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Belt and Road Insights - Tax reforms give birth to an aircraft leasing platform

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Summary: Welcome to BLP’s refreshed ‘Belt and Road Insights’. With several high-profile projects already in full flow, our focus now shifts to examine in detail the key legal considerations associated with these major projects, and their potential implications on how they can shape trade and investment opportunities along the Belt and Road Route.

Ever since the Belt and Road Initiative ("BRI") was launched, the challenge for Hong Kong has been how to position itself to offer services relevant to the BRI. The amendments to the Inland Revenue Ordinance introduced in July 2017 (Inland Revenue (Amendment) (No. 3) Ordinance) can and should be seen as an early response to this challenge. The amendments that give profits tax concessions to companies involved in the commercial leasing of aircraft have given HK a solid basis to become a significant platform for providing aircraft leasing services in competition with the long standing centres in Dublin and Singapore.

The commercial aviation sector has been growing (and is expected to continue to grow) at rates which are significantly ahead of the growth in world trade and is propelled by the increasing disposable wealth of individuals living in Asia and the countries included within the BRI. Just less than half of the world’s fleet of commercial aircraft are owned by leasing companies and projections suggest that this will only grow in the coming years as evidence indicates that having a mix of owned and leased aircraft provides optimal gearing for most airlines. For many of the newer airlines which operate as low cost carriers and ultra-low cost carriers and for those legacy airlines wishing to pursue an “asset light” model the existence of a strong aviation leasing market is essential. It will not be a surprise that many of these newer airlines are based in Asia and in BRI countries.

In the new world of ever increasing oversight of the countries which try to attract investments by granting tax holidays/incentives, and of companies which seek to shelter profits in low tax jurisdictions in which they have little or no real presence or in which their profits do not arise, the HK authorities have come up with a tax position which they reckon is more robust than older structures which rely on granting accelerated capital depreciation allowances to defer payment of tax almost indefinitely. Under the new HK regime for qualifying aircraft lessors and qualifying aircraft leasing managers annual revenue tax remains payable but the tax burden may be (depending on their cost of funds and other factors) reduced to an effective rate that is likely to be less than 4%. The key issue for those leasing companies wishing to take advantage of the regime is the requirement for a substantial business presence in HK which involves some elements of central management and control.

The reform of the tax code for aviation leasing companies is only the first of three steps which HK needs to complete to allow HK to really offer an unrivalled service in the sector. The remaining two are (i) to ratify and introduce the protections for owners/lessors provided by the Cape Town Convention (Convention on International Interests in Mobile Equipment 2001) and (ii) to expand the network of double taxation treaties between itself and the countries with expanding aviation demand, and in this context particularly with the BRI countries, in order to reduce the cost to airlines of making cross-border lease payments.

HK already hosts a number of significant aircraft leasing companies and an even greater number of investors in the commercial aviation space. An expansion in the use of HK as a leasing hub will attract existing and new players to establish presences in HK and those in turn will attract more financial and professional service providers (much in the way Dublin has attracted them in the past). Growth in this area will likely have a knock on effect on arbitration services in HK, will draw more financial institutions, insurers and investors to the aviation sector and likely attract leasing companies to list on the HK stock exchange and to use the public debt and equity markets in HK to raise additional capital.

BLP advised ICBC Financial Leasing on the first qualifying aircraft leasing structure under the new regime in a transaction with Korean Airlines which completed in December 2017. We believe it will be the first of many and that with a favourable wind many of the leasing companies which turn (or return) to HK will want to use it as a hub for leasing with BRI connected airlines.
 

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