Accountancy and Tax Considerations for Lessors Brian O Callaghan and Pieter Burger Deloitte May 2017

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1 Accountancy and Tax Considerations for Lessors Brian O Callaghan and Pieter Burger Deloitte May 2017

2 International Tax Recent developments 2

3 Timeline Relevant BEPS, EU & International Tax developments Final OECD BEPS Package Final EU Anti- Tax Avoidance Directive CCCTB / Multilateral Convention EU Anti-Tax Avoidance Directive Amendments Multilateral Convention Interest deduction limitations (not minimum standard) Permanent establishment changes (not minimum standard) June 2014 Double Tax Treaty abuse prevention Interest deduction limitations General antiavoidance Rule ( GAAR ) CCCTB relaunched (October 2016) January 2016 US / Ireland Treaty renegotiation (October 2016) Multilateral Convention Text agreed EU ECOFIN Council agrees text of ATAD 2 (expansion of hybrid mismatch rules) October 2016 Anticipated signing of the Multilateral Convention in June 2017 Actions 8 to 10 (Transfer Pricing) October 2015 June 2016 November 2016 February 2017 June

4 Multilateral Convention Key points Outcome of BEPS Action 6 to put an end to conduit companies and double tax treaty abuse Final text of amendments to double tax treaties agreed amongst over 100 jurisdictions. Approximately 2,000 double tax treaties affected. o Multilateral Convention ( MMI ) agreed in November 2016 contains both the Principal Purpose Test ( PPT ) and the Limitation On Benefits ( LOB ) rule. o o Options are: (i) PPT only; (ii) PPT and simplified LOB or detailed LOB; (iii) detailed LOB plus mechanism dealing with conduit arrangements PPT is default option. Note, MMI does not include the detailed LOB. Parties need to reach a bilateral agreement satisfying Action 6 minimum standard if detailed LOB is preferred Most countries expected to adopt PPT, including Ireland. LOB likely to be included in treaties with Japan, Canada and USA Instrument is open for signature signing ceremony planned in Paris early June After signing ratification will be needed in line with domestic constitutional arrangements. Likely to have effect earliest 1 January 2018 and onwards 4

5 PPT test: No treaty benefit if reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit. EU recommendation ( ) to add exclusion where benefit reflects a genuine economic activity 5

6 Multilateral Convention Key points BEPS Action 6 final report contain 10 examples to illustrate the PPT application. Examples of non-tax principal purposes for establishing an SPV could include: Availability of skilled labour force Reliable legal system Business friendly environment Political stability Membership of a regional grouping Sophisticated banking industry Will be important to demonstrate the carrying on of a real business; substantive economic functions; using real assets; assuming real risks; business must be carried on by own personnel located in that country; and decisions necessary for the conduct of the business needs to occur there. What does this mean for LILO structures? 6

7 Interest deductibility restrictions Key points 1. Fixed ratio Net interest expense deduction limited to 30% of tax-adjusted EBITDA which must exclude tax-exempt income Disallowance is wider than just interest includes finance lease, derivative instruments related to borrowings, certain FX gains / losses, guarantee fees, arrangement fees and similar costs related to borrowing Option to calculate on group basis - group for tax purposes in accordance with the country s local tax laws 2. Possible reliefs Exclusion of stand-alone entities from the rules A deduction for interest up to 3million (calculated on a group basis group for tax purposes) Full deduction where certain leverage ratios are in line with that of its consolidated group ( group for accounting purposes) Unlimited carry-forward of capped interest and five year carry-forward of excess capacity Three year carry-back of capped interest Grandfathering of pre-17 June 2016 loans (subsequent modifications not grandfathered) Long term public infrastructure projects where lenders in the EU Effective 1 January 2019 but delayed to 1 January 2024 if country has national targeted rules that are equally effective to the interest limitation rule 7

8 Permanent Establishment Changes Action 7 Key points As part of the Multilateral Convention the definition of Permanent Establishment is changing Original wording from OECD Model Treaty..where a person other than an agent of an independent status to whom paragraph 6 applies is acting on behalf of an enterprise and has, and habitually exercises, in a Contracting State an authority to conclude contracts in the name of the enterprise, that enterprise shall be deemed to have a permanent establishment in that State in respect of any activities which that person undertakes for the enterprise, unless the activities of such person are limited to those mentioned in paragraph 4 which, if exercised through a fixed place of business, would not make this fixed place of business a permanent establishment under the provisions of that paragraph. Wording from Multilateral Convention where a person is acting in a Contracting Jurisdiction to a Covered Tax Agreement on behalf of an enterprise and, in doing so, habitually concludes contracts, or habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise, and these contracts are: a) in the name of the enterprise; or b) for the transfer of the ownership of, or for the granting of the right to use, property owned by that enterprise or that the enterprise has the right to use; or c) for the provision of services by that enterprise, that enterprise shall be deemed to have a permanent establishment in that Contracting Jurisdiction in respect of any activities which that person undertakes for the enterprise 8

9 What is the industry saying? 9

10 Game changer not game over Deloitte survey and report January 2017 For this report, we looked at the current tax risks facing aviation finance, and how the industry is likely to respond. Report drew on a worldwide survey of over 400 senior executives involved in the sector, as well as in-depth interviews with eight leading executives, regulators, and other experts. There were a number of key findings in the report and from the survey including an anticipated moderate effect on aviation finance as a result of tax developments; actions companies can be taking now; the impact of Brexit, etc. 10

11 Game changer not game over Fastest growing jurisdictions BEPS is unlikely to force the major restructuring of companies into different jurisdictions because, unlike allegations about other industries, aircraft lessors conduct most of their operations in the countries in which they are taxed. The geography may diversify, with Chinese FTZs the jurisdictions expected to grow the fastest, however, for international leasing operations the leading players are likely to remain for some time. 11

12 Key tax takeaways EU ATAD will impact interest deductibility and intergroup financing structures, but in many cases impact not nearly as severe as initially anticipated Impact on LILO structures to be evaluated on a case-by-case basis The activity of marketing/sales team in other jurisdictions will need to be monitored to ensure no PE is inadvertently triggered The current leading jurisdictions for international leasing should remain favourable 12

13 Accountancy Considerations IFRS 16 and maintenance developments 13

14 IFRS 16 - Embracing a BIG change Reasons for change US$ trillions of off balance sheet lease commitments Concerns about the lack of transparency and comparability Investors & analysts did not have a complete picture 14

15 IFRS 16 - Embracing a BIG change Key Highlights Majority of operating leases on balance sheet Significant impact on income statement & KPIs Assets: Right-of-Use Asset Liabilities: Financing Finance costs Operating costs EBITDA Example KPIs Impacted: Gearing Ratio Asset turnover Current ratio 15

16 IFRS 16 - Embracing a BIG change Key Highlights Majority of operating leases on balance sheet Changed definition of a lease Effective date: 1 January 2019 Significant impact on income statement & KPIs Lessor accounting largely unaffected 16

17 IFRS 16 - Practical expedients Recognition exemption Short-term Less than or equal to 12 months from commencement Low value $5,000 or less 17

18 IFRS 16 - Key considerations: Operational changes: systems, training etc. Changes to KPIs Compliance with loan covenants Compensation arrangements Terms and conditions of new lease contracts Procurement strategy: lease or buy? Cost of borrowing 18

19 Maintenance intangibles Accounting hot topic Key Highlights Background in US GAAP Allocation of purchase price Acquisition of mid-life aircraft or engine Adoption under IFRS and FRS 102? Day two accounting? 19

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