The taxation of aircraft assets and leasing - Ireland, Singapore, Hong Kong and other jurisdictions compared
Deloitte's Pieter Burger compares the aircraft leasing regimes of leading jurisdictions. He compares the attractions of Ireland's regime, Singapore's new Aircraft Leasing Scheme and Hong Kong's new offering for the sector. He says that while some of the 'traditional well-trodden paths to achieve tax efficiency will be closed' as a result of changes in the international tax environment 'new opportunities will emerge as a trend towards lower headline corporate tax rates' strengthens with a subsequent move towards 'low taxes actually paid' as opposed to 'high taxes avoided'.

“Investment decisions should be made on the basis of the most probable compounding of after-tax net worth with minimum risk” (Warren Buffet).

Without doubt, tax remains an essential part of any calculation of rate of return on an investment and the certainty of the applicable tax rate is integral to that calculation. The aviation finance and leasing industry is no different and with investment in aircraft as an asset class becoming more widely recognised, interest (from investors and government authorities) has certainly increased in the taxation of aircraft and the impact of ongoing international tax developments.
Pieter Burger

The debate and momentum globally around international tax reform shows no sign of slowing down; in fact it seems to be increasing in ferocity with tax continuing to make the headlines worldwide. And while the greater focus globally remains on putting an end to what is perceived to be unfair tax planning and ensuring countries get their fair share of tax, other countries are more focused on increasing the attractiveness of their own tax regimes in order to attract investment, including investment in aircraft leasing.

In a fast changing and politically sensitive international tax environment, both new entrants into the industry and traditional players need to be mindful of how ongoing tax developments may impact returns on their investment. We often hear people say that, due to an increase in competition and other factors, aircraft investors may have to settle for lower returns compared to that achieved historically as part of the “New Normal”. Similarly, aircraft lessors and other aviation financiers should be prepared to accept a New Normal of international taxation. However, while in some respects traditional well-trodden paths to achieve tax efficiency will be closed forever, new opportunities will emerge as a trend towards lower headline corporate tax rates seems clear – a move towards “low taxes actually paid” as opposed to “high taxes avoided”.

How is an aircraft leasing investment taxed?
Similar to most investments, there are typically three layers of direct taxes that can erode the return on an investment (there are possible indirect taxes as well such as VAT, GST, customs duties etc. but that’s a topic for another day). Firstly there is taxation in the country where the income stream is considered to have its source. In an aircraft leasing context this is the source where the lease income emanates from such as, typically, the country where the airline is based or sometimes where the aircraft is operated. Secondly there is taxation of the lease income in the country where the aircraft owner (i.e. the entity that owns and leases out the aircraft) is tax resident. Thirdly, there is a further possible layer of taxation when the profits are remitted to the investor in the form of, for example, withholding taxes on dividend payments or interest payments on shareholder loans.

Clearly, if lease income (or any other investment income for that matter) suffers taxation at all three levels, the investment makes no economic sense. In choosing a favourable tax jurisdiction where the aircraft will be owned, therefore, investors should have regard to attributes that mitigate taxes at all three levels, namely: a wide double tax treaty network that gives the right to the country of the aircraft owner to tax the lease income, not the country of the airline (i.e. with the result that no withholding or income taxes are suffered in the airline jurisdiction on lease payments); a competitive corporate tax rate that applies to the leasing profits and any gains on a future sale of the aircraft (and also a reasonable manner of calculating the profits subject to tax so it is aligned with the economic profits); and exemptions from withholding and other taxes on the remittance of the profits to the investors.

Favourable jurisdictions and growing competition
Aircraft lessors are attracted to favourable tax jurisdictions (as is any sensible investor that seeks to maximise return) and in this regard Ireland is often mentioned due to its competitive 12.5% tax rate applicable to trading profits. Over half of the world’s leased aircraft are currently managed from Ireland but certainly not only because of the 12.5% tax rate. Ireland has long since been recognised as the global leader in aviation finance with compelling non-tax (such as people with experience and skills in aircraft leasing, a supportive legal environment, an English speaking EU-member, to name but a few) and tax attributes for establishing an aircraft leasing platform here. But there are other jurisdictions that are focused on this industry, such as Hong Kong, Singapore, Labuan, Malta, Cyprus, the China Free-Trade Zones as well as several others focused on attracting financial services more widely. These jurisdictions all compete for aviation industry investment through, in part, favourable tax regimes.

According to a recent Deloitte and Euromoney Institutional Investor Survey (Game Changer Not Game Over, January 2017), the majority of the over 400 senior aviation executives surveyed believed that the fastest growing jurisdiction over the next 5 years as a location of choice for aircraft leasing will be China’s free-trade zones (FTZs). This, though, is likely to be a high percentage growth relative to a current low base. Also, it does not suggest that the FTZs will become the next global hub for international leasing. Instead, experts expect that they will service the growing Chinese domestic market (leasing to Chinese airlines from the FTZs results in no Chinese withholding tax, compared to 6% when leased from an Irish or Singapore lessor and 5% from a Hong Kong lessor). After the FTZs, Singapore, Ireland, and Hong Kong were predicted to experience the fastest growth over the next 5 years. We would, however, expect Hong Kong to grow even faster than initially anticipated since the enactment of the new Hong Kong concessionary tax regime for aircraft leasing (which occurred post the publication of the survey and provides for a 1.65% tax rate on certain leasing profits - see below). The Singapore Aircraft Leasing Incentive Scheme was also extended for 5 years from 31 March 2017.

