With Summer just around the corner, welcome to our late Spring edition of Legalflyer where we once again review a series of topical issues for the aviation industry.
We start this edition with an update on a topic hardly out of the news - the Volcanic Ash crisis. The European Commission was widely criticised for its handling of the original crisis and the speed of its response to protect an already fragile air transport industry. Following a briefing sent out to clients in April, Anna Anatolitou, senior associate in our dispute resolution team, Abu Dhabi, Norton Rose (Middle East) LLP , examines the latest response of the European Commission to the ongoing eruptions.
In a finance market where sources of funding have been in short supply, the European Export Credit Agencies have played an important role in helping to fill the funding gap. Our second article examines some of the key considerations in European ECA financings and highlights some of the new types of financing structures which have either been closed recently or may lie on the horizon. The article is written by Owen Mulholland, a partner in our aviation finance practice, Norton Rose LLP, London.
A case involving an aircraft lease rarely comes in front of the English Courts and when it does, perhaps greater than usual attention is paid to it by the aviation community. Our third article looks at two recent cases which have been dealt with by the Commercial Court in London. The first case is Celestial Trading 71 Limited v Paramount Airways Private Limited  EWHC 185 (Comm) in which the High Court was asked to determine whether it had jurisdiction to grant relief from forfeiture under the operating leases which were before it and if so, whether it was appropriate for the Court to exercise its discretion to grant such relief. In the second case, Tandrin Aviation Holdings Ltd v Aero Toy Store LLC (ATS)  EWHC 40 (Comm) one party sought to argue before the High Court that a dramatic change in market conditions had triggered a force majeure clause under an Aircraft Sale Agreement. The judgments in both cases will be of interest to those involved in aircraft transactions.
In spite of turbulence elsewhere in the aviation sector, Abu Dhabi’s ambitious plans for the aviation industry remain steadily on course. Our fourth article looks in more detail at expansion plans for the aviation industry, as set out in a number of strategic framework documents, the most prominent of which is Plan Abu Dhabi 2030. The article is written by Emma Giddings, aviation finance partner, and Alan Bainbridge, corporate finance partner, both based in Abu Dhabi, Norton Rose (Middle East) LLP.
We complete this Spring edition with a round up of recent UK tax developments following both the budget in March and the election in May including an announcement by the government that the existing air passenger duty is to be replaced with a tax charged on a per-aircraft rather than a per-passenger basis. The tax update is provided by David Ward, an associate in our tax department, Norton Rose LLP, London.
As always, I hope that you will find our articles to be of interest and I would be delighted if readers could provide any comments on the content, or suggestions for future editions of Legalflyer, by using the comments box which can be accessed through this hyperlink. Likewise please feel free to pass on the details of colleagues who may wish to receive Legalflyer.
Patrick Farrell, Partner
Norton Rose LLP , London
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The Volcanic Ash crisis - the European Commission’s response
The eruption of Mount Eyjafjallajokull brought European air traffic to a standstill between 15 and 21 April 2010, at the height of which airspace was simultaneously closed or partially closed in 19 EU states, and six non EU states. This unprecedented air transport crisis has cost the industry more than $1.7 billion in lost revenue plus significant additional costs related to matters such as passenger rights exposures (as detailed in our recent briefing note “Volcanic Ash Crisis: Air Carrier Obligations”).
Whilst many hoped that the crisis was over when airspace re-opened after the initial six days, subsequent eruptions have caused ongoing closures, albeit on a much smaller scale.
The European Commission has been widely criticised for its handling of the crisis and the speed of its response to calls for assistance from a fragile air transport industry, still trying to recover from two of the most difficult economic years in its history. Much of the Commission’s initial focus was on the enforcement of passenger rights under EC Regulation 261/2004, to protect the 10 million passengers affected by the cancellation of over 100,000 flights. However, Information Note 1915, published on 27 April by European Transport Commissioner, Siim Kallas, in association with Mr Almunia (VP - Competition & State Aid) and Mr Rehn (Commissioner for Economic and Monetary Affairs), seeks to address some key items of concern for the air transport industry. The Information Note sets out a series of short term measures and mid to longer term structural change proposals with a view to assisting the industry to deal with this and future crises.
