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31 July 2013
In May 2013, two changes - one legislative and one regulatory - substantially altered the way in which aircraft may be financed for Brazilian operators. The changes affect virtually all new cross-border aircraft finance transactions, although the precise impact will depend on the type of Brazilian operator. For business aviation, the modifications are the most significant and sweeping to occur in nearly two decades.
To date, nearly all Brazilian cross-border aircraft transactions have been structured as operating leases. There are several reasons for this trend, one of which relates to taxation. If an aircraft is imported under an operating lease, it is exempt from many of the taxes that are normally levied on assets (including aircraft) imported into Brazil.
Of the taxes applicable to assets imported into Brazil, three can be applied and consequently affect the structuring of aircraft imports:
The IPI rate is either 10% or 5% of the value of the asset.
The usual rate of withholding tax is 15% of the interest portion of a payment. However, if the payee is located in a jurisdiction deemed a tax haven by the Revenue Service, the rate is 25%. Withholding tax has never been due in respect of operating lease rental payments, since the asset is not being financed and there is no interest component in rent payments. Thus, withholding tax is an issue only when using structures other than operating leases.
The ICMS rate varies from state to state and by product. It can be as high as 18%, but in most states it is 4% for aircraft. There are valid arguments against the application of ICMS on aircraft imported under operating leases, and for many years operators have obtained injunctions from courts to avoid the application of ICMS on aircraft lease imports. At least one Brazilian state no longer imposes ICMS on aircraft imported under operating leases.
Aircraft imported into Brazil under operating leases are admitted for limited periods under a set of regulations known as 'temporary admission'. A temporary admission authorisation allows an asset to remain in Brazil for a fixed period (which for leases would usually be equal to the lease term).
Aircraft admitted into Brazil under finance leases or contracts of purchase and sale, including title retention agreements, are not admitted through the temporary admission regulations, but through a process called 'nationalisation'. In this context, nationalisation does not refer to the confiscation of goods by a government entity. It refers merely to the more definitive nature of the import of assets that are intended to be purchased by the Brazilian importer.
The rules applicable to imported aircraft have tended to apply to aircraft manufactured in Brazil by Embraer, a Brazilian aerospace conglomerate, because in many cases such aircraft are exported when they are new and are later imported into Brazil. Therefore, the relevance of the new law and regulations affects many Embraer products, as well as aircraft manufactured in other countries.
In Brazil there are three main categories of operator - commercial airlines, air taxi companies and private aircraft operators. Taxes on these three types of operator, whether in the past or under the new law and regulations, are applied in different ways.
Of the three types of operator, commercial airlines are least affected by the new rules and regulations. In the past, commercial airlines enjoyed a complete exemption from IPI on aircraft imported under leases. Furthermore, through a specific exemption applicable to airlines, withholding tax has not been due on operating leases for several years (although that exemption is scheduled to expire at the end of December 2016). There is some variation in the application of ICMS, since it is a state tax, but as a result of court injunctions, Brazil's commercial airlines have frequently not been required to pay ICMS on aircraft imports.
Therefore, from a tax perspective, the main difference between an operating lease and a finance lease is the risk of the withholding tax exemption not being renewed after 2016. This has prompted Brazilian airlines to import most of their fleets through operating leases, although there have been a few scattered finance leases since the exemption first took effect.
Under the new rules, there will be no change to the direct application of IPI, withholding tax or ICMS. However, a new 100-month limitation will now be applicable to temporary admission - that is, the import approval period for operating leases is now limited to 100 months. Many airlines rely on lease terms in excess of 100 months and there are therefore doubts about how the airlines will deal with this new limitation.
The new law and regulations do not prohibit airlines from entering into operating leases for terms in excess of 100 months per se. However, by limiting the temporary admission period to 100 months, a functional limit on operating leases now exists. There have also been doubts as to whether new operating leases should have lease terms limited to 100 months or whether they can be entered into for longer periods, even if the temporary admission period is approved for only 100 months.