One might wonder if even more favourable tax regimes might appear for leasing in the race to attract the highly mobile investments and operations of this lucrative industry. As mentioned above, however, we live in a different international tax environment and the OECD’s Base Erosion and Profit Shifting (BEPS) Action Plan is reshaping tax systems, both current and future. As part of the BEPS deliverables a specific action - BEPS Action 5 on countering harmful tax practices - is aimed at ensuring that preferential tax regimes meet certain standards and don’t have harmful features such as ring-fencing, a lack of transparency or allowing tax benefits even if no substantial activities are carried out in that country. In other words, countries forming part of the BEPS Inclusive Framework (more than 100) are not free to simply implement any beneficial tax regime to attract investment; it has to adhere to certain standards and in particular it cannot allow tax benefits without substantial activities. A progress report issued by the OECD in October 2017 found the Singapore and recent Hong Kong aircraft leasing regimes to be “not harmful”, whereas the Labuan regime is described as in the process of being amended to meet required standards. The “game changer, not game over” survey mentioned above found that the current leading jurisdictions for aircraft leasing is likely to remain, which makes sense, as it is not easy for a country to attract substantial activities purely with a beneficial tax regime - non-tax factors are needed as well. A further aspect that is clear as well is, given BEPS Action 5 and the monitoring of preferential tax regimes, aircraft lessors should not be surprised if those regimes are strict going forward and require significant substance before tax benefits can be availed of.

How do the jurisdictions compare?
Ireland’s corporate tax rate of 12.5% remains one of the lowest corporate income tax rates of the major leasing hubs with over 70 double taxation treaties in effect. This is compared to the new Singapore Aircraft Leasing Scheme rate of 8% with 82 treaties ratified. The new Hong Kong aircraft leasing tax regime subjects certain qualifying profits of aircraft leasing managers to a tax at 8.25%. The headline grabbing tax rate of 1.65% mentioned above applies to net rental income and is derived at as 20% of 8.25% (i.e. half of the standard Hong Kong tax rate of 16.5%). However, tax depreciation is not an available deduction in the calculation of the taxable profits as is the case in Ireland and Singapore. This leads to the potential scenario that cash tax may be payable even as more aircraft are acquired and before aircraft has been disposed of, whereas under regimes where tax depreciation is available the tax is usually deferred until such time as the aircraft is sold.

A beneficial regime for the taxation of profits in the lessor entity however is not sufficient. The quality of a country’s double taxation treaty network is invaluable for an aircraft investment as rental payments may attract high levels of domestic withholding or income tax. In Ireland’s case, the majority of the double tax treaties reduce the potential domestic withholding tax on rental payments on aircraft to nil. As a result, Ireland still possesses the best quality double tax treaty network for aircraft leasing even though Singapore may have a larger quantity. Given however that the international forum on harmful tax practices have reviewed and approved the Hong Kong and Singapore leasing tax regimes, this may assist Hong Kong and Singapore to enter into new leasing friendly double taxation agreements in future.

Ongoing international tax debate and reform
The OECD BEPS Action Plan and the EU Anti-Tax Avoidance Directives will impact all industries, including the aviation finance and leasing industry. A few key areas to be aware of in modelling future after-tax returns from an aircraft leasing investment include Action 4 (or Article 4 of the EU ATAD) on restriction of interest deductions and Action 6 on the prevention of double tax treaty abuse. Action 6 ultimately led to the conclusion of the Multilateral Instrument earlier this year (signed by over 70 countries thus far this year, amending over 1,100 tax treaties) which is mainly aimed at preventing the abuse of double tax treaties by, for example, using conduit companies in a country to gain access to that country’s treaty network. If there is one thing that should be clear by now it is that countries in the developed and developing world will scrutinise structures that provide tax benefits (including double tax treaty benefits) without real and substantive economic functions. Due to reputational risk countries that become aware that their regimes inadvertently facilitate tax avoidance will likely address any abuse swiftly. Revised OECD Transfer pricing guidelines (issued in July 2017) will also impact on cross-border intergroup financing structures.

The rise of tax disputes
Without doubt, Revenue Authorities around the world will seek to raise additional taxes with growing legislative powers and a supportive political environment to scrutinise current investment platforms. Perceived tax avoidance schemes will come under dispute by local authorities and substance-aligned tax planning within parameters set by the BEPS process will become increasingly important for aircraft lessors and other investors into the industry. In fact, in several jurisdictions Revenue Authorities are already applying BEPS inspired principles even in advance of legislative changes strictly speaking taking effect. Investors in aircraft should be mindful of ongoing international tax reform and its possible impact on after-tax returns from aircraft leasing. Having said that, the vast majority of aircraft leasing profits are earned in countries where the actual substantial economic activities take place and hence any impact of international tax reform should be moderate and manageable. In addition to possessing a number of supportive non-tax factors, the current leading centres for aircraft leasing should result in the actual payment of low taxes where economic activities take place (as opposed facilitating the avoidance of high taxes) and we expect to see an increase in substance and activities in those locations. Ultimately, this should aid certainty regarding the amount of tax to be paid on aircraft investments amidst a growing uncertain global tax environment.