Aviation Finance & Leasing 2023: USA

• Published date: 11 July 2023
• Subject Matter: Finance and Banking, Transport, Insolvency/Bankruptcy/Re-structuring, Charges, Mortgages, Indemnities, Insolvency/Bankruptcy, Aviation
• Law Firm: Pillsbury Winthrop Shaw Pittman
• Author: Mark N. Lessard, Melissa B. Jones-Prus, Richard J. Evans and Dania Slim

1. General and Contractual

1.1 What are the typical structures available for financing the purchase of an aircraft?

Financing structures will generally vary based on whether an airline or aircraft lessor is borrowing and on market dynamics. Large airlines and lessors with corporate ratings are better able to access the capital markets, both on a secured and unsecured basis. In order to finance aircraft deliveries, airlines have traditionally used a mix of bank debt, export credit financing and leveraged tax leases, such as the JOLCO product, which has been very popular in recent years. Airlines have also been very actively tapping the sale-leaseback market, shifting the financing burden onto the leasing community. Lessors who rely on secured financing often use bank warehouse facilities to build inventory and then look to refinance portfolios in the "ABS" or term loan market. Term financings can also take the form of bank debt or private placements.

1.2 What are the key advantages/disadvantages and main issues arising in relation to these financing structures?

Aviation is a capital-intensive business. Industry participants have spent the last decade or more educating an ever-broadening investor base. As a result, deal volume has increased and structures and terms have become more and more standardised - even if the tax and legal complexity of these structures remains high. The capital markets have provided a deep and liquid pool of capital for lessors and airlines, and generally more flexibility on covenants. But, in turbulent times, a disparate group of investors cannot participate in workouts in the same way that a syndicate of relationship banks can. Operating leases are generally viewed as more and more advantageous, even for large airlines that can trim their balance sheets and obtain more flexibility to match supply and demand than with an owned fleet.

1.3 What types of leasing are possible under the laws of your jurisdiction? What are their essential characteristics?

Lease characterisation issues can arise in the tax, accounting, bankruptcy and aircraft registration context. Generally, an operating (or true) lease is distinguished from a capital (or finance) lease based on whether the lessor (in the first case) or lessee (in the second) bears the benefits and burdens of ownership, though the specific tests applied can differ depending on the context. So, a lease with a bargain purchase option, for example, will generally be treated as a capital lease. In an operating lease, the lessor will be treated as the owner of the asset for tax and accounting purposes, entitling them to depreciation and placing the asset on its balance sheet (subject to the use rights of the lessee). A capital lease, on the other hand, results in the lessee being treated as the owner for tax and accounting purposes, with the lessor essentially viewed as providing a secured loan while retaining title as security. Generally, a capital lease is also treated as a financing under U.S. bankruptcy principles, meaning that the lessee is considered the equity owner of the asset notwithstanding that it does not have legal ownership. The lessee under a capital lease will also be treated as the owner for Federal Aviation Administration (the "FAA") registration purposes. There are, in addition, various synthetic and hybrid lease approaches that can be deployed to achieve different characterisations in different contexts.

1.4 Are there any proposals for reform in the area of aviation finance?

Tax reform, both internationally and domestically, is an issue that could have a very significant impact on the structure and location of aviation leasing and finance companies. Corporate tax rates in individual jurisdictions, tax treaties between various countries, and initiatives to restrict the movement of profits across borders can all significantly impact the industry.

Concerns over climate change and aviation emissions remain at the forefront (see answer to question 7.2 for details).

The COVID-19 pandemic and Russian invasion of Ukraine have tested the wherewithal of the international treaty governing possessory rights in aircraft. Compliance with the Cape Town Convention remains generally high, but there have been many notable exceptions of governments or local courts taking actions that are not consistent with the treaty. We expect increased emphasis on compliance at the governmental and commercial levels in the years to come.

LIBOR transition issues are affecting the aviation community in the same way as all other LIBOR-based loan arrangements.

1.5 Is it possible according to the laws in your jurisdiction to enter into non-binding or partially binding pre-contractual agreements (e.g. 'letters of intent') that will NOT take effect as fully enforceable agreements?

