The Inland Revenue issued new anti-avoidance legislation in December, which will have a significant impact on tonnage tax companies that lease vessels. Sue Bill, tax partner at leading shipping accountants Moore Stephens says, "These changes will particularly affect the financing of expensive ships such as gas carriers or large cruise ships, as capital allowances will be restricted where a ship costs more than £40 million. As a result, the cost of financing such ships will increase where the lessee is in the tonnage tax regime. Thus, a company within the regime may be at a disadvantage compared to a UK company which has not made a tonnage tax election. The new rules may also reduce the attractiveness of the UK tonnage tax regime to overseas shipping groups considering setting up or expanding operations in the UK." Bill explains, "When UK tonnage tax was introduced in 2000, the Government felt the regime might not be sufficiently attractive unless capital allowances were available to finance lessors leasing ships to tonnage tax companies. The rules were therefore drafted to enable lessors to claim capital allowances. The new rules are designed to stop lessors offering leases that have many characteristics of finance leases without strictly being finance leases. They extend the restrictions on claiming capital allowances to all leases and not just finance leases for leases entered into on or after 19 December 2002." The restrictions are that capital allowances are: * restricted where a ship costs more than £40 million. Capital allowances are available at a reduced rate of 10% on expenditure between £40 million and £80 million and no capital allowances are available on expenditure over £80 million * denied where the lease is 'defeased' and * * denied in the case of certain sale and leasebacks. A lease is "defeased" for this purpose if the "greater part" of the lessor's risk that lease payments will not be made has been removed by unacceptable forms of security such as a third party's obligation or guarantee given in exchange for a lump sum payment. There are two exceptions to the new rules, where the lessor: * remains responsible for operating the ship at all times or * * grants the lease due to short-term fleet over-capacity and the lease does not exceed three years. Bill warns, "The ship leasing industry is likely to be affected as the new rules will restrict lessors' ability to offer attractive leasing deals, particularly for expensive ships. The change in the rules may reduce the number of ships coming into the UK tonnage tax regime in the future as one of the more attractive aspects of the UK tonnage tax regime, compared to other tonnage tax regimes, has been reduced. The rules may also affect companies looking to raise finance by using sale and leaseback arrangements. "It is easy to understand why the Government wishes to close this loophole. However, it is important to remember that the UK tonnage tax regime was originally introduced in order to help reverse the decline in the UK shipping industry and that the UK tonnage tax regime is effectively in competition with tonnage tax regimes of other countries. One of the few advantages that the UK tonnage tax regime has over most other tonnage tax regimes is that capital allowances may be available to lessors leasing ships to tonnage tax companies and it is important that this advantage is not further eroded."