Yes, defend ships in the Red Sea, but tax them too

By Chris Bryant

Ship owners are diverting vessels thousands of miles round the southern tip of Africa in response to Houthi attacks in the Rea Sea, boosting freight rates from low levels and encouraging investors to bid up shipping stocks. The crisis should draw renewed attention to an industry that mostly operates outside global taxation norms and now expects governments to protect it.

Western governments have dispatched navies to protect ships wanting to transit the Suez Canal — a key artery for global trade — and the US and UK have begun airstrikes on Houthi targets in Yemen to prevent more attacks.

These maritime defense efforts are essential; seafarers are in peril, manufacturers have been forced to curtail production and such upheaval could yet reignite inflation. But they're not cheap.

From this year large multinational companies are subject to a minimum 15 per cent tax rate on their earnings, but the shipping industry successfully lobbied the Organisation for Economic Co-Operation and Development for an exemption.

This has preserved a system whereby ships are often registered in lightly regulated, low-tax jurisdictions known as open registries and fly a so-called flag of convenience rather than that of the country of ownership. Some 44 per cent of the world’s ships by dead-weight tonnage are registered in just three countries — Panama, Liberia and the Marshall Islands. (This represents a dramatic change from the 1950s when open registries accounted for less than 5 per cent of the global fleet.)

Credit: Bloomberg

To counteract open registries, more than 20 European countries, plus South Korea and Japan, have offered ship owners preferential treatment whereby they are taxed according to their fleet’s tonnage rather than the profits earned.

The effective tax rate paid by the world’s shipping companies was just 7 per cent between 2005 and 2019, according to a study by Olaf Merk, head of ports and shipping at the OECD’s International Transport Forum. Some categories paid considerably less: The average tax rate for liquid bulk carriers such as oil tankers was just 3 per cent, while cruise lines paid an average of 0 per cent.

Trade unions have long criticized flags of convenience for undermining labor standards, but shipping firms’ cushy tax arrangements received little attention — in part because this cyclical industry often lost money.

That changed when container-shipping companies suddenly began generating tens of billions of dollars of profit during the Covid-19 pandemic, and some revealed they owed as little as 1 per cent in taxes and governments forwent billions in potential revenue.

Even the boss of German container-shipping giant Hapag-Lloyd AG conceded in 2022 that low tonnage tax rates aren’t fair. His discomfort didn’t prevent Hapag paying out a total of €17.3 billion ($18.8 billion) of dividends for the 2021 and 2022 financial years.

There’s been progress on promoting competition in shipping and penalizing pollution, but exempting it from the global minimum tax was a missed opportunity.

The lesson of the pandemic and now the Houthis is that ocean trade is acutely susceptible to disruption; and in a multipolar world, freedom of navigation is no longer a certainty.

The Houthis don’t differentiate between the nationality of the ship owner and the flag it flies. And nobody seriously expects the Marshall Islands, Liberia or Panama to sail to the rescue if a vessel is attacked. That’s up to the US, UK and their allies.

This “freeloading” requires a “rethink” of flags of convenience once hostilities have ceased, according to a post on X (the service formerly known as Twitter) by Kevin Rowlands, head of Royal Navy Strategic Studies Centre, the British force’s internal think tank .

Meanwhile, a UK parliamentary committee warned in 2022 that the use of flags of convenience has created a “jurisdictional vacuum” on the high seas.

Ironically, the shipping industry argued for its exemption from the OECD minimum on the basis that maintaining a domestic shipping fleet via tax subsidies was important for national security.

In fact, the need for governments to defend cargo vessels in international waters — at considerable expense — is a good reason to tax shipowners properly.