On 1 January 2011, the UK’s VAT rules in relation to the supply of aircraft, aircraft engines and parts changed substantially. This followed a ruling by the European Commission that the UK’s previous rules did not correctly implement the provisions of the EU VAT Directive (Council Directive EC 2006/112).
The UK rules previously provided that any supply of an aircraft with a take-off weight exceeding 8,000 kg and which was neither designed nor adapted for recreation and pleasure should be zero-rated (and the rule applied also to engines and parts for such an aircraft). However, the zero-rated treatment provided for in the EU VAT Directive is tested by reference to the airline rather than the aircraft, applying to supplies of aircraft and parts that are “used by airlines operating for reward chiefly on international routes”. This test has now been implemented in the UK by section 21 of the Finance (No.3) Act 2010.
The rules apply to the “supply” of an aircraft or aircraft equipment, i.e.
The supply of a qualifying aircraft is zero-rated. Supplies of other aircraft are standard-rated (at the rate of 20% since 4 January 2011).
As mentioned above, a “qualifying aircraft” is now any aircraft which is used by an airline operating chiefly on international routes. Following the decision of the European Court of Justice in the 2005 Cimber case (C-382/02), the test is whether the airline itself operates chiefly on international routes and not what route any particular aircraft is used for. Analysing each component of the test in more detail:
An airline is defined as “an undertaking which provides services for the carriage by air of passengers or cargo”. An airline will need to operate at least one aircraft which it may own, lease or hire. This definition will be of particular interest to business jet operators who may have been concerned that they are not “airlines” under a colloquial definition.
Operating for reward
The airline must be providing either passenger or freight transportation (or both) on scheduled or unscheduled flights (or a mixture of both) and receiving consideration for that supply. This must be a business operation in nature for VAT purposes. There is a significant body of case law in relation to the requirements for a taxpayer to be operating a business for VAT purposes. However, there is no requirement for an airline to be operating for profit.
An international route
An international route is any route that is not a domestic route within UK airspace. A non-UK airline that mainly flies between airports within its own territory should therefore be regarded nonetheless as international for these purposes.
“Chiefly” means that the non-UK domestic flights of an airline must exceed its domestic flight operations. This test can be based on the value of turnover attributable to international routes compared to that attributable to domestic routes, the relative number of passengers carried, mileage or “any other method that produces a fair and reasonable result” (HMRC Notice 744C, December 2010).
Most aircraft are, of course, owned by special purpose companies set up by leasing companies or banks. If at the time of the supply to such an “intermediary” (as the HMRC Guidelines refer to them) it is known that the ultimate supply to the end user will be of a qualifying aircraft, then the supplier may “look through” the transaction (or series of transactions) and treat its own supply as zero-rated.
For practical purposes HMRC intend to permit, “in very narrow circumstances”, suppliers to “look through” the supply to an immediate customer that is not an airline and on to the ultimate consumer of the supply. The critical point is that the ultimate consumer of the supply of either goods or services must be an airline operating qualifying aircraft and that the entities in the supply chain are fully taxable for the purposes of the transaction so that no input tax restriction would occur anywhere in the chain were the zero-rating not to be permitted.
This will be of particular relevance when a special purpose company purchases an aircraft and leases it to an airline. The seller of the aircraft will need to be convinced that HMRC will treat such a transaction as a “flow through” transaction and that the lessee is an airline operating the aircraft for reward chiefly on international routes – otherwise it may seek to charge VAT on the purchase price. The lessor will similarly need to be convinced that its lessee is such an airline, otherwise it may seek to charge VAT on lease rentals. It should be noted also that an airline which satisfies the test at the commencement of a lease may cease to satisfy the test during the term of a lease, in which case the VAT treatment could change.
Normally the responsibility for determining the liability to VAT in relation to a supply rests with the supplier. HMRC recognise that, in the case of aircraft, this requires knowledge about the status of the customer and the use to which the aircraft is to be put. In cases of doubt, HMRC recommends obtaining evidence of entitlement to zero-rating, for example by way of a declaration (Note 744C, paragraph 12.2 suggests the format of this).
One particular concern is how the revised rules on zero-rating would be applied by the significant number of UK businesses engaged in the repair, maintenance and modification of aircraft and the supply of spare parts. In order to zero-rate such supplies, the supplier would need to know at the time of the supply that the aircraft will be a qualifying aircraft. This may not always be straightforward, as the supplier may be engaged to make supplies to multiple customers at relatively short notice and may not always be aware at the time of the supply of the identity of the end user in the supply chain. To discharge that responsibility the supplier may have to ensure that some form of documentary evidence of the airline’s qualifying status is retained.
In its Guidelines, HMRC set a high standard for this evidence, giving the example of a declaration by the customer of its entitlement to zero-rating together with an undertaking to notify the supplier of any changes to that entitlement before the time of the supply and to pay any VAT properly due. However, HMRC state that the documentary evidence could take other forms, and it is expected that it will only be necessary to retain such evidence in cases where there is some doubt that the customer qualifies. If the airline in question is based overseas and operates only a small proportion of its flights within the UK, it may be abundantly clear that the supply qualifies for zero-rating and so it may not be necessary to retain any evidence. In addition, HMRC have noted that, in “normal circumstances”, where a supplier is engaged by an airline to make multiple supplies, they would only expect the supplier to obtain one declaration from that airline each year to cover all of the airline’s aircraft.
In general terms, the UK VAT position in relation to business jets will be as follows:
Aircraft chartered out
Potentially zero-rated, provided the use is a genuine business use and not a disguised private use. The general consensus is that there will need to be some degree of serious marketing to third parties and records kept of genuine charters. Following analogies from the yachts market, the “business” might be deemed abusive if it sustained significant ongoing losses or the chartering to third parties “would not, alone, be of sufficient continuity and substance to comprise an economic activity”. The ECJ case of Enkler (C-230/94) provides guidance on this.
20% VAT is likely to apply. It should be noted that many commonly used business aircraft registries only permit private use of their aircraft. There has been some commentary in the business jet community that “the VAT problem will go away if an aircraft is placed on an AOC”. However, in such a circumstance the beneficial owner would need to avoid being the main user of the aircraft. Further, it is in any event currently contrary to UK regulations for an AOC holder to operate a private flight.
Businesses owning aircraft for the transport of staff
A business owning an aircraft used for the transport of its staff will not normally be considered to be an “airline”. However if the aircraft is operated by an associated company, separate from the main business, and otherwise the conditions set out in the rest of its Guidance are satisfied, HMRC have stated that they will normally accept that such associate company is an airline.
It is of course open to buyers of business jets to import an aircraft into the EU for free circulation within the EU through an EU country which has lower VAT rates, such as Luxembourg.
The new rules in the UK represent a substantial change and this article can offer only a short overview of those rules and the relevant HMRC guidelines. It is of course critical to obtain specific tax advice in respect of any particular transaction.