Aircraft leasing was a lifeline for airlines during the Covid-19 crisis. Our experts explain why the choice of lessor location is more important than ever.
Faced with unprecedented cash burn challenges during the pandemic, many aircraft operators sold and leased back chunks of their fleets to shore up liquidity. At the same time, startup carriers filling gaps left by airline failures often turned to lessors for their initial aircraft.
As a result, leased aircraft are breaching 50% of the global fleet. This is good news for lessors, but it will also mean greater scrutiny of the cross-border payments between airlines' home jurisdictions and the small number of countries where most lessors are based.
Topical Brazil
Brazil offers a pertinent example of why all parties to a leasing deal should keep abreast of local legislation and international tax treaties. The past few years have produced a complex and confusing discussion around withholding tax on operating leases out of Brazil, where the possible rate has fluctuated from 0% up to a proposed high of 25%, making it extremely difficult to plan and enter into long-term structures.
At the time of writing (11 January), Brazil had gazetted a provisional measure to reduce the rate to 0% from 2022 to 2024, and then to raise it gradually to 3% by 2026. But for a long period, lease payments from Brazil were exempt from withholding tax. If imposed, it could have a significant impact, as almost 60% of commercial aircraft in Brazil are on lease*, and airlines would be exposed to the tax via grossing-up provisions in their leasing contracts.
That said, withholding taxes on lease payments exist elsewhere in the world, as do structures to minimise their burden.
Traditional routes in the past through withholding tax issues have been lease-in lease-out [LILO] financings or the use of aircraft-owning entities in specific jurisdictions.
For example, lessors often use special purpose vehicles (SPVs) in Sweden as the lessor of record to Argentinean airlines so that all parties benefit from the double-taxation treaty between Sweden and Argentina. US lessors, meanwhile, can access a slightly lower withholding tax by establishing entities in Ireland for leases into China.
Local knowledge
Ireland remains the epicentre of aircraft financing and leasing due to its favourable tax regime, numerous international treaties and tight aircraft registration standards. However, as with other big leasing hubs, asset managers can only benefit from these facets if they can demonstrate substantial activities in the country, which means setting up a local office with local employees.
Without external help, establishing such a presence can prove to be a considerable administrative burden. Lessors that wish to offer the benefits of LILO deals via Sweden, for example, should ensure they obtain the necessary tax advice to ensure enough substance exists to obtain treaty benefits. For example, organise regular board meetings in Sweden of any SPV set up to do so, with decisions made there, and ensure that at least half of the SPV's directors reside in Sweden.
For jurisdictions like Argentina and Bolivia which are yet to ratify the OECD BEPS multilateral instrument, Sweden has become an attractive jurisdiction for setting up aircraft SPVs.
For similar reasons, many Irish lessors use France for onward leases to Indonesian airlines. And again, knowledge of local regulations and procedures helps to streamline this process. It is essential to open a local bank account, for example, but compliance requirements in France can extend this process unduly without the right advice.
Access to local expertise on the ground also is needed to prepare for any changes to national legislation. As Brazil is showing, such developments can be significant and mitigating their financial impact often requires specialist advice.
Finally, airlines and lessors must also retain a firm grasp of international tax law when structuring their contracts, especially given the pace at which such legislation is evolving across key jurisdictions such as the United States, EU and OECD.
*Airfinance Journal Fleet Tracker data.
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TMF Group is one of the world's leading providers of business support services to the airline finance industry. Our dedicated aviation finance team manages hundreds of aircraft leases all over the world. We work with a wide range of aircraft lessors, including new entrants and established players, airlines, private equity, hedge funds and banks.
Our capital markets, aviation finance and regulatory compliance teams tailor their services to the particular needs of the industry, helping clients to create efficient structures, acquire appropriate assets and negotiate effective relationships with lessees. Contact us to find out more.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
