The supply, importation, leasing and maintenance of qualifying aircraft are zero rated for VAT purposes throughout the European Union. This relief is enshrined in Article 148 of Directive 2006/112/EC and applicable to aircraft used by airlines operating for reward chiefly on international routes.
The UK legislation, for many years, has treated an aircraft as "qualifying" if it was of a weight of not less than 8,000 kg (which would include most corporate jets). At the time of enactment, this legislation was considered an acceptable simplification of the EC Directive as very few aircraft, if any, of that weight or more could be expected to be used otherwise by an airline. Times change, of course, and jet aircraft owned privately or by businesses other than airlines ("corporate aircraft") became common. In time, the UK became a highly advantageous jurisdiction for the importation of an aircraft which was treated as qualifying under the UK legislation - the importation of the aircraft would not be subject to VAT and the aircraft would then be in free circulation throughout the European Union.
The New UK Legislation
Inevitably, this treatment could not last for ever and, with effect from 1 January 2011, the definition of a qualifying aircraft in UK legislation was changed (except for aircraft used by a State institution) and became:
"any aircraft which is used by an airline operating for reward chiefly on international routes" (Note (A1)(b) Group 8, Schedule 8, Value Added Tax Act 1994).
This raises the following preliminary issues:
(a) What is an airline?
Paragraph 3.5.1 of HM Revenue & Customs ("HMRC") Public Notice 744C states as follows:
An airline is defined in the law as 'an undertaking which provides services for the carriage by air of passengers or cargo'. The undertaking can be a sole proprietor, partnership, corporate body or any other entity, but is not necessarily confined to a single entity. A VAT or corporate group of companies may also be airlines and HMRC will consider other arrangements and business structures on a case by case basis, this treatment does not affect the normal accounting arrangements between the entities.
An airline will need to operate at least one aircraft which it may own, lease or hire for the purpose above.
This means that a company holding an Air Operator Certificate can be an airline.
(b) What is meant by operating for reward?
Paragraph 3.5.2 of HMRC's Public Notice 744C states as follows:
The airline must be providing either passenger or freight transportation (or both) on scheduled or unscheduled flights (or a mixture of both) in return for a consideration for that supply. There is no need for the airline to be operating for profit, but it must be a business operation in nature.
(c) What is an international route?
Paragraph 3.5.3 of HMRC's Public Notice 744C states as follows:
An international route is any route that is not a domestic route within UK airspace, UK airspace boundary is normally twelve nautical miles from the coast. Routes between the UK to the Channel Islands, the Isle of Man and oil rigs outside the twelve mile limit are international routes. Routes which leave UK airspace in the course of a UK domestic route are not international routes, for example, Northern Ireland to Wales crossing the Irish Republic.
More recently, HMRC have changed their view on flights between the UK and the Isle of Man - these are now regarded as domestic routes.
Can corporate aircraft be treated as qualifying aircraft?
The above interpretations and initial indications from HMRC gave rise to hope that the traditional structure for operation of a corporate aircraft could still give rise to a qualifying aircraft. The traditional structure typically has the aircraft owned by a company (the shares in which are ultimately held by the wealthy individual who is funding it and requires flights) and operated by another company which holds an Air Operator Certificate ("AOC") pursuant to a management agreement. There are substantial arguments that the company with the AOC (being the company which has full operational control of the aircraft) is therefore the user of the aircraft so that it qualifies.
However, this has become a contentious area in which HMRC has given a succession of rulings, each one more adverse than the one before. In particular, HMRC's most recent ruling in relation to this structure is that aircraft management is not a supply of transportation and that an aircraft management company is not operating as an airline when performing this function so the relevant aircraft will not be a qualifying aircraft. It is highly likely that this view will be challenged in the courts, in due course.
What about alternative structures?
Aircraft management companies are currently in a difficult position as a regards a possible move to alternative structures. The costs involved in the restructuring of contracts in relation to every aircraft in the company's fleet are substantial. Furthermore, it is not certain that such re-structuring is necessary (as HMRC's view of the traditional structure may ultimately be defeated before the courts) nor that an alternative structure has better prospects of success.
Nevertheless, there are initial indications that alternative structures based in the Isle of Man are being found acceptable to the Isle of Man Customs. A variety of these alternative structures have been proposed and typically involve the wealthy owner paying a company for flights, so that the company is providing zero-rated passenger transport (enabling VAT on the cost of the aircraft to be recovered) or that the aircraft becomes qualifying because the company providing the transport must be regarded as an airline having the use of the aircraft. It is not yet known what the reaction of HMRC to these types of structure will be and, ultimately, Isle of Man Customs are likely to defer to their view.
If you would like more information about this topic, please contact Nick Beecham
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