Some observations on the effect of the new ILR rules from an aviation finance perspective
Aviation finance is a capital-intensive industry and a financing business where profits derived on lease rentals to a large extent depend on a mark-up on the cost of funding. Lessors are typically very highly leveraged and therefore the new interest limitation rules have the potential to restrict interest deductions (even relative to other industries) due to the fact that 1) lessors are in a lending business and deploy significant amounts of capital each year and 2) the lease rentals returns on operating leases are not classified as interest income even though lease rentals have an implicit interest rate return.
As such, it would appear reasonable that the net borrowing expense should include the implicit interest return of aircraft operating lease rentals – thereby potentially mitigating the impact of the rules for operating lessors (as restriction applies on net interest cost [interest expense less interest income]). Unfortunately, we may not see anything on this matter as part of the ongoing consultation.
S.110 entities are not excluded from the interest limitation rules. S.110 companies are often used to own / hold aircraft as “qualifying assets”. The interest limitation rules could more significantly impact on s.110 companies as they are wholly debt-funded causing some limitation on the profit participating interest.
The availability of the €3million de minimis threshold on an entity by entity basis would offer a measure of relief to aircraft lessors and will help minimize the inequitable impact of the new rules on aviation. Remember, these new limitation rules do not apply to regulated financial businesses conducting similar asset financing activities or broader financing activities.
The group ratios provided in ATAD (Equity Escape rule and Group Ratio rule) will warrant careful consideration for aviation groups particularly given the current expectation that both ratios may be made available as optional for taxpayers. As different lessors will have different underlying capital structures, one may be preferable to the other. If the group has a high debt to equity ratio of external debt, this could mitigate the impact of the rules. The definition of a group will be key and the consultation should bring some welcome clarification on this matter. In particular, it is entirely possible these group ratio rules could provide a measure of relief for orphan structures and other collective investment structures held through limited partnerships with nominal equity funding.
In the context of the group ratios, the flexibility afforded to taxpayers around the use of the appropriate GAAP will be important to monitor particularly for multinational leasing groups not using IFRS or Irish GAAP. Restating results in IFRS or Irish GAAP for the purposes of the Group ratio calculations would be a time-consuming exercise.
EBITDA as a measure might not be very reliable for an aircraft leasing company. By way of example, components of revenue such as end of lease compensation payments and maintenance events could drive complexity in examining the impact of the new rules on transactions and introduce uncertainty into cashflow modelling exercises.
The practical impact of the rules will need to be considered together with new transfer pricing measures on debt capacity, the interaction with the leasing ringfence on capital allowances under s.403 TCA 1997 and the use of losses and loss planning where there are multiple aircraft owning SPVs as is common in the aviation leasing sector.
