The Legal and Tax Considerations In Acquiring A Private Aircraft

The following is a guest post by David Dannreuther, Partner and Philip Munro, Associate, of Withers LLP. Withers is an international law firm with capability to act in aircraft transactions through its Hong Kong, London, Milan, New Haven and New York offices.

The credit crunch and the global recession have plainly had an impact on the private aircraft market with second hand aircraft now marketed at a discount on the prices previously achieved and with there being increased delivery positions available on new aircraft. That said, as the recent interest in the first contracts to acquire the Gulfstream G650 showed, the private aircraft market remains busy and acquisitions continue to be made. A number of legal and tax considerations impact on the acquisition of a private aircraft that should be considered in advance of a purchase to ensure that the purchase takes place through a structure that is optimal from a tax, liability and operational perspective. All too often these considerations are neglected.

1. Liability and asset protection

There is plainly potential exposure to third party claims associated with owning and operating an aircraft. Litigation risk is not a uniquely American phenomenon such that consideration should be given to obtaining liability protection wherever the aircraft in question is operating. As a starting point in limiting liability, it is recommended that the aircraft in question is both owned and operated through a limited liability vehicle such as a company, limited liability partnership or LLC. To the extent that the aircraft is to be owned by a trust, it is preferable if a corporate trustee is used for similar reasons. It would not be ideal to hold an aircraft personally given the risks involved in aviation.

The limited liability vehicle chosen to own the aircraft should, ideally, be a special purpose entity that does not hold other assets. If the entity holds other assets such that it has more than the aircraft on its balance sheet, the structuring may not have been as effective from an asset protection perspective as these other assets could be put at risk in the event that there is an aircraft failure. Accordingly, we would suggest a policy of segregation of high risk assets to try to limit exposure. In some structuring to try to obtain liability protection, steps might also be taken to borrow against the value of the aircraft so as to reduce the value of the aircraft in the owner’s hands.

While there are circumstances under many legal systems in which the ‘corporate veil’ of a limited liability entity can be pierced such that the principals behind the company can, accordingly, be subject to personal liabilities, use of limited liability structures can provide a degree of protection. To the extent that the operation of the aircraft can be contracted to a third party with appropriate warranties and undertakings built into the operating agreement, exposure can be further reduced as the greatest area of risk tends to be associated with the operation rather than the mere ownership of an aircraft.

2. Operating considerations

2.1 Regulatory obligations

Exposure to third party claims exist not just in relation to claims in the event of an aircraft failure but also should there be a failure to comply with applicable regulatory regimes. It is vital that the aircraft has appropriate certificates and licences to operate in the jurisdictions relevant to it. For UK purposes, for example, European Union regulations provide that an Operating Licence (an ‘AOL’) is required if an undertaking (established in the EU) is to be permitted to carry by air passengers and/or cargo for remuneration and/or hire within the EU. Further, an Air Operator’s Certificate (‘AOC’) will be required in relation to an aircraft that flies for the purpose of public transport even if there is no payment for such flights. Accordingly, an AOC and an AOL may be required where an aircraft is operating in the UK although often an aircraft will be able to fly under an AOC and (if necessary) an AOL held by its operator rather than its owner.

2.2 Registration of the aircraft

In accordance with the Convention on International Civil Aviation all aircraft must be registered with a national registry with proof of this registration in the form of a Certificate of Registration carried on the aircraft at all times when it is in operation. Different registries impose different obligations on aircraft owners and operators before they will issue a Certificate of Airworthiness (‘CoA’). The CoA must also be kept on board an aircraft by the operator and must be presented to aviation authorities upon request.

2.3 Insurance

Insurance requirements in relation to aircraft need to be carefully considered prior to purchase and take effect at the moment of purchase. Usually there will be three types of insurance – hull, hull war risk and liability insurance. Hull insurance covers physical loss or damage subject to a deductible according to the type of aircraft but this too can be insured against. Hull war risk and other perils specifically writes back into the hull policy certain risks such as war risk and sabotage which are excluded from the hull policy. Liability insurance covers damage done to property or people outside the aircraft and liability to passengers and baggage on the aircraft. The amount to be insured for hull insurance is the value of the aircraft and for liability depends on the size of the aircraft.

It is very important that the insurance for any aircraft to be acquired is reviewed in detail to check what is covered, what is not covered, the liability amounts and that the insurers are persons of recognised responsibility.

3. Tax considerations

The tax treatment of the acquisition, operation and future disposal of an aircraft needs to be considered before its acquisition. The tax treatment depends very much on the jurisdiction in which its acquirer and operator will be based and on the degree to which it is used for business rather than personal use. As the tax considerations in relation to a particular aircraft are, then, very specific, specialist advice in relation to any purchase will be required.

In relation to a purchase of an aircraft to be operated in Europe, a significant concern will be whether or not the aircraft is being imported into Europe for VAT purposes; if the aircraft is being brought into the European VAT area, consideration will need to be given as to whether the aircraft is a ‘qualifying aircraft’ such that the import VAT is levied at the rate of 0% or whether the aircraft will be subject to a charge at the standard rate on import. In the UK, an aircraft is a ‘qualifying aircraft’ if it has a gross weight of 8,000 kilos or more and is not viewed as being　either ‘designed nor adapted for use for recreation or pleasure’.

