Broadly speaking, a company carrying on a trade of leasing in the United Kingdom will be subject to UK corporation tax on the profits of that business. Rents will generally be taxable, although only the interest element of any receipts under a ‘long funding lease’ will be considered taxable income for these purposes. Deductions against rental income will generally be available for revenue expenditure incurred wholly and exclusively for the purposes of the trade, including for the interest (but not the principal) element of payments under any borrowing incurred on the provision of the aircraft.
Additionally, a UK lessor purchasing an aircraft for leasing could be entitled to claim capital allowances which it can deduct in computing its taxable profits. Capital allowances are intended to reflect depreciation of an asset on which capital expenditure has been incurred and may generally be claimed by the lessor in the case of operating and finance leases and by the user in the case of hire purchase, conditional sale and credit sale agreements.
The UK VAT regime with regard to the supply of aircraft is codified in the Value Added Tax Act 1994. To be zero-rated for VAT purposes, aircraft must fall under item No. 2 of Schedule 8 of the Value Added Tax Act 1994, which was itself implemented by section 21 of the Finance (No. 3) Act (2010). This item No. 2 says that: ‘[t]he supply, repair or maintenance of a qualifying aircraft . . .’ will be zero-rated for VAT purposes.
The VAT rules (HMRC Notice 744C, December 2010) therefore apply to the supply of an aircraft or aircraft equipment. HMRC considers that the word ‘supply’ in this context includes:
- sale, import or acquisition of an aircraft or aircraft equipment; and
- charter of an aircraft or aircraft equipment, including hire or lease.
While the supply of ‘qualifying aircraft’ is zero-rated, supplies of all other aircraft will be standard-rated (at the current rate of 20 per cent).
In note (A1)(b) to Schedule 8 of the Value Added Tax Act (1994), a ‘qualifying aircraft’ is described as any aircraft that ‘is used by an airline operating for reward chiefly on international routes’.
Following the decision of the Court of Justice of the European Union in the Cimber case (C-382/02), the test of a ‘qualifying aircraft’ is whether the airline itself operates chiefly on international routes and not whether a particular aircraft operates chiefly on international routes. In essence this means that supplies of aircraft will be zero-rated even if the aircraft operates only on domestic routes, providing it is used by an airline operating for reward chiefly on international routes.
In note (C1) to Schedule 8 of the Value Added Tax Act 1994, an ‘airline’ is defined as ‘an undertaking which provides services for the carriage by air of passengers or cargo (or both)’. The undertaking concerned may be a sole trader, partnership or company or other entity, but it is not necessary for the undertaking to be a single entity. For example, a VAT or corporate group of companies may be considered as an airline.
An airline will need to operate at least one aircraft, which it may own, lease or hire. This definition includes commercial business jet operators. However, HMRC states that if the business does not have an air operator’s certificate (AOC) this will provide an indication that the business is unlikely to be considered as an airline for this purpose (HMRC Notice 744C). If a business does not hold an AOC, it will likely be asked for evidence of how it is operating as an airline.
The airline must be providing passenger or freight transport on scheduled or unscheduled flights (or a mixture of both), and receiving consideration for that supply. This must be a business operation in nature for VAT purposes. There is a significant body of case law in relation to the requirements for a taxpayer to be operating a business for VAT purposes. However, there is no requirement for an airline to be operating at a profit.
An international route is any route that is not a domestic route within UK airspace. A non-UK airline that mainly flies between airports in its own territory should therefore be regarded nonetheless as international for these purposes.
Therefore, any UK airline that flies even only one route that is not a UK domestic route will be operating on international routes.
For an airline to be operating ‘chiefly’ on international routes, the non-domestic or international route operations of an airline must exceed its domestic route operations. The European Court of Justice in Cimber left it open to the national courts to assess the extent of domestic and international operations. They made it clear that ‘in doing so [the national courts] may take account of all information which indicates the relative importance of the type of operations concerned, in particular turnover’.
In the United Kingdom, HMRC has given advice to airlines in applying the test. They have stated that the test can be based on the value of turnover attributable to international routes compared with that attributable to domestic routes, the relative number of passengers carried, mileage or any other method that produces ‘a fair and reasonable’ result ‘capable of verification by HMRC’ (HMRC Notice 744C). In line with the advice of the court in Cimber, HMRC notes that turnover will be particularly significant when comparing the operations of an airline.
When considering whether an airline meets this test, HMRC will allow airlines to base their current position on a ‘backward look over [the] last financial year’. Airlines may also base the test on a shorter or rolling period if they prefer, but the period, frequency and parameters of the test must be consistent and must not be frequently changed so as to ‘manipulate a particular outcome’. In some cases, a forward-looking test may be allowed where material changes in the business have occurred or where business plans and projections support such a view.
Most aircraft are owned by special purpose companies, whose sole purpose is to own the aircraft. Such companies are often set up by leasing companies or banks. As such, many supplies will be to special purpose companies rather than ‘airlines’. However, HMRC considers that where supplies are provided through such ‘intermediaries’, as they term them, the supplier may ‘look through’ the transaction (or series of transactions) and treat their supply as zero-rated. This will only be possible if the ultimate consumer of the supply of either goods or services is an airline operating a qualifying aircraft, and if the entities in the supply chain are fully taxable for the purposes of the transaction so that no input tax restriction would occur at any point in the chain (ie, so that there would be no recoverable VAT).
Lease rentals and instalment payments under hire-purchase agreements do not attract withholding tax and it is generally accepted that it will not apply to the ‘finance charge’ element of payments under conditional or credit sale agreements. Nonetheless, there remains a risk that payments under hire-purchase agreements could in some circumstances be regarded as annual payments for tax purposes and, for that reason, a lease will normally provide that the lessee will bear any withholding tax that may be imposed by ‘grossing up’ payments due to the lessor. It is standard from the lessor’s point of view to include such a provision, to cover the risk that withholding tax could arise as a result of a change of law, or of its interpretation.
No stamp duty is payable in respect of the creation of an aircraft lease.
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