The measures proposed may be summarised as follows:
Immediate measures to support the air transport sector
1. Application of passenger rights legislation
Although the Commission remains committed to the uniform application and enforcement of passenger rights (EC Regulation 261/2004), it will nevertheless encourage national enforcement bodies to take into account the practical difficulties encountered by airlines during the crisis. The Commission states that it will continue to monitor the situation and may, if appropriate, propose a review of the Regulation to take account of the ash cloud crisis experience.
2. Operational flexibility to relaunch air traffic
The Commission states that it will not object to Member States allowing flexibility to operational restrictions, as necessary, to ensure a quick return to normality.
3. Application of Slots Regulation
The EU Slots Regulation (EC Regulation 95/93 as amended) should be interpreted so that airlines do not risk losing their unused slots simply as a consequence of the ash cloud crisis. Article 10(4)(a) allows carriers to cite exceptional circumstances affecting the use of slots.
4. En-route charges
In order to assist with immediate cash flow concerns for airlines, the Commission recommends that both Member States and Eurocontrol assess the possibility of deferring actual payments for en route charges, for a restricted period.
5. Emissions Trading Scheme (EU ETS)
The Commission will assess the impact of the fall in air traffic on the ETS Directive (EC Directive 2008/101EC) and other legislation, although it admits that the practical effect of the six day grounding is likely to be minimal.
6. Application of the rules on state aid
The Commission will favourably consider any support measures by Member States to compensate net losses directly linked to the crisis for those undertakings directly affected by the closure of airspace to offset losses incurred, provided that such measures are temporary, uniform, non-discriminatory and do not result in over-compensation or distort the market.
Structural measures to support the air transport sector
1. Assessment of risks
The crisis has demonstrated the importance of proper data collection and risk assessment. The Commission will create a working group of experts (with representatives from Eurocontrol, EASA, Member States, ICAO and industry) to identify relevant gaps and produce a roadmap on necessary research and technology required to make appropriate decisions in the future. A coherent approach to risk assessment and risk management will also be developed in relation to the future closure and reopening of airspace. The Commission will prepare a paper for submission by the EU to the ICAO General Assembly meeting in September 2010.
2. Prioritising the implementation of a Single European Sky
The Commission will prioritise the acceleration of the full implementation of a Single European Sky giving priority to the five factors identified by the February 2010 Madrid Declaration. The Information Note sets out a list of seven ‘concrete actions’ to be taken over ‘the coming weeks’, including the immediate creation of a ‘Crisis Coordination Cell' to react immediately to future crises. It is proposed that this cell could launch an unmanned aircraft vehicle (UAV) to collect data.
3. Strong neighbourhood policy – Creation of a Common Aviation Area
The Commission will cooperate with neighbouring countries and key partners such as the US and Canada, with a view to creating a single Common Aviation Area covering 58 countries and representing 1 billion people. The Commission will prepare a framework for this initiative by the end of 2010.
4. Promote a pan-European mobility plan
The Commission favours the development of a pan-European mobility plan, such that if one mode of transport is affected by a crisis, other transport modes can quickly substitute. A working group with stakeholders will be established to asses the current situation and make proposals to member states with a view to enabling a swift response to future crises.
5. Consideration of a European instrument to respond to such crises
In considering the economic impact of the crisis, the Commission will evaluate which mechanisms might be developed to provide assistance to specific sectors affected by future crises. Two examples identified for further consideration are (i) specific insurance and (ii) the creation of a common fund.
The crisis and ongoing eruptions demonstrate the need for crucial reform, and whilst many feel that the Commission’s measures do not go far enough to address the economic impact upon the industry as a whole - let alone other sectors affected by the crisis - it has been welcomed by many air transport industry bodies. Time will tell when and to what extent these proposals are implemented and whether or not they prove to be effective.
Anna Anatolitou is a senior associate in the Dispute Resolution team, Norton Rose (Middle East) LLP , Abu Dhabi.
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Recent developments in ECA-supported financings
In a finance market where the availability of commercial debt remains at a premium, Airbus financings which are supported by the European Export Credit Agencies (ECAs) continue to attract high levels of interest from airlines and operating lessors.
This article examines some of the key considerations in European ECA financing and highlights some of the new types of financing structures which have either been closed recently or may, potentially, be on the horizon.
The “vanilla” European ECA financing structure is well-established.
