 31 days in the current year, and the sum of the following exceeds 183 days:

• all the days present in the United States during the current year;

• two-thirds of the days present in the United States during the immediately preceding year; and

• one-third of the days present in the United States during the second preceding year.

In counting days under the substantial presence test, there are several nuances. First, a day of presence is the day or any part thereof in which an individual is present in the United States. Second, in any year in which an individual is not present in the United States more than 30 days, no days of presence are counted. Third, days when an individual was unable to leave the United States because of a medical condition that arose while there are excluded. Thus, if a crew member had COVID-19, the days of illness and quarantine would not count for the substantial presence test (discussed below).

There is one particularly relevant exception for crew members “temporarily present in the United States on any day as a regular member of the crew of a foreign vessel engaged in transportation between the United States and a foreign country.”¹⁷ When vessels are out of service because of COVID-19 restrictions, it is unlikely they will be considered engaged in transportation. Although there is no authority directly on point, following Hurricane Katrina in 2005, foreign vessels were permitted to transport petroleum released from the U.S. Strategic Petroleum Reserve. The IRS provided (Notice 2005-65, 2005-2 C.B. 607) a limited window during which it would not challenge an individual’s assertion that he was a crew member of a foreign vessel engaged in international transport.¹⁸ The clear inferences were that the transport was domestic, as were wages earned by crew members, and that a vessel operating domestically — or not at all — is not engaged in international transport.

Finally, despite being a resident under the mechanical test, an individual who is present in the United States less than 183 days in the current year, has a tax home in a foreign country, and can establish a closer connection to that country than the United States is a nonresident and will be taxed as such. One of the challenges crew members face is a requirement that the statement claiming a closer connection must have been filed with the tax return for the year for which a closer connection is claimed or, if no return is required, by the due date of the return for that year.¹⁹

Nonresident Aliens

Individuals who are not U.S. residents or citizens are taxed on income effectively connected with a U.S. trade or business, as well as fixed or determinable annual or periodic income, such as interest and dividends.²⁰ FDAP income derived from U.S. sources is taxed at a fixed rate of 30 percent on the gross earnings or a lower rate as prescribed by treaty. The performance of personal services in the United States at any time is considered a U.S. trade or business.²¹

Wages received by a crew member for services rendered within the territorial limits of the United States are generally U.S.-source income, and services rendered outside the territorial limits are not.²² If a crew member performs services both within and outside the United States as an employee, apportionment of the income earned should be based on time worked in the United States. Because the United States includes its territorial waters, wages earned on a vessel while docked or anchored in those waters are earned in the United States.

Two exceptions to that general rule deem income earned in the United States to be non-U.S.-source. The first is a rule of general application: A nonresident alien employed by a foreign corporation that itself is not engaged in a U.S. trade or business will not be considered engaged in a U.S. trade or business if she is present less than 90 days during the year and earns less than $3,000 from U.S. sources (the so-called business visitor exception). The concept of engaged in a U.S. trade or business is a fact-driven analysis, but if the shipping company has an office in the United States, it is highly unlikely that a crew member could avail herself of this exception.²³

The second exception parallels that for crew members under the substantial presence test. Because it requires that the nonresident alien be employed on a foreign vessel engaged in transportation between the United States and a foreign country or U.S. possession, it will likely not apply to vessels that are out of service or not actively engaged in the required transportation.

Another issue regarding the income earned by crew members remains. As a matter of necessity, crew are provided meals and lodging on board the vessel. Under U.S. law, the value of meals and lodging provided by or on behalf of an employer for the employer’s convenience is excluded from income. The meals must be furnished on the employer’s premises, and the employee must be required to accept the lodging as a condition of employment.

In the normal operation of a vessel, satisfaction of those conditions would not be questioned. However, crew work on vessels under contracts of various lengths. While under contract, the individuals are employees, and their meals and lodging would be excluded. If a crew member’s contract expires but she is unable to debark because of COVID-related travel restrictions, her meals and lodging cannot be considered “for the benefit of the employer.”²⁴ Thus, she could be subject to tax on the value of the meals and lodging until back under contract.²⁵

COVID-19 Relief

The IRS issued Rev. Proc. 2020-20, 2020-20 IRB 1, to address some of the issues stemming from COVID-related travel disruptions. The revenue procedure has general application and does not address specific issues regarding crew members and their inability to repatriate.

