Yacht finance consultancy Moore Stephens has produced a frank and enlightening report to help its clients understand – and cope with – the recent sudden shift in Italian VAT enforcement. The following is an abridged version of that report:

“The past three months have seen a number of high-profile yacht arrests in Italy – the most dramatic of which was the armed boarding of the 63m Force Blue. The yachts have been stopped for reasons ranging from suspected smuggling to tax evasion.

The announcement, therefore, on June 21st of the conditional release from detention of the Cayman Islands flagged Force Blue to carry on with its charter trade along the Mediterranean and Italian coasts, reflects continuing confusion about Italy’s position on VAT rules for commercial yachts.

Since 2004 the Italian authorities have appeared to treat commercial yachts as ‘merchant’ ships – exempting them from VAT.

It meant that any yacht holding a commercial registration certificate from any flag state (with a permanent crew and operating in a bona fide commercial way) was neither asked to have Italian VAT registration, nor required to undergo any kind of customs import procedure.

The VAT exemption appeared to apply to yacht owners by default. They could perform charters in Italy, buy parts and equipment and receive services of repair and maintenance – all free of Italian VAT.

So Italy’s sudden switch to armed intervention has shocked the industry – but should it?

Speaking on Italian VAT practice on yachts at a conference some years ago, one Italian expert panelist pointed revealingly to the distinction between the formal way and “the Italian way.” He was referring to the yawning gap between Italy’s VAT legislation on yachts and its on-the-ground practice. A key example has been the constant dogfighting between Italian leasing companies and the authorities over the scope of reduced-rate VAT.

Characteristically, leasing activities rely heavily on tertiary practice and extra-statutory concessions, rather than primary law, allowing the authorities to shuffle capriciously at every step. The leasing companies often have different interpretations from what the authorities think.

With the advent of new EU cross-border place of supply rules from January 2010, nobody seems to be sure anymore as to how Italian leasing schemes should actually interact with the new rules.

Little wonder then that a negative undercurrent has been eroding this fragile picture of a VAT-free Italy for superyachts.

Italy’s legislation on the VAT treatment of yachts has actually remained unchanged.

The law maintains the typological distinction between classes of vessels. There is the class of ‘qualifying ships’ which is traditionally deemed to be eligible for VAT exemption under Article 148 of the VAT Directive. This class is interpreted to include only ‘merchant’ and ‘cruise’ ships that go on to the high seas – their activities have ‘export’ connotations for VAT purposes.

Then there is the class of ‘pleasure craft’ (so called because they are designed or adapted for use for recreation or pleasure), which is not exempt from VAT. Yachts – whatever their function and manner of operation – are classed as pleasure craft under this traditional view.

Therefore, unless a yacht is VAT paid, or deemed VAT paid, it is non-compliant and should not be used or chartered in the EU.

Tax suspension regimes, such as Temporary Importation and Inward Processing Relief, offer conditional easements for non-EU means of transport entering the EU. And there are other very restrictive provisions for commercially used means of transport operating in the EU only for ‘the time required for carrying out the transport operations’ under Article 562(b) of the Community Customs Code. But none of these exemptions or suspensions actually caters legally for the modern ‘commercial’ yacht that operates charters in the EU without a VAT paid status.

France realized this and amended its primary VAT and customs legislation in 2004 to reflect its true intentions. Italy, however, has not changed its legislation, but its tacit approval of yachts coming over from France has created an atmosphere fraught with ambiguity and misperception. Italy’s approach has also been hardened by a new band of spirited local prosecutors whose stark view of the law is un-nuanced by the unscripted culture and tolerances of the yachting industry.

Meanwhile, much has been made of EU maritime cabotage rules and the fact that some of the yachts arrested in Italy fly non-EU flags. But there is no actual evidence that the Guardia is specifically targeting non-EU flags. Instead, they are targeting tax abuse amidst a severe domestic financial crisis. In an industry where over 95 per cent of superyachts fly non-EU flags it’s statistically obvious why non-EU yachts should fall victim in any sweep.

Much remains unclear about the vague EU cabotage rules – despite the European Commission’s assertion in 2003 that most activities of yachts fall outside the scope of these rules.

But changing to an EU flag for any reason without structuring the ownership of the yacht to achieve essential EU tax compliance is unlikely to offer an advantages.”