The UK Inland Revenue (HMRC) had issued draft legislation setting out changes to the tonnage tax regime, as required under ruling by the Commission. Under the changes, vessels providing transport in connection with services at sea would no longer qualify for tonnage tax. Safety standby vessels would have however continued to qualify for tonnage tax as they were considered to be providing marine assistance carried out at sea. The recent withdrawal of some of the tonnage tax changes has come as welcome relief for many, although worries still remain about the implementation of EU flagging rules.

The Finance Act 2005 included rules whereby, when a UK tonnage tax company or group starts to operate a new vessel, the vessel must be flagged under an EU flag if the following conditions are satisfied.

Firstly, the financial year has been specified by the UK Government as a financial year where the proportion of vessels within the UK tonnage tax regime registered under an EU flag has reduced on average in the preceding three calendar years. Secondly, less than 60% of the tonnage tax company or group’s fleet is already flagged under an EU flag. Lastly, that the tonnage tax group or company’s fleet contains a lower proportion of EU Member State registered tonnage than on 17th January 2004 or, if later, the end of the first period when it entered tonnage tax.

If all of the above conditions apply, then the ship will need to be registered under an EU flag within three months, otherwise it will not be within tonnage tax. If the flagging requirement applies, a company may be able to re-flag an existing vessel under an EU flag instead of the new ship.

Sue Bill, a tax partner with More Stephens, said, 'The EU flagging rules have caused great consternation within the shipping sector and a number of groups are considering relocating some or all of their operations outside the UK. However, it is important to remain calm and to consider carefully the effect of the rules and whether it is possible to plan to ensure that they do not apply.'