The relief granted is limited to the exclusion of days counted for residency in the substantial presence test or for relief under income tax treaties. An eligible individual may exclude up to 60 days of presence in the United States during the COVID-19 emergency period between February 1 and April 1, 2020.

To be eligible for relief, the individual must: (i) not be a U.S. resident at the close of the 2019 tax year; (ii) not be a lawful permanent resident at any point in 2020; (iii) be present in the United States on each of the days of the individual’s COVID-19 emergency period; and (iv) not become a U.S. resident during 2020 because of days of presence outside the individual’s COVID-19 emergency period. So an eligible crew member on board a vessel present in the United States from, say, January 1 to July 3, 2020 (183 days), could be considered to have only 123 days of physical presence. If he contracted COVID-19 while on board after April 1, the days he was ill or quarantined could also be deducted.

That exclusion applies only to residency determinations. Individual crew members on board ships in U.S. territorial waters, although not residents, may be subject to taxation as nonresidents on the earnings attributable to services performed while the vessel is in U.S. territorial waters.²⁶

There are also practical issues for crew members to claim relief under the revenue procedure, not the least of which is the knowledge that they have or may have U.S. filing obligations and the inability to access tax advice or compliance assistance. Part of that filing obligation will include obtaining a taxpayer identification number. Consider three other topics.

First, if a vessel is exclusively in the United States while out of service during, for example, the hiatus for cruise vessels, will the exclusion of 60 days be sufficient to avoid residency status?

Second, if the vessel does not remain exclusively in the United States between February 1 and April 1, 2020, the individual’s COVID-19 emergency period may be limited. For example, a vessel is at port or anchored offshore in the United States from February 1 to February 20, when it relocates to the Bahamas. On March 15 it returns to the United States, where it remains through April 1. Because the presence in the United States must be continuous, the maximum the individual may exclude from the substantial presence residency test is 20 days (February 1-20).²⁷

Third, the revenue procedure requires individuals claiming COVID-19 emergency travel disruption and medical condition relief to file tax returns and supplemental schedules and retain documentation. Individuals confined to vessels are highly unlikely to be aware of those requirements or have access to the advice necessary for their proper completion.

Employment Tax Obligations

Social Insurance Taxes

The United States has three significant social insurance taxes imposed or based on wages paid. FICA has two separate taxes that are collected in tandem for old age and survivors disability insurance and hospital insurance. Those taxes are imposed equally on the employee and employer: via withholding from the employee and a separate payment from the employer. The employer also pays federal unemployment tax (FUTA) based on wages paid to employees.

In some important respects, those taxes differ from income tax as discussed above. Although they generally apply to wages paid, there is a crew member exception that provides that specific services do not constitute employment and that if the service is not rendered in the course of employment, the tax does not apply.

If a crew member works on a non-U.S. vessel when it is outside the United States, none of the wages paid are considered received from employment.²⁸ Consequently, unlike income tax, which excludes only income earned outside the United States, if the individual works while the vessel is outside U.S. territorial waters, all income — including that earned in the United States — is not subject to FICA or FUTA.²⁹ The exclusion for FICA does not apply to U.S. citizens employed by a U.S. employer.

Employer Responsibilities

An employer, whether located in the United States or abroad, is required to report wages subject to U.S. withholding, even if it does not have a trade or business in the United States.³⁰ It will be required to withhold any income or FICA tax due and pay its share of FICA and FUTA. The employer will also have to file quarterly and annual payroll tax returns and provide annual wage and tax statements to employees.

Failure to withhold and remit withholding tax or pay taxes the employer owes can result in penalties in the amount of the tax not collected. Interest, late-filing, and failure-to-pay penalties may also be imposed.

Liability for payroll taxes that were supposed to be withheld from employees that were not withheld, or were withheld but not paid to the government, may be imposed on officers or employees responsible for the failure to withhold and remit.

Takeaway

U.S. measures taken in response to the COVID-19 pandemic are inadequate to prevent crew stranded on ships from becoming tax residents or being subject to tax on U.S.-source income. There are also specific questions regarding the taxation of employee fringe benefits for any crew that remained on board a vessel while off contract.

Conclusion

Based on the above analysis, and because tax certainty is particularly fundamental to the shipping sector, we encourage legislative and administrative action to develop an agreed position to completely exempt seafarers from taxation when they were unable to repatriate or their vessels were unable to engage in meaningful transport under COVID-related restrictions.

Regardless of that kind of action, the pandemic’s tax effects on those individuals should be neutralized to the extent possible.