On a typical structure, ECA lenders will advance a loan of up to 85 per cent of an aircraft’s purchase price to a borrower entity. This will, almost invariably, be a special purpose company incorporated in a jurisdiction which is acceptable to the ECAs. The borrower will acquire title to the aircraft on delivery, usually by way of an assignment of the airline’s right to take title to the aircraft under the airline’s purchase agreement with Airbus. The borrower will then lease the aircraft to the airline under a finance lease and use the rent it receives under the finance lease to service the debt due under the ECA Loan. The balance of the purchase price will be financed by the airline itself, either through the airline’s own equity or by way of a separate commercial loan. The obligations of the borrower will, in the usual way, be limited in recourse to monies which it receives from the airline under the finance lease. The transaction will be documented on the basis set out in the ECAs’ Harmonised Documents with a standard security package of borrower share charge, first priority mortgage and relevant security assignments securing the loan.
The ECAs support the ECA Loan through the issue of their guarantee/support agreements. Typically the transaction will be “fronted” by one lead ECA who will issue the relevant guarantee/support agreement to the ECA Lenders and then re-insure a portion of its risk through the other ECAs. This is done by inter-ECA reinsurance arrangements.
One fundamental principle which lenders need to bear in mind when reviewing these structures is that the ECAs do not take structural risk on ECA financings. Risk on the borrower special purpose company and the general integrity of the financing structure is, therefore, something which all lenders need to consider carefully, particularly when their objective under an ECA financing will be to “zero weight” the ECA Loan on their books.
Both the European ECAs and Ex-Im Bank have been widely praised by airlines and operating lessors for the pro-active approach they have taken in a market where, during 2009, the commercial debt market almost dried up completely. That supportive approach is evidenced by the figures (2009 was a record-breaking year for the ECA-backed financings) and the type of transactions which the ECAs have been prepared to consider and underwrite.
ECA-supported operating lessor financings, which, until relatively recently, were considered a niche variant of ECA financing have become more common and some interesting new variants of the traditional ECA financing structure have emerged.
In February of this year, the Brazilian carrier TAM Linhas Aéreas S.A. closed the first ever ECA-supported Spanish Operating Lease (SOL) of three new A319s (a transaction on which Norton Rose LLP acted for the ECAs). Prior to the framework established by the 2007 Aircraft Sector Understanding on Export Credits for Civil Aircraft (ASU), the ECAs had underwritten Japanese Operating Lease (JOL) structures supported by ECA debt but, with activity in the JOL market drastically reduced since 2007, the TAM SOL deal is one of the few examples where, post-ASU, a highly leveraged tax-based financing product has been successfully combined with ECA debt. It remains to be seen whether, as the JOL market begins to show some faint signs of recovery, ECA-supported JOLs will re-emerge as a potential financing tool for airlines.
One of the hottest topics in ECA financing at the moment is the possibility of ECA-supported capital markets financings.
Following the conclusion of the first Ex-Im Bond financing in 2009, the Ex-Im Bank capital markets bond structure has emerged as a key financing tool for buyers of the Boeing product.
When it comes to a choice between Airbus and Boeing aircraft, all things being equal (which, of course, they hardly ever are) buyers of the Boeing product can now access a form of financing which does not, yet, have any European ECA equivalent. It remains to be seen whether a successful European ECA-supported capital markets financing will get off the ground but the challenges, both political and structural, should not be over-estimated, not least the fact that, in order for this type of financing to work, it would seem inevitable that the ECAs move from their traditional position of not taking structural risk.
Each structure will always be looked at, and tested, by the ECAs on its own merits but the types of transactions which the ECAs have been prepared to underwrite in recent times, and possible new developments such as capital markets financings, are bound to be of interest to existing, and prospective, Airbus customers.
The ECAs expect the overall level of ECA-supported financing in 2010 to be down on 2009’s record year but ECA financing remains possibly the key financing tool in the aviation finance market at the present time. The market will, no doubt, be watching closely to see what further developments 2010 may bring.
Owen Mulholland is a partner in the Banking team, Norton Rose LLP , London.
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Clarity - a vital ingredient for contracts in uncertain times
Parties to agreements require clarity and certainty in their contractual relationships: clarity as to what the contract means and certainty that when a dispute arises, such as a default, as to the likely outcome.