As well as the tax issues arising out of the acquisition, the tax treatment of the aircraft’s ongoing operation needs to be considered with key questions being the taxation of any charter fees and the deductibility of operating costs, particularly if the aircraft is being used for some business activities. For UK purposes, the risk of a ‘benefit in kind’ charge should be considered - the use of an asset held by a company can result in a UK income tax charge if the individual using that asset is not paying market rent for the usage and is – or could be taken to be – a director of that company. The benefit in kind rules might make a corporate structure inefficient for UK tax purposes unless a market rate charter fee was paid whenever the aircraft in question was used.

Finally, the tax treatment arising on the disposal of the aircraft should be considered. To the extent that no gains arise on the disposal, the use of any losses arising needs to be considered and, in particular, whether these can be set against profits in other business activities. Over the last few years, gains have often been made on the disposal of private aircraft because of the premiums being paid.

4. Flight crew

If a private aircraft is being operated by an independent operator, that operator will often provide the flight crew. It is important in considering the terms of the operating agreement to ensure that you have some control over the composition of flight crew, so you can refuse crew members that you have previously found unsatisfactory.

If you are not using an independent operator (or if you are using an independent operator but you want to provide your own flight crew), the employment law position of the crew can be complex. Some issues to consider include:

4.1 Status of flight crew – as flight crew may act in relation to a number of aircraft, it is not uncommon for crew to consider themselves as independent contractors rather than employees. This can often improve their tax position and, if they genuinely are independent contractors, could mean that their ‘employment’ rights are limited. However, be wary; the legal distinctions between ‘employed’ and ‘self-employed’ is a fine one and whatever label is applied by the partners will not be determined if the facts point to a different conclusion. For this reason, great care needs to be taken when determining the terms of the crew’s appointment and drafting crew contracts.

4.2 Tax compliance – even if the crew are genuinely independent contractors, rather than employees, tax compliance obligations can arise. To the extent that the crew are employees, then a wide range of employer tax obligations (such as withholding and national insurance/social security payment requirements) may apply.

4.3 Employing entity – staff come with at least some ‘employment’ rights, which means additional liability. Therefore, just as it is sensible not to own aircraft directly, so too is it preferable (if possible) not to employ crew directly. From an asset segregation perspective, there can be merit in setting up a separate entity to employ crew to avoid wider assets being exposed to any claims they bring, and because on an aircraft replacement the option of selling a corporate owner of an aircraft might not be available if that company also employs the crew needed to staff the replacement aircraft.

4.4 Governing law – where crew are international in composition and in their work, there is some flexibility as to the choice of law to govern their contractual rights. However, in addition to contractual rights, staff may have ‘statutory rights’, which are determined by other factors. For example, the UK right not to be ‘unfairly dismissed’ is only available to staff employed ‘in Great Britain’. The focus of this test is on the location of the work but where, as with flight crew, staff work in many countries, a range of factors may be relevant (including contractual terms and the individual’s ‘base’), so careful thought needs to be given to these issues before terms are finally agreed. In the US, some rights depend only on individuals being US citizens and employed by a US employer, which is another relevant factor when deciding which should be the employment entity.

4.5 TUPE – where aircraft operations have a European nexus, the EU ‘Acquired Rights Directive’, incorporated into English law as the

Not only then is specific tax advice required in relation to an aircraft purchase, employment law advice in relation to flight crew may also be required.

5. Banking arrangements

External financing is often sought for private aircraft acquisitions even where the purchaser could effect a cash transaction so as to spread the cost of the acquisition and, to some extent, the risks associated with it.

Where lenders are still willing to lend on private aircraft transactions, the percentage of the aircraft value they will lend will depend on their own particular policies and the amount of the security which can be offered. Although the arrangement fee and margins over base rate or LIBOR are now higher, this is offset by the low rates of base rate and LIBOR. Banks will typically take a first priority mortgage over the aircraft which they will register with the Civil Aviation Authority or other authority with which their aircraft is registered. They will also take an assignment of the aircraft’s insurances and earnings.

It should also be noted that the requirements of the lender may well impact on the structuring of the acquisition vehicle and on the choice of the aircraft registry. It is therefore important to involve a lender in the transaction as soon as possible.

Transfer of Undertakings (Protection of Employment) Regulations 2006 (‘TUPE’), might be relevant to the transfer of thse operations between entities. Where TUPE applies, it will result in the automatic transfer (and protection of employment terms) of employees assigned to the operations transferred. TUPE can be relevant to second hand aircraft sales, as well as contracting out (and in) of certain operating services.

While in principle the acqusition of a private aircraft might seem like a relatively straightforward proposition, it should, in fact, be treated as a sophsiticated commerical transaction. It is essential that consideration be given to the optimal structure for the ownership and operation of the aricraft before the transaction proceeds to ensure that, ultimately, the purchase is effected in a tax efficent limited liability structure. Arrangements in relation to the operation, insurance and crewing of the aircraft need to be decided at the outset particularly to the extent that these impact on the aircraft’s regulatory position which must be considered in light of its likely operating arrangements.

If you enjoyed this article, please subscribe to our feed and follow us on Twitter