Under New York law, parties may generally enter into letters of intent ("LOIs") that are non-binding, if they expressly provide for this in the LOI. Absent such a statement, there is a risk that an LOI will be treated as binding. Typically, even with non-binding LOIs, provisions relating to security deposits, exclusivity, expenses and governing law are often expressed to be binding.

1.6 Is there a doctrine of 'good faith' in your jurisdiction that applies to all pre-contractual agreement, financing and leasing transaction documents, and the conduct of parties connected to them?

Under New York law, even where a preliminary agreement is intended to be non-binding, parties may nevertheless be deemed to have a duty to negotiate in good faith. To determine whether such a duty exists, a court will generally examine: (1) whether the intent to be bound is revealed by the language of the agreement; (2) the context of the negotiations; (3) partial performance; (4) the existence of open terms; and (5) the necessity of putting the agreement in final form. If a duty to negotiate in good faith is found to exist, a breach could arise from a simple refusal to deal, or from the imposition of new or more onerous conditions beyond the open terms of the LOI.

2. Taxation and Related Matters

2.1 Which government authority in your jurisdiction has primary responsibility for the accounting for and regulation of revenue control and taxes?

The United States Internal Revenue Service (the "IRS") has the primary national responsibility for taxes in the United States. In addition, the states (and some localities) have their own independent tax authorities that impose a variety of taxes that are potentially relevant for transactions involving aircraft and engines, particularly sales tax.

2.2 What are typically the taxes in your jurisdiction that may arise in relation to a sale, a lease or a financing of an aircraft or an engine?

U.S. corporations are subject to U.S. federal income tax on their worldwide income, whether the income arises in relation to a sale, lease or financing of an aircraft or an engine. If the income is foreign source, a foreign tax credit may be available. Absent tax treaty protection, a non-U.S. corporation generally is subject to 30% withholding on U.S. source rent, meaning rent that is attributable to flights that begin and end in the United States and rent with respect to engines located in the United States. The United States also imposes a 4% gross transportation tax applicable to rent from flights that begin or end in the United States, subject to potential relief under a treaty or reciprocal exemption. U.S. source interest on a financing can be exempt under an applicable income tax treaty or the portfolio interest exemption. A non-U.S. corporation that is doing business in the United States is taxed on a net income basis on its effectively connected income and a branch profits tax, in each case subject to potential relief of an applicable income tax treaty.

2.3 Is the provision of a current tax-residency certificate by a payee sufficient for a lessee or a borrower potentially subject to withholding taxes in your jurisdiction on rental or interest payments to avail itself of treaty access and the mitigation of tax liability?

A non-U.S. payee that is entitled to the benefits of a tax treaty must provide the appropriate IRS Form W-8 to the applicable withholding agent to avail itself of an applicable exemption from U.S. withholding tax under a treaty or the portfolio interest exemption in the case of interest, as well as to evidence an exemption from FATCA withholding. Current tax-residency certificates are not utilised in the United States.

2.4 Has the advent of BEPS (the Base Erosion and Profit Shifting initiative of the OECD) had any effect as regards structures in aviation finance and leasing or their interpretation?

BEPS has had an effect, particularly with respect to arrangements involving hybrid instruments and hybrid entities. In addition, at the end of 2022, the European Union agreed on a directive generally requiring their members to adopt Pillar 2 legislation by the end of 2023, imposing a 15% minimum tax. Although the United States has not adopted BEPS or Pillar 2, it has introduced its own anti-hybrid rules, most recently finalising revised anti-conduit regulations, and a new corporate alternative minimum tax effective for tax years beginning in 2023.

2.5 What are the typical thresholds in your jurisdiction for which a permanent establishment may be triggered under the terms of any relevant double-tax treaty or similar?

The typical permanent establishment thresholds include the taxpayer having a U.S. office or other fixed place of business. The activities of a dependent agent that has and habitually exercises the authority to conclude contracts on behalf of the taxpayer can also trigger a permanent establishment. In contrast, the activities of an agent of independent status acting in the ordinary course of its business does not trigger a permanent establishment.

2.6 Is the authority at question 2.1 likely to establish a 'look-through' right or similar as regards a lender or a...