Over the years, the standard wording for aircraft operating leases has become more and more refined and whilst every deal is different commercially, parties do rely on what is sometimes called “boiler plate” to deal with the very important contractual wording which should be found in all well drawn leases.
It is for this reason that when a case involving an aircraft lease does come in front of the English Courts, perhaps greater than usual attention is paid to it by the aviation community. Two cases have recently been dealt with by the Commercial Court in London which will be of interest to those involved in aircraft transactions.
In Celestial Trading 71 Limited v Paramount Airways Private Limited  EWHC 185 (Comm) the High Court was asked to determine whether it had jurisdiction to grant relief from forfeiture under the operating leases which were before it and if so, whether it was appropriate for the Court to exercise its discretion to grant such relief.
Relief from forfeiture is a discretionary power which an English Court may have in certain circumstances to restore a lease to a lessee who has forfeited as a consequence of a default. The Court held here that it had no such discretion in respect of the leases in question mainly because the leases were aircraft operating leases conferring no proprietary rights on the lessee and that even if it had such discretion it would not have exercised it in favour of this particular lessee.
Celestial Trading 71 Limited (Celestial) leased three Embraer 175 aircraft to Paramount Airways Private Limited (Paramount), an Indian airline. The leases had terms of eight years and required Paramount to make payments of rent and supplemental rent (being monies to be paid by Paramount on account of maintenance costs associated with the aircraft). Paramount was also required to pay a security deposit to Celestial.
The Court held that Paramount had defaulted on numerous occasions during the term of the leases, in the payment of rent and supplemental rent, in the provision of letters of credit to constitute security deposits and in the provision of certain technical information. Celestial sent a number of notices of default to Paramount and eventually sought to terminate the leases by reasons of the defaults and recover possession of the aircraft as the terms of the leases permitted them to do.
Celestial applied for summary judgment before the English Commercial Court where Paramount intended that it should be entitled to relief from forfeiture. The Judge at the initial hearing decided that the question of Paramount’s entitlement to relief from forfeiture was arguable and gave directions for an expedited full trial.
Jurisdiction to grant relief against forfeiture?
The court at the full trial reviewed the various authorities (mainly from shipping cases) and held that in order to determine whether there was jurisdiction to grant relief against forfeiture in any particular circumstances, the following considerations are of relevance:
- Whether the contract involves the transfer of proprietary or possessory rights;
- If so, whether (i) it is possible to state that the object of the transaction and of the insertion of the right to forfeit is essentially to secure the payment of money and/or (ii) the primary object of the bargain is to secure a stated result which can effectively be attained when the matter comes before the Court and whether forfeiture provision is added by way of security for the production of that result; and
- If so, whether reasons of legal public policy support the existence of such a jurisdiction.
Here, the Paramount leases were operating leases with a term of approximately one third of the aircrafts’ useful lives. The court held that on the facts of the case, the lessee had no proprietary (but only possessory) rights over the aircraft and that the termination provision was not inserted essentially to secure the payment of money. The primary object of the bargain was not the repayment of money with the termination provision being inserted as security for the production of that result. The Court found as follows:
“In the present case … Paramount only has a right to possess the aircraft for a proportion of its economic life. As such, Celestial retains a very real interest in the aircraft themselves, including their proper maintenance, the extent of their use, their condition and their rental and resale value. Possession of the aircraft will revert to it at a time when the bulk of their economic life is still to run and there are detailed terms addressing the return of the Aircraft and their required redelivery conditions. Celestial therefore retains many of the risks and rewards of ownership. Moreover, rent was not calculated on the basis of recouping the cost of the Aircraft together with interest and profit …”.
The Court also went on to consider whether, even if it had had the relevant discretion, it would have exercised it in favour of this particular lessee and gave a robustly negative answer. The Court helpfully laid out the matters which it should take into account in deciding whether or not to grant relief including:
- The conduct of the lessee and whether his default was wilful or arose by “surprise, accident or ignorance”; In this case, the Court found that there was a long history of defaults. Over twenty separate notices (notice of events of default, warning and grounding notices) had been sent. Paramount had never paid rent on time for any of the aircraft, had never provided a utilisation report for any of the aircraft on time and had never paid supplemental rent on time for any of the aircraft, except once. The Judge described this as a “background of persistent default” and said that it showed a “cavalier disregard” to their contractual obligations and moreover of obligations which are stated to be of the essence and to involve a repudiation if breached. Paramount also had ample warnings of the consequences of continuing default.
