crowley

The New York SchoolofInternational Aircraft Finance: 

The New York School of International Aircraft Finance United States Tax Considerations In Aircraft Finance Transactions Richard Crowley New York, New York April 10, 2003

A. Two Basic Kinds of Investment in Aircraft: 

A. Two Basic Kinds of Investment in Aircraft 1. U.S. income tax law classifies investments in property (such as aircraft) in one of the following two general categories: (a) Equity investment -- ownership. (i) Purchase, own and operate. (ii) Purchase, own and lease to operator. (b) Debt investment -- secured loan. (i) Lend to operator, secured by aircraft. (ii) Lend to lessor to operator, secured by aircraft and lease. 2. The various forms of financial investment in aircraft available in the market are variations of those two basic kinds of investment.

Some Income Tax Consequences of Choosing an Equity Investment or Debt Investment in Aircraft: 

Some Income Tax Consequences of Choosing an Equity Investment or Debt Investment in Aircraft 1. Equity investment – owner/lessor. (a) Deductions for depreciation with respect to lessor's cost of aircraft. (b) Recovery of undepreciated cost (if any) when aircraft is sold. (c) Possible deferral of gain on sale through like-kind exchange. (d) Payments received from aircraft operator are classified as rent. (e) Deductions for interest on any loan borrowed by owner/lessor to purchase the aircraft. 2. Equity investment – lessee. (a) No deductions for depreciation with respect to the aircraft. (b) Deductions for rent payable to owner/lessor.

Some Income Tax Consequences of Choosingan Equity Investment or Debt Investment in Aircraft – cont’d: 

3. Debt investment – secured lender. (a) Tax-free recovery of principal. (b) Payments received from borrower are classified as principal and interest. (c) Deductions for interest on any loan borrowed by secured lender to fund its loan to borrower. 4. Debt investment – borrower. (a) Deductions for depreciation with respect to the borrower's investment in the aircraft. (b) Recovery of undepreciated cost (if any) when aircraft is sold. (c) Possible deferral of gain on sale through like-kind exchange. (d) Deductions for interest on the loan. Some Income Tax Consequences of Choosing an Equity Investment or Debt Investment in Aircraft – cont’d

How to Determine Whether an Investment in an Aircraft Will Be Treated for U.S. Income Tax Purposes as an Equity Investment, a Debt Investment or Something Else?: 

How to Determine Whether an Investment in an Aircraft Will Be Treated for U.S. Income Tax Purposes as an Equity Investment, a Debt Investment or Something Else? 1. Internal Revenue Service Guidelines. (a) Ref: Revenue Procedures 2001-28 andamp; 2001-29. Statement of IRS advance ruling policy; not intended to be statement of applicable law; not intended to be used for audit purposes. (b) Basic requirements of IRS guidelines. (i) Minimum lessor investment. (A) Unconditional, 'at-risk' equity investment. (B) 20% of total aircraft cost. (C) Maintenance of minimum investment at all times during lease term, including fixed rent renewals. (ii) Economic profit.

How to Determine Whether an Investment in an Aircraft Will Be Treated for U.S. Income Tax Purposes as an Equity Investment, a Debt Investment or Something Else? (cont’d): 

Purchase and sale rights. (A) Lessee cannot have option to purchase aircraft for less than fair market value. (B) Lessor cannot have the right to require lessee or a third party to purchase the aircraft. No lessee investment in the aircraft. Exception for certain removable improvements. Exception for certain non-removable improvements. No lessee loan to lessor or lessee guarantee of any third party loan to lessor. (vi) The aircraft to be leased must not be 'limited use property'. How to Determine Whether an Investment in an Aircraft Will Be Treated for U.S. Income Tax Purposes as an Equity Investment, a Debt Investment or Something Else? (cont’d)

How to Determine Whether an Investment in an Aircraft Will Be Treated for U.S. Income Tax Purposes as an Equity Investment, a Debt Investment or Something Else? (cont’d): 

2. Criteria used by U.S. Tax Court. (a) Reference: Levy v. Commissioner, 91 T.C. 838 (1988). (b) Relevant factors. (i) Lessor's equity interest in the leased property. (ii) Whether the useful life of the leased property extends beyond the lease term. (iii) Whether any renewal term rent or purchase option price at end of lease term is based on fair market value. (iv) Whether estimated residual value of leased property plus cash flow from rental of the property allows lessor to recover its initial cash investment. How to Determine Whether an Investment in an Aircraft Will Be Treated for U.S. Income Tax Purposes as an Equity Investment, a Debt Investment or Something Else? (cont’d)

How to Determine Whether an Investment in an Aircraft Will Be Treated for U.S. Income Tax Purposes as an Equity Investment, a Debt Investment or Something Else? (cont’d): 

