New Delhi: A B747 aircraft of the Air India at the IGI Airport before its departure for coronavirus-hit city of Wuhan in China to bring back Indians, in New Delhi, Friday, Jan. 31, 2020. (PTI Photo) (PTI1_31_2020_000229B) | Photo Credit: -

The Indian aviation industry is growing by leaps and bounds (barring a recent slowdown due to Covid-19). Around 80 per cent of the total commercial fleet in India is leased against 53 per cent globally. A working group for developing avenues for aircraft financing and leasing activities in India was constituted by the Ministry of Civil Aviation in May 2018. The group observed that the International Financial Services Centre (IFSC) provides a valuable platform to host aircraft leasing and financing businesses. Accordingly, in its 2019 report ‘Project Rupee Raftaar’, the group laid down key regulatory changes required, including changes in tax laws.

Types of leasing

There are many leasing structures that may be used to finance aircraft, including (i) Finance lease (ii) Operating lease (iii) Sale and leaseback transaction and (iv) Lease-in-lease-out.

(i) Finance lease: Here, an owner or lessor: (i) Buys an aircraft from a manufacturer, which it leases to an airline or other lessee, (ii) Structures the lease so that: (a) rent payments return all or substantially all of the purchase price, and (b) the lessee is expected to purchase the aircraft at the end of the term. In accounting parlance, a lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to the ownership of an underlying asset. Whether a lease is a finance or an operating lease depends on the substance of the transaction rather than its form.

(ii) Operating lease: A lease that does not have attributes of a finance lease is classified as an operating lease. Here, the lease does not transfer substantially all the risks and rewards incidental to ownership of an underlying asset. An operating lease is usually resorted to when the use of an asset is for a particular period that is shorter than the economic life of the asset. This makes operating leases more attractive than finance leases for aircraft leasing. The advantages of this structure for an airline include giving lessees flexibility in fleet management (they can contract for increased capacity as and when needed). According to the Project Rupee Raftaar Report, over 70 per cent of the aircraft acquisitions over the last decade have been on an operating lease basis and the trend is expected to continue in the future. Under the Act, operating lease rentals are typically taxable as royalty in the hands of a lessor, subject to availability and eligibility to claim tax treaty benefits. The lease rent paid to the lessor is deductible expense for the airline, provided the conditions for the claims are met. In the context of taxability under the tax treaty, the fact-specific analysis is required to be undertaken from an income-tax perspective to analyse the tax implications of operating a lease in the hands of the lessor.

There are two types of operating lease:

(a) Dry lease: Here, the owner or lessor only provides the aircraft and the lessee is responsible for operating, maintaining, insuring, and providing a crew for the aircraft.

(b) Wet lease: The owner or lessor retains operational control of the aircraft, operates flights for the airline, maintains and ensures the aircraft and provides a crew for the flights.

(iii) Sale and leaseback:

An aircraft lease is often, given effect through a Sale and-Leaseback model (SLB), wherein an airline sells either a used aircraft or its right to purchase a new aircraft from a manufacturer to a leasing company. The airline then leases the aircraft back from that entity. The flip side is that airlines are left with asset-light balance sheets, and over time, they end up paying more for the asset. Low-cost carriers in India, such as IndiGo airlines, usually procure aircrafts through SLB backed operating leases. Income-tax implications, implications mentioned above regarding operating or finance lease would equally apply vis-à-vis the second leg of the transaction (i.e. lease).

(iv) Lease-in-Lease-out (LILO) structures:

LILO structure, also known as head-lease-sub lease structure, whereby the owner of the aircraft (head lessor) leases an aircraft asset to an intermediate lessee/lessor and that intermediate subleases the aircraft asset to the operator/lessee. In the context of IFSC, under the LILO, the head lease rentals are not taxable in India, in the hands of the head lessor due to the recent amendment in the Act. Further, the intermediate lessee/lessor is eligible to avail of tax holiday for 10 consecutive years out of 15 years. IFSC is emerging as an attractive destination for the financial services industry given the regulatory framework coupled with tax incentives. The efforts of the government and IFSCA need to be applauded for developing a conducive framework for the aircraft leasing industry.

The authors are all chartered accountants

Published on November 14, 2021