- The gravity of the breaches;
- The disparity between the value of the property of which forfeiture is claimed as compared with the damage caused by the breach;
- Whether the asset in question is one which “as contrasted to land is easily moved, easily concealed and easily sold, is liable to rapid depreciation and require a considerable expenditure to maintain”; and finally
- The need for the lessor to take speedy and irrevocable action to protect his rights in the asset.
A need for certainty
The Court also emphasised the need for certainty in transactions of this type and noted that the granting of relief against forfeiture in these circumstances could have a destabilising effect on the operating lease industry as a whole.
In Tandrin Aviation Holdings Ltd v Aero Toy Store LLC (ATS)  EWHC 40 (Comm), Mr Justice Hamblen (again) gave judgment against a party who argued that the dramatic change in market conditions triggered a force majeure clause.
Tandrin entered into an Aircraft Sale Agreement with ATS for the sale of a jet aircraft for US$31.75 million. Under the Agreement, ATS paid a deposit of US$3 million to an escrow agent; with the balance due upon delivery of the aircraft. When ATS failed to take delivery of the aircraft or pay the balance, Tandrin terminated the Agreement and sought recovery of the deposit.
ATS's main defence was that the
"unanticipated, unforeseeable and cataclysmic downward spiral of the world's financial markets"
triggered the force majeure clause in the Agreement.
Mr Justice Hamblen rejected this argument and held that ATS could not rely upon the force majeure clause to excuse its non-performance. It is a well established principle of English law that a change in economic or market circumstances affecting the profitability of a contract or the ease with which the parties' obligations can be performed, is not regarded as a force majeure event.
Further, there has been no reported case where change of economic or market circumstances has been held by any English court to amount to force majeure.
Of course, whether a force majeure clause in a contract is triggered depends on the proper construction of the wording of the relevant clause. The force majeure clause in the Agreement did not refer to economic circumstances and Hamblen J could see no basis for construing the clause so as to include any funding difficulties encountered by ATS.
The decision follows a 2005 Commercial Court case, Thames Valley Power Ltd v Total Gas & Power Ltd  1 Lloyds's Rep. 441 where the defendant's attempt to rely on a force majeure clause was similarly rejected. In that case , Mr Justice Clarke referred to a line of cases on force majeure clauses and frustration to the effect that the fact that a contract has become more expensive to perform, even dramatically more expensive, is not a ground to excuse a party’s performance on the grounds of force majeure or frustration.
A robust approach
It could be said that these cases are indicative of the current economic times but they do give a clear indication of the robust way in which English courts deal with such disputes. Whilst parties look for certainty in their dealings, as always much depends on the clarity and accuracy of the contractual wording.
Patrick Farrell is a partner in the Dispute Resolution department, Norton Rose LLP , London and editor of Legalflyer.
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On course - the aviation industry in the Emirate of Abu Dhabi
Abu Dhabi’s ambitious plans for the aviation industry remain steadily on course despite turbulence elsewhere in the sector.
Plan Abu Dhabi 2030
The expansion of Abu Dhabi’s aviation industry is one aspect of the Emirate’s vision of using oil revenue to diversify its economy, develop its infrastructure and improve the quality of life for its residents. The features of this initiative are set out in a number of strategic framework documents, the most prominent of which is Plan Abu Dhabi 2030 (Plan 2030).
Published in September 2007, Plan 2030 focuses on the proposed physical expansion of Abu Dhabi city to meet a number of anticipated challenges, including substantial population growth (at least tripling the current population by 2030) and a burgeoning tourist industry. These two factors alone will make an improved transportation network essential - plans are already underway for high-speed rail links, a metro system and improved traffic calming measures - and will require additional development and expansion of the Emirate’s commercial aviation industry to meet increasing demand.
With an eye on increasing air passenger numbers through the Emirate, Abu Dhabi launched Etihad Airways (PJSC) (Etihad) in 2003. A subsidiary of the Abu Dhabi Government, Etihad has enjoyed a meteoric rise: the airline was voted the World’s Leading Airline at the World Travel Awards 2009 and at the date of writing flies to 59 destinations worldwide with a further 47 destinations available through its code share partners.
