Historically, the UK has been a very convenient place in which to take delivery of an aircraft. Over the last couple of years, however, changes to the UK value added tax ("VAT") rules have made it not quite so straightforward. The most recent VAT change on December 1, 2012 punctuates the shift toward decreased convenience, as taking delivery of an aircraft in the UK now requires (i) a check on whether the aircraft falls within the new qualifying aircraft definition and (ii) an application to Her Majesty's Revenue and Customs ("HMRC") for exemption from registration.
VAT can be a significant cost when taking delivery of an aircraft in Europe, so title to aircraft is sometimes transferred in international airspace. However, there are various legal, non-tax concerns with this.
In particular, any financier of the aircraft acquisition will wish to be sure that he has a valid security interest in the aircraft. This can be the case only if the purchaser has itself a proprietary interest in the aircraft. Thus, an aircraft financier will generally require a lex situs (the law of the place in which property is situated in the event of a legal conflict) opinion to confirm validity of title transfer and the aircraft mortgage. While it is beyond the scope of this article to discuss lex situs issues in the context of aircraft acquisition where transfer of the title takes place by delivery in international airspace, doubts as to whether a valid security interest in the aircraft has been created may exist. In most instances, purchasers and financiers alike prefer title to pass when the aircraft is within a particular jurisdiction. If UK banks are providing finance, the preferred jurisdiction is likely to be the UK. Even where no UK parties are involved, the UK is often still regarded as a good jurisdiction in which to acquire title. A major reason for this has been the lack of tax complications in so doing, in particular VAT.
VAT on Aircraft
There are two VAT issues to consider with aircraft transfer:
- Is there a requirement on the seller to register for VAT in the UK as a result of the delivery in the UK?
- Is there a requirement to charge VAT?
Until recently, the UK response to these questions was very straightforward. A "qualifying aircraft" was zero rated for VAT in the UK.1 Furthermore, an aircraft could be regarded as a capital asset of the seller's business, and so the value of the supply would not be taken into account in determining whether the seller had reached the registration threshold for VAT purposes.2 In the UK, there has been no obligation to register for VAT until a person's "taxable supplies" reach a certain threshold. Taxable supplies have included zero rated supplies.
The UK, however, was considered out of line with the European VAT rules, both in terms of its definition of qualifying aircraft and, more recently, the registration requirements.
Qualifying Aircraft
The first aspect to change was the definition of "qualifying aircraft."3 Until September 1, 2010 (the time by which the UK was required to come into line with the rest of Europe), the definition of a "qualifying aircraft," i.e., an aircraft that could be supplied at the zero rate, was based on the weight and usage of the aircraft. Provided the aircraft weighed 8,000 kg or more and was not designed or adapted for use for recreation or pleasure, it could be delivered in the UK with no obligation on either party to register for, or to pay any, VAT. This contrasted with other European jurisdictions where delivery of such an aircraft would give rise to a VAT registration obligation, and VAT would be imposed.
After December 2010, the UK definition of "qualifying aircraft" was changed to make it a customer status based test, to come into line with the requirements of the EU VAT directive.4 The UK definition of "qualifying aircraft" now has two limbs. The first limb is an aircraft that is used by an airline operating for reward chiefly on international routes.5 The second limb is an aircraft that is used by a Member State institution and that meets a certain condition.6
Aircraft Used by Airlines—The Customer Status Based Test
The expression "an airline operating for reward chiefly on international routes" used in the first limb of the definition mirrors the 2006 VAT Directive wording. However, this expression is not defined in the directive, but there is published guidance as to how HMRC interprets the expression.7
"Airline" is defined to mean an undertaking that provides services for the carriage by air of passengers or cargo (or both).8
HMRC guidance indicates that an airline will need to operate at least one aircraft that it may own, lease, or hire for the purposes of operating for reward chiefly on international routes. An Air Operators Certificate is seen by HMRC as an indicator as to whether or not a business is allowed to operate as an airline for the purpose of using a qualifying aircraft.
HMRC states that the expression "operating for reward" does not indicate a requirement that the airline should be operating at a profit but that it must be a business operation in nature.
What is an "international route"? HMRC regards any route that is not a domestic route within UK airspace as international. If an airline operates domestically in another jurisdiction, it is still regarded by HMRC as an international route for these purposes.
What does "chiefly" mean? To HMRC, this means that international route operations must exceed the UK domestic route operations. Turnover of the respective operations is seen as a significant indicator, but other indicators can be relevant; for example, whether one type of operation is more important than the other. Testing flights are not counted when considering "chiefly." Normal positioning flights are counted by reference to the next flight for which the aircraft has been positioned, but where a positioning flight occurs as a result of an emergency diversion, this is counted by reference to the original routing of the diverted flight.