Different trends may develop in different airports. In June 2013 temporary admission approvals for 100 months were issued in respect of a few new commercial aircraft imports with operating leases for terms of 120 or 144 months. If this becomes a generally applicable rule, operating leases with airlines can continue to be entered into for periods in excess of 100 months, provided that the lessor and lenders are aware that the temporary admission approval will be limited to 100 months.
It is also uncertain how airlines will deal with the 100-month limitation if it is still in effect eight years from now. Initially, airlines have lobbied the federal government to amend the law and regulations to repeal the 100-month limit as it applies to them. If they are unsuccessful, they will likely endeavour to export and re-import aircraft. There is no express prohibition against such practice, but if customs inspectors refuse to approve re-imports, the Brazilian operators may become liable to their lessors for the consequences of early termination of leases. This is generally considered to be an unlikely outcome, but it cannot be ruled out.
Air taxi companies
Brazil has many air taxi companies operating a variety of fixed-wing business jets and helicopters for charter, including significant helicopter charter operations in support of Brazil's offshore oil and gas industry.
In relation to IPI, although air taxi companies have not enjoyed the exemption that airlines enjoy, the rate applicable to air taxi companies has been and remains at 5%, which is half the usual rate. In addition, air taxi companies have been able to pay IPI proportionally over the term of an operating lease. However, in the case of finance leases or financed purchases, IPI must be paid at the time of import.
Air taxi companies do not benefit from the exemption from withholding tax until the end of 2016, which is one reason why air taxi companies have not entered into many finance leases over the past few years. Air taxi companies have had, and will continue to have, the same treatment as airlines in relation to ICMS.
Under the new rules, air taxi companies will also be subject to the 100-month limitation for temporary admission. This limitation has the potential to affect air taxi companies more than airlines, because air taxi companies are liable for IPI at the reduced rate of 5%. As with airlines, if the 100-month rule is not repealed during the coming eight years, Brazil's air taxi companies will likely be required to export and re-import aircraft or to change the structure of their leases to finance leases, thus creating liability for IPI, withholding tax and ICMS.
Business aircraft operators
The new law and regulations will have their heaviest impact on operators that are neither airlines nor air taxi companies. After the United States, Brazil has traditionally been one of the top markets for business aviation, due to its geographic size and the lack of commercial flight options to many locations. Typical business aircraft operators are companies engaged in civil construction, agribusiness activities, meat processing, pharmaceuticals and cosmetics.
In the past, such operators were subject to a 10% IPI rate. However, with operating leases, the IPI could be paid proportionally during a lease term (similar to air taxi companies). For those business aircraft operators who entered into finance leases or direct cross-border financing, in addition to paying IPI, withholding tax and ICMS were also due. Consequently, most of the cross-border aircraft finance transactions for business aircraft operators were structured as operating leases to reduce this high tax burden.
Under the new law and regulations, operators that are not airlines or air taxi companies are no longer eligible for temporary admission. As a result, these business aircraft operators cannot enter into operating leases at all. Therefore, for such operators to directly import aircraft, they must purchase the aircraft or enter into finance leases and pay IPI, withholding tax and ICMS. Some business aircraft deals that were being documented in May and June 2013 are being reconsidered at present and may be restructured. There are relatively few alternatives for this type of operator, which may reflect a policy of the current government to discourage business aircraft imports.
When the new law and regulations were published in late May 2013, there were many uncertainties concerning their potentially far-reaching consequences. Although some of those doubts have been clarified, many remain. Industry groups are organising lobbying efforts to make the federal government aware of the consequences of the new law and regulations, arguing that they will almost inevitably lead to a reduction in business aviation and the possibility of Brazilian airlines becoming liable for damages caused by early termination of leases.
While it is likely that challenges to the new law and regulations will be made at different levels in courts and that there may be changes, for the time being all operators and their financiers must adapt to the new rules and limitations.
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