(v) Potential for lessor to realize a profit from sale or re-leasing of leased property. (vi) Whether there is a 'turnaround' point after which the deductions allowed to the lessor are less than the income received by the lessor from the lease. (vii) Whether the net tax saving for the lessor is less than the investor's initial cash investment. How to Determine Whether an Investment in an Aircraft Will Be Treated for U.S. Income Tax Purposes as an Equity Investment, a Debt Investment or Something Else? (cont’d)

How to Determine Whether an Investment in an Aircraft Will Be Treated for U.S. Income Tax Purposes as an Equity Investment, a Debt Investment or Something Else? (cont’d): 

(c) Factors generally considered to be 'neutral'. (i) Absence of significant positive net cash flow to the lessor during the lease term. (ii) The fact that the rent schedule during the lease term matches the schedule of payments of principal and interest due from the lessor to the lessor's lender. How to Determine Whether an Investment in an Aircraft Will Be Treated for U.S. Income Tax Purposes as an Equity Investment, a Debt Investment or Something Else? (cont’d)

Tax Considerations for a Lessor Incorporated Under the Laws of a State of the United States: 

Tax Considerations for a Lessor Incorporated Under the Laws of a State of the United States 1. Deductions for depreciation. (a) General rule: (i) Depreciation calculation method: 200% declining balance method. (ii) Depreciation period: 84 months, assuming that the aircraft is placed in service at the midpoint of the tax accounting year (the 'half-year convention'), subject to the '4-40 rule'. (iii) Additional first-year depreciation deduction allowed for certain aircraft.

Tax Considerations for a Lessor Incorporated Under the Laws of a State of the United States – cont’d: 

(b) Aircraft used predominantly outside the U.S.A.: (i) Depreciation calculation method: straight-line method. (ii) Depreciation period: 144 months, half-year convention, subject to the 4-40 rule. (iii) Special rule for U.S. registered aircraft: 'to and from rule'. (iv) Additional first-year depreciation deduction allowed for certain aircraft. Tax Considerations for a Lessor Incorporated Under the Laws of a State of the United States – cont’d

Tax Considerations for a Lessor Incorporated Under the Laws of a State of the United States – cont’d: 

(c) Aircraft leased to a 'tax exempt entity': (i) Depreciation calculation method: straight-line method. Depreciation period: the greater of the following – (A) 144 months, half year convention, subject to 4-40 rule, or (B) 125% of the lease term, including all optional extensions (whether or not any extension option is actually exercised). Tax Considerations for a Lessor Incorporated Under the Laws of a State of the United States – cont’d

Tax Considerations for a Lessor Incorporated Under the Laws of a State of the United States – cont’d: 

2. Deductions for interest on lessor's indebtedness. 3. Timing of accrual of rent. (a) Ref: U.S. Internal Revenue Code Section 467. (b) 'Section 467 loan'. 4. Availability of like-kind exchange. 5. Withholding taxes on rent payable by lessee. 6. Withholding taxes on interest payable to lessor's lender. 7. Sales tax, value added tax, goods and services tax or similar tax on acquisition of aircraft and/or on rent payable by lessee. 8. Applicability of U.S. federal tax shelter registration requirements. Tax Considerations for a Lessor Incorporated Under the Laws of a State of the United States – cont’d

U.S. Tax Considerations for a Lessor Incorporated Under the Laws of a Jurisdiction Outside the United States: 

U.S. Tax Considerations for a Lessor Incorporated Under the Laws of a Jurisdiction Outside the United States 1. Withholding taxes on rent payable by lessee. 2. U.S. federal gross transportation income tax. 3. U.S. state income tax, sales/use taxes, personal property tax.

F.Tax Considerations for a Lessee Incorporated Under the Laws of a State of the United States: 

F.Tax Considerations for a Lessee Incorporated Under the Laws of a State of the United States 1. Timing of accrual of rental expense. 2. Withholding taxes on rent payable to lessor. 3. Withholding taxes on interest on lessor's indebtedness secured by the lease and the aircraft. 4. State income taxes, sales/use taxes, and personal property taxes. 5. U.S. federal gross transportation income tax if the lessor is incorporated in a jurisdiction outside the United States. 6. Applicability of U.S. federal tax shelter registration requirements.

G. Tax Considerations for a Lender: 

G. Tax Considerations for a Lender 1. Withholding taxes on payments of interest, fees and indemnities receivable from the borrower. 2. Withholding taxes on rent payable by lessee, if the loan is secured by a security assignment of the lease and the rent payable pursuant to the lease. 3. Applicability of income tax imposed by the jurisdiction in which the borrower is resident. 4. Applicability of U.S. federal tax shelter registration requirements.