An aircraft can still be a qualifying aircraft even if it is not used on international routes—the test is applied to the airline, not individual aircraft.
In the case of A OY [2012] 6-33/11, the European Court of Justice held that the expression "operating for reward on international routes" should be interpreted as encompassing international charter flights to meet the requirements of companies and private persons, for the purposes of Article 15(6) of the Sixth Directive, now called Article 148(f) of the 2006 VAT Directive. HMRC consequently accepts that charter airlines can count as "an airline operating for reward chiefly on international routes."
Aircraft Used by State Institutions—The Weight and Usage Test
The condition in the second limb of the definition is the old UK qualifying aircraft definition that used to apply to all aircraft, namely that the aircraft is of a weight of not less than 8,000 kg and is neither designed nor adapted for use for recreation or pleasure.
"State institution" for the purposes of the second limb of the definition of "qualifying aircraft" is regarded by HMRC as including the Crown, Central Government departments and agencies, devolved administrations, local authorities including fire and police, the Royal Mail, and similar bodies in other countries.9
HMRC's guidance in Notice 744C does not form part of UK VAT legislation, but it can be relied upon until such time as HMRC changes its opinion.
Registration for VAT
Even after the change in definition of "qualifying aircraft," provided the aircraft was not going to be used by an airline that operated predominantly UK domestic flights, parties could be reasonably confident that the delivery of an aircraft in the UK would not give rise to a VAT charge or an obligation to register for VAT.
Under UK VAT legislation prior to December 1, 2012, there was no obligation to register for VAT because businesses not established in the UK were treated in the same way as UK established businesses; they did not need to register for UK VAT until such time as they reached the UK domestic VAT registration threshold. Delivery of an aircraft would inevitably take the seller above the VAT threshold (currently £77,000). However, in determining the value of a person's supplies for the purposes of calculating whether the threshold had been reached, the supply of the capital assets of the business in the course of which they are supplied is disregarded.10 Accordingly, it was generally considered that supplying an aircraft in the UK did not of itself take the supplier over the VAT registration threshold. This particular aspect has not changed.
In contrast, as of December 1, 2012, businesses not established in the UK must register for UK VAT when they make any supplies in the UK, regardless of value. The removal of the registration threshold for non-established taxable persons was introduced in the wake of the ECJ decision in the Schmelz case (Ingrid Schmelz -v- Finanzant Waklvierter).11 The Schmelz court held that the threshold for registration should apply only to businesses established in the Member State. Businesses established outside a Member State could not have the benefit of a VAT registration threshold in that Member State. Thus, it is no longer possible for an aircraft supplied by someone not established in the UK to rely on the UK domestic VAT registration threshold. The seller will become liable to register for UK VAT 30 days before the delivery of the aircraft, or, if later, as soon as the seller has reasonable grounds for believing that the supply of an aircraft will take place.
All is not lost, however, because where a person who has an obligation to register for VAT can demonstrate that the only supplies it will be making will be exempt or zero rated, HMRC has the discretion to waive the requirement to register and will generally do so. The seller must apply to HMRC for the exemption. While the sanction for not registering for VAT is a penalty, the penalty is based on the amount of VAT lost.12 As the supply would be zero rated, there would be no lost tax and so no penalty. If the seller warrants in the sale documentation that it has made all necessary registrations and filings and consequently fails to do so, or fails to apply for exemption from registration, the failure could give rise to a breach of warranty.
Conclusion
Taking delivery of an aircraft in the UK now requires (i) a check on whether the aircraft falls within the new qualifying aircraft definition and (ii) an application to HMRC for exemption from registration. The application should be made 30 days before the supply, or if later, at the time when the seller has reasonable grounds for believing that delivery will occur. If these steps are taken, delivery of an aircraft in the UK can still be VAT free.
Footnotes
1. Item 2 of Group 8 of Schedule 9 to the Value Added Tax Act 1994 (VATA 1994).
2. Paragraph 1(7) of Schedule 1 VATA 1994.
3. Note (A2)(b) to Group 8 of Schedule 9 VATA 1994.
4. Article 148(e) and (f) of Council Directive 2006/112/EC (the 2006 VAT Directive), previously Article 15(6) of the Sixth Council Directive C(77/33/EEC) (the Sixth Directive).
5. Note (A1)(b)(i) of Group 8 of Schedule 9 VATA 1994.
6. Note (A1)(b)(ii) of Group 8 of Schedule 9 VATA 1994.
7. HMRC Notice 774C Ships, aircraft and associated services, July 2011.
8. Note (C1) of Group 8 of Schedule 9 VATA 1994.
9. HMRC Notice 744C Ships, aircraft and associated services, July 2011.
10. Paragraph 1(7) of Schedule 1 VATA 1994.
11. Case C-97/09 (Schmelz).
12.Paragraph 13 of Schedule 1AVATA 1994.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
