Will the Cruise Industry Navigate Around the Minimum Tax?—Part 1

The cruise industry is in the process of recovering from Covid-19. Royal Caribbean Cruises Ltd., a Liberian corporation that is publicly traded and is the world’s second-largest cruise ship operator, reported financial accounting income of approximately $2 billion in 2019. The company reported a $6 billion financial accounting loss in 2020, a $5 billion financial accounting loss in 2021, and a $3 billion annualized financial accounting loss in the first half of 2022. But in a September 2022 8-K filing, Royal Caribbean reported that its bookings have exceeded 2019 levels since its Covid-19 restrictions were eased in August.

Section 883

Royal Caribbean’s 202110-K acknowledges that the company and several of its principal subsidiaries, which also are incorporated in Liberia, are, in connection with operating cruises between US and foreign ports, engaged in a trade or business in the US and deriving US source income. The 10-K observes that Section 883 generally provides corporations a statutory exclusion from gross income and, as a practical matter, provides a US corporate income tax and US corporate branch tax exemption, for the shipping income of foreign corporations whose country of incorporation provides US corporate shipowners a reciprocal exemption.

Specifically, Section 883 provides that qualifying shipping income “shall not be included in gross income of a foreign corporation, and shall be exempt from taxation under this [income tax] subtitle.” Conversely, IRS Rev. Rul. 80-147 and Treas. Reg. 1.883-1(j) imply that expenses attributable to such exempt income are not deductible and cannot create a US net operating loss carryforward against effectively connected non-exempt, non-shipping income.

The IRS, relying on an exchange of diplomatic notes between Liberia and the US, concluded in Rev. Rul. 2008-17 that Liberia is such a reciprocating country. Accordingly, for regular US corporate income tax purposes, Royal Caribbean and its financial-accounting-consolidated Liberian subsidiaries appear to have relatively little US effectively connected income or loss from their shipping activities.

Royal Caribbean’s 10-K notes that the Treasury Regulations—namely Treas. Reg. 1.883-1(h)(2)—disqualify certain income from the Section 883 tax exemption. Such disqualified income includes providing tours of the city of Miami before or after cruises end there.

Corporate Alternative Minimum Tax

Beginning in 2023, the Inflation Reduction Act of 2022 can impose a US corporate minimum income tax on certain foreign-parented corporate groups whose average worldwide adjusted financial statement income exceeds $1 billion.

However, CAMT only applies in a limited fashion to such foreign-parented groups. Section 56A(c) states that in determining the amount of a foreign corporation’s AFSI, “the principles of Section 882 shall apply.” CAMT generally only applies to a foreign-parented group if the group’s AFSI is at least $100 million, considering the application of limitation of Section 56A(c)(4) to foreign corporate members of the group. A foreign-parented group, even one with worldwide AFSI exceeding $1 billion, must have a minimum of $100 million in AFSI to be subjected to CAMT, excluding US net income of foreign group members excluded under the principles of Section 882 and 56A(c)(4).

If a foreign-parented group, apparently including Royal Caribbean, has more than $1 billion of worldwide AFSI, it will not be subject to CAMT if the group’s income that is not exempted under Section 56A(c)(4), such as non-exempt income described in Treas. Reg 1.883-1(h)(2), is less than $100 million. Even if such a group has $1 billion of worldwide AFSI and at least $100 million in Section 56A(c)(4)-limited AFSI, the AFSI tax base of the CAMT is limited by Section 56A(c)(4).

The cruise industry faces some ambiguity on the interaction of Section 883 with Section 56A(c)(4). For example, several of Royal Caribbean’s cruises sail from Fort Lauderdale, Miami, or Port Canaveral, Fla., to Nassau, Bahamas, and then return to Florida. Under Section 863(c)(3), 50% of the passenger revenue of such cruises is treated as US source effectively connected income described in Section 882. See TAM 9348001. However, Section 883 can exempt this 50% from regular US corporate income tax and branch profits tax. For purposes of the $100 million AFSI threshold, and the CAMT tax base if such $100 million is exceeded, would AFSI include 100%, 50%, or none of such Florida–Bahamas cruise income?

Section 59(k)(2)(A) treats Section 56A(c)(4) as inapplicable to foreign-parented groups only to determine whether the $1 billion worldwide AFSI threshold is met, not to determine whether the $100 million threshold is met or, if so, what the CAMT tax base is. Therefore, it seems that the IRS could not include 100% of Royal Caribbean’s Florida–Bahamas round trip passenger income in AFSI in determining whether the $100 million threshold is met or, if so, what the CAMT tax base is.

With respect to inclusion of 50% of Royal Caribbean’s Florida–Bahamas round trip passenger income in AFSI, the situation is less clear. As noted, Section 56A(c)(4) states that “in the case of a foreign corporation, to determine [AFSI], the principles of Section 882 shall apply.” Some IRS rulings are unclear on the question, which was academic before the enactment of the CAMT, as to whether such reciprocally exempt shipping income should be viewed as effectively connected income under the principles of Section 882 but excludable under the independent application of Section 883, or as excludable from Section 882 consideration in the first instance. Compare Rev. Rul. 87-15—which states that “[a] portion of [the shipping company’s] income [is] effectively connected with a United States trade or business....Such income, however, is exempt from United States tax under the reciprocal shipping exemption of Section 883(a)(1)”—with PLR 8129051, in which the IRS National Office notes, without adverse comment, that the shipping company concluded that its revenue was excluded from its “gross income under Section 882(b) by reason of the ‘reciprocal exemption’ provisions of Section 883(a)(1).”

Under the cruise-line-unfavorable view that Section 56A(c)(4) only incorporates the exceptions in Section 882 and not those in Section 883, the 50% of the passenger net revenue characterized as effectively connected income could be includable in AFSI. In the short term, the application by Section 59A of a three-year average in determining applicable corporation status, and the allowance to applicable corporations by Section 56A(d) of an unlimited carryforward of post-2019 financial statement losses to offset up to 80% of current year AFSI, could reduce the CAMT exposure to Royal Caribbean and other cruise lines, whose businesses were harmed by Covid-19 between 2020 and 2022. Under the cruise-line-favorable view that Section 56A(c)(4) also incorporates the exceptions in Section 883, 0% would be includable in AFSI.

Some cruise lines companies, such as Royal Caribbean, have ship-owning subsidiaries that lease the ships to affiliates who operate the cruises. These ship-owning subsidiaries apply Section 883 to avoid being subject to the otherwise applicable Section 887 4% gross transportation tax on their US non-effectively connected source income. The analogous issue exists as to whether such income is exempted from inclusion in AFSI under Section 56A(c)(4). Another analogous issue exists as to whether any shipping or other income that is exempt from US corporate income tax and US transportation tax under the terms of an income tax treaty is likewise excepted by Section 56A(c)(4).

A source of optimism to the cruise line industry is that in former Treas. Reg. Sections 1.56-1(b)(6)(ii)(B) and 1.56(g)-1(m)(4), dealing with the analogous repealed corporate alternative minimum tax on book income and adjusted current earnings preferences, the Treasury favorably excluded earnings of a foreign shipping company attributable to its Section 883 or treaty income that was exempt from regular US corporate income tax.

Part 2 of this article will consider whether the OECD Pillar Two minimum tax can apply to cruise line income.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Alan S. Lederman is a shareholder at Gunster, Yoakley & Stewart, P.A. in Fort Lauderdale, Fla.

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