Ireland’s continued growth in the aviation sector
April 2014 | EXPERT BRIEFING | BANKING & FINANCE
Ireland is one of the leading locations in the world for all forms of aircraft finance and leasing activities. This is due to Ireland’s very favourable tax environment, its long and successful tradition in the aviation industry, and the required skills, knowledge and expertise located in Ireland.
Nine of the top 10 global aircraft lessors have significant operations in Ireland. AerCap, which is headquartered in the Netherlands but effectively operates from Shannon Ireland, will control assets of $41bn when it takes over International Lease Finance Corporation. The recent announcement of the $5bn deal will triple AerCap’s fleet to almost 1400 aircraft, about 300 short of world leader GECAS, which also operates out of Shannon. The move will bring Ireland’s share of the world’s leased aircraft to 55 percent.
Ireland’s taxation regime
AerCap cited Ireland’s low corporation tax rate as one of the motivations behind the massive acquisition. The significant components of Ireland’s tax regime include very beneficial tax depreciation and interest deductibility rules and access to an extensive network of treaties which can eliminate foreign tax on lease rentals.
Ireland has signed double tax treaties with over 68 countries. The treaties provide an Irish tax resident aircraft leasing company with certain safe guards from double tax in their international operations and frequently permit a foreign lessee to make lease rental payments to an Irish lessor free from foreign withholding tax. Payments of interest by an Irish company to a bank or other financial institution situated in an EU member state or country with which Ireland has a double tax treaty will generally be free from interest withholding tax. This achieves a very tax efficient payment flow from the lessee through to the bank or financial institution.
In order to benefit from Ireland’s favourable tax regime and its double tax treaties, a company must be resident in Ireland for tax purposes. Tax residency is primarily determined by the ‘central management and control test’. Management and control relates to the decisions of fundamental importance to the business of the company as opposed to the day to day administration of the company.
The main indicators of central management and control are that the majority of the board of directors are Irish resident, all board meetings should be held in Ireland and all strategic management and business decisions should be made in Ireland. Ultimately, the residence of the company for tax purposes is a question of fact.
Irish corporation tax
Ireland has two rates of corporation tax; a 12.5 percent rate and a 25 percent rate. The 12.5 percent rate will apply to trading income generated or received by a company in Ireland and not attributable to passive income.
Trading generally means the carrying on of business or the engaging in activities on a regular basis with a view to realising a profit. It is important to demonstrate that the company has the necessary ‘substance’ in Ireland. The Irish Revenue acknowledge, however, that certain activities can be outsourced.
Calculation of profits and tax deductions
Companies are subject to corporation tax on trading income on the full amount of the profit or gains of the year of assessment. An Irish trading company is entitled to deduct any revenue expenditure incurred ‘wholly and exclusively’ for the purposes of the trade. Therefore, interest payments are generally tax deductible for an Irish trading company.
A lessor can also claim a tax deduction (referred to as ‘capital allowances’) in respect of capital expenditure incurred by it on the acquisition of aircraft, provided that the burden of wear and tear of the aircraft falls on the lessor. The rate of capital allowance available is 12.5 percent of the capital expenditure on a straight-line basis over a period of eight years.
The financing expense and tax depreciation should generally further reduce the effective tax rate of the Irish lessor substantially. In the case of ‘lease in/ lease out’ structures, where a foreign lessor leases through an Irish company to a foreign lessee, generally the Irish company will only be taxed on the margin or retained profit it earns.
Ireland’s securitisation regime
Companies which qualify under the provisions of Section 110 of the Irish Taxes Consolidation Act 1997 (Section 110 Companies) have long been used as tax-neutral vehicles in capital markets transactions. The Irish government introduced changes which allow Section 110 Companies to directly hold and manage plant and machinery, such as aircraft and engines. The aviation industry has been swift to take advantage of this change.
A Section 110 Company involved in aviation financing will typically acquire aircraft or engines using senior and junior debt or equity and enter into leasing transactions. The senior debt is provided at typical margins while the junior debt is typically structured as a profit participating loan which carries a rate of return equal to any remaining profit. Provided an appropriate structure is adopted, the cost of funding both the senior and junior debt, along with operating costs, are allowable expenses and result in a profit neutral company. The Section 110 Company is an ordinary Irish tax resident company which meets a number of qualifying criteria and notifies the Irish Revenue Commissioners of its status.
In Q4 of 2013 Avolon’s Irish tax resident special purpose vehicle, Emerald Aviation Finance, issued $636m worth of bonds securitised on the rental payments of part of its fleet. This was the first significant aircraft securitisation to come to the market since 2006.
The Irish Stock Exchange
The Irish Stock Exchange (ISE) has announced plans to create a specialist debt listing platform to enhance Ireland’s status as a global centre in aviation finance. The exchange will trade aviation-related debt and other instruments, recognising increased demand from capital market investors and lessors requirements to source alternative sources of funding. There are already 26 aviation-related debt instruments listed on ISE markets, with a total value of $12.7bn. These include Avolon’s $636m bonds, $1bn associated with Emirates and Milestone Aviation Group’s US Ex-Im backed bonds.
Cape Town Convention
The Convention on International Interests in Mobile Equipment signed in Cape Town on 16 November 2001 and the Protocol to the Convention on Matters Specific to Aircraft Equipment (generally referred to as the ‘Cape Town Convention’) is an international treaty intended to standardise transactions involving aircraft and aircraft engines. The Cape Town Convention was ratified by Ireland in 2005 and came into force on 1 March 2006. The Cape Town Convention creates international standards for registration of ownership, security interests (liens), leases and conditional sales contracts, and various legal remedies for default in financing agreements, including repossession and the application of particular states’ bankruptcy laws.
Once the Cape Town Convention applies, the creditor or secured party will be afforded all of the rights, benefits and protections afforded to creditors under the convention. This is an important factor for certain export credit agencies and lenders engaged in the aviation industry.
The Irish Government has announced changes to legislation that will allow the country to adopt a new insolvency regime for the financing of aircraft and aircraft engines. The changes will enable Ireland to have a regime equivalent to Alternative A in Protocol Article XI of the Cape Town Convention. The changes will also facilitate the issuance of EETCs in Ireland.
The enhanced insolvency regime will make Ireland’s aircraft leasing sector more competitive by giving more certainty to leasing companies, airlines and investors. Banks and lessors will have legal certainty as an insolvent company will have 60 days to discharge all liabilities due on leased aircraft and engines or return them to the lessor or other secured party.
David Maughan is a partner and Head of Aviation & Asset Finance at William Fry. He can be contacted on +353 1 639 5102 or by email: firstname.lastname@example.org.
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