Etihad has committed itself to further expansion with record-breaking orders in July 2008 for up to 205 aircraft (100 on firm order) at the Farnborough International Airshow, and in May 2009 for up to 469 engines (239 on firm order) at the Paris Air Show. The new aircraft and engines are scheduled for delivery between 2011 and 2020.
This development is in part down to the airline’s bullish approach to the prevailing economic conditions and to the perceived opportunities available in the region - the Middle East is currently the one world region bucking the decline trend in air passenger numbers with an additional 3.1 per cent gain on passenger kilometres in January, following growth of 3.9 per cent in December according to recent International Air Transport Association (IATA) figures. In Etihad’s case this market resilience (and its accelerated development) is the consequence of a number of factors, including significant governmental support, a determined marketing strategy and the emergence of Abu Dhabi on the world stage as a valid financial, commercial and tourism centre.
Focus on Abu Dhabi
In recent years Abu Dhabi has asserted itself as a financial powerhouse in the Middle East. The Emirate’s prominence in the region is evident in both the number and scale of projects being undertaken and the amount of corporate relocations to Abu Dhabi’s financial centre.
Abu Dhabi’s place on the global stage has also been well publicised by the increasing number of big-ticket sporting events attracted to the Emirate: Abu Dhabi holds a European PGA Golf Tour event and in the last few months has also played host to an F1 grand prix, an International Triathlon, the annual Wakestock wakeboarding event, and an Ultimate Fighting Championship meeting. Benefiting directly in ticket sales from these events, Etihad has also increased its profile with big-name sporting sponsorships including the former Telstra Dome (now Etihad Stadium) in Melbourne, Australia, the F1 Ferrari team and Abu Dhabi Grand Prix, Manchester City and Chelsea football clubs and Harlequins rugby club. This sponsorship model is increasing the international profile of both the Emirate and its national carrier, particularly in Asian and European markets.
Abu Dhabi has placed great stock in measured development. Sustainability is listed as one of the “Key Directions” in Plan 2030 and will feature heavily in the Emirate’s modernisation plans. In addition, in March of this year Abu Dhabi established a new oversight committee to ensure the smooth running of state-owned companies like Etihad. The Emirate is also setting up a debt management office to coordinate debt issued by the government and government-related entities to avoid a situation where government debt is an open issue.
Abu Dhabi has invested significantly in the development of Emirati nationals rather than relying solely on overseas talent. Etihad has, for example, a keen Emiratisation programme developing pilots, graduate managers and technical engineers; at the end of 2009 over 150 UAE national trainees worked for the airline. Etihad has also entered into agreements with local colleges to promote the pursuit of aviation careers among the UAE youth.
A global hub
Although Etihad has taken the majority of recent headlines in the aviation sector, several other Abu Dhabi companies have been busy behind the scenes. Perhaps most prominent is Mubadala Aerospace, part of Abu Dhabi’s state investment company, recently heralded as the Gulf’s playmaker to watch in the industry. Over the past 2 years, the company has announced a series of acquisitions and partnerships including the takeover of a majority stake in SR Technics, a Swiss maintenance, repair and overhaul (MRO) company, and becoming a major stakeholder in Piaggio, the Italian business aircraft manufacturer.
In February of this year, Mubadala Aerospace also announced a move into component and engineering finance. A subsidiary of the company currently has a $100 million financing deal for 12 spare engines with Air Berlin, including a 10 year engine maintenance contract and is providing $30 million in component financing for the Airbus fleet operated by Etihad.
Other subsidiaries of Mubadala Aerospace include MRO specialist Abu Dhabi Aircraft Technologies (ADAT), which is currently expanding its scope of operation from Abu Dhabi’s main airport, and Strata (a joint venture with EADS and Finmeccanica) which is expected to close a deal with Boeing in the second half of this year to manufacture advanced composite aircraft components; the company already has a similar deal in place with Airbus.
