Norton Rose partner Matthew Hodkin, and senior associate (tax) Judy Harrison, explain how changes to the tax regime will impact on aircraft, ships, and trains.
From 1 January 2011 two changes will occur to the UK tax rules which will affect the leasing of large assets.
The first is that there will be a reduction in the rate of capital allowances available for expenditure on ships and rail assets. The second is that the UK will be changing its VAT rules in relation to aircraft, which will make the buying and selling of aircraft in the UK potentially more complicated.
Capital allowances on ships and railway assets
From 1 January 2011, the rate of capital allowances available for new expenditure on ships and UK railway assets will be reduced from 20% to 10% (and further to 8% from 1 April 2012).
This change will bring the rate of tax depreciation for ships and railway assets in line with that available for other assets with a similar life and represents a reluctance on the part of the UK government to extent the previously beneficial regime into the future.
This was always likely to be the case for rail assets where the previous rule (which only applied to UK assets) was susceptible to challenge under EU rules, but will be a blow to the UK shipping industry.
VAT on aircraft
The UK has traditionally been a popular location for the transfer of title to aircraft and aircraft engines.
The reason for this has been largely due to the UK’s pragmatic interpretation of the rules relating to when the sale of an aircraft or aircraft engine can be zero-rated for VAT purposes.
However, the European Commission has challenged the UK’s interpretation of these rules and, as a result, the UK has agreed to change its laws from 1 January 2011.
From that date, the supply of an aircraft or aircraft engine and many other maintenance supplies where the supply takes place in the UK will only be zero-rated if the aircraft is “used by airlines operating for reward chiefly on international routes”.
The new test is more complicated to apply than the current test which looks simply at the size of the aircraft and whether it has been adapted for recreation or pleasure.
Although this will be more difficult to evidence than the previous rules as a supplier will have to be sure of the status of the aircraft operator, it is likely that the practical effect will be limited: the vast majority of aircraft zero-rated under current rules will continue to be so from 2011.
Two questions
Two questions arise in the context of leasing.
Will supplies of aircraft to leasing companies for onward supply to ‘qualifying airlines’ be zero-rated?
Current draft guidance is helpful on this and suggests, while a leasing company might have to obtain some form of certification or warranty as to the status of the end user, HMRC will accept that the acquisition of an aircraft for leasing to an international airline is zero-rated.
How does one establish whether an airline is operating for reward chiefly on international routes? One would expect that in determining whether an airline qualifies, it will be necessary to look at the turnover generated by international and domestic travel.
This may not be the only factor. For example, it may be necessary to consider the number of international flights, the number of passengers carried on such flights or the total mileage of international flights.
We understand HMRC will permit airlines to carry out these tests over a reasonable period of time so that an airline does not become subject to VAT merely as a result of seasonal variations in its operations.
Draft guidance also suggests HMRC will apply these tests from a UK standpoint so that an airline that flies primarily domestic flights within the US will still be regarded as ‘international’ for UK VAT purposes.
Given the UK has traditionally been a favourable jurisdiction for buying and selling aircraft, it is likely (to the extent permitted by EU law) the UK government will take a pragmatic and sensible approach to try to ensure that the impact of this change to the VAT rules is mitigated.