Abu Dhabi’s investment in Etihad clearly illustrates its desire to attract corporate and private travel through the Emirate. High-profile sponsorships neatly align with Etihad’s luxury service offering and Abu Dhabi’s brand image; they have also done much to stimulate growth in the past two years in the commercial aviation and tourism industries, particularly in Asian and European markets. Abu Dhabi’s future success in the aviation sector in establishing an economically viable and diverse industry will also rely on the development and expansion of Mubadala Aerospace and its subsidiaries. However, with a clear business strategy, government backing and investment in local expertise, Abu Dhabi remains on course to meet its ambitious objectives in the sector.
Emma Giddings is a partner in the Banking team and Alan Bainbridge is a partner in the Corporate Finance team, Norton Rose (Middle East) LLP , Abu Dhabi.
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Recent tax developments in the aviation sector
On 11 May 2010 the Conservative and Liberal Democrat coalition announced that they have agreed to replace the existing air passenger duty with a tax charged on a per-aircraft rather than a per-passenger basis. No details have yet been made available and it is not clear whether this tax will discriminate between aircraft on the basis of their carbon output or any other environmental criteria. However, the announcement will not come as a great surprise to members of the industry as both the Conservatives and the Liberal Democrats had previously promised to review air passenger duty if they won the election. Many representatives from the aviation sector have been lobbying for changes to air passenger duty, arguing that a tax charged on a per-aircraft basis would be more closely linked to the environmental impact of aviation. However, the change will not be welcomed by all members of the aviation industry; in particular, it is likely to represent an increased cost to those airlines offering a greater proportion of first or business class seats.
Other tax developments that will be of interest to the aviation sector were contained in the 2010 Budget. The first relates to the UK ’s treatment of supplies of aircraft and aircraft parts for VAT purposes. As we reported in the Autumn edition, the UK’s position as a jurisdiction of choice for the transfer of title in aircraft and aircraft parts has been placed under some threat as a result of the European Commission’s challenge of the UK’s implementation of the European law permitting exemption from VAT for transfers of certain aircraft. In the 2010 Budget, the UK Government announced that the changes that must be made to comply with European law will be implemented by 1 September 2010.
The Budget announcement was short on detail and since the General Election was called (and under Cabinet Office rules) HMRC have been unable to discuss the changes further for the time being. However, what we do know is that the conditions of the revised exemption will have to reflect the relevant European law, which means moving from a test based on the nature of the aircraft (i.e. weight not less than 8,000kg and neither designed nor adapted for use for recreation or pleasure) to a test based on the status of the end user of the aircraft.
From 1 September 2010, the exemption is unlikely to be available unless the aircraft will be used by an airline operating for reward chiefly on international routes (a qualifying airline). As a practical matter, from 1 September 2010, suppliers will need to obtain clear evidence that a supply is being made to a qualifying airline before the supplier can apply the zero rate and this will have to be reflected in the documentation. Parties involved in the sale or lease of an aircraft or aircraft parts in the UK, will need to confirm that there will be no unexpected VAT costs and will need to consider including specific conditions precedent or warranty protection in the documentation in relation to the qualifying status of the airline. We expect more detailed guidance to be published in the summer and will include any update in the next edition of Legal Flyer.
The other relevant announcement in the 2010 Budget Report was that the so called “Lennartz accounting method”, which permits upfront VAT recovery on the purchase of certain goods that will be used partly for business and partly for private purposes, will no longer be available in respect of aircraft. This could be a significant development for prospective purchasers of corporate jets, many of whom will expect to use the aircraft partly for business and partly for private purposes.
Broadly, the Lennartz accounting method permitted upfront recovery of all input VAT incurred on the purchase by a business of an aircraft which was to be used partly for business and partly for private purposes. The business was then required to account for output VAT in full over subsequent years in relation to both the business and private use of the asset. Therefore, the Lennartz accounting method offered a useful cash-flow advantage to taxpayers purchasing aircraft for mixed business and private use. From 1 January 2011, the application of the Lennartz accounting method will be restricted so that any input VAT incurred on the purchase of an aircraft will have to be apportioned between the business and private use and no recovery will be permitted in respect of any input VAT apportioned to the private use. Clearly, this will remove the cash-flow advantage which the Lennartz accounting method provided. For taxpayers who are already using the Lennartz accounting method, the UK tax authorities have introduced “revenue protection legislation” to ensure that the VAT due continues to be paid.
David Ward is an associate in the Tax team, Norton Rose LLP , London.
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