BUSINESS AIRCRAFT FINANCE OPTIONS
Category: Finance for Business Aircraft
Author: Greg Cirillo
When leasing and financing business aircraft you need to understand your options.
As a buyer of a new or used jet or business turboprop aircraft for sale, you have a number of options available to you for financing this purchase. There are a number of considerations that go into a final decision of financing, but the most prominent, by far, are tax consequences.
As will be discussed below, aircraft are large, depreciating assets, and a corporate purchaser can shelter a great deal of income if it is able to take advantage of depreciation deductions.
Own or Lease?
The decision to own or lease is generally determined by the tax outcome that you seek, and whether or not you wish to appear as an owner of a business aircraft. Pricey, depreciating assets create big tax deductions. These deductions are available to the person or entity that is, in the eyes of the IRS, the owner of the aircraft. This would include conventional aircraft ownership, but also the lessee in a "synthetic" lease.
If the operator of the aircraft can take advantage of the tax benefits of depreciation, then the total cost of ownership will be offset in part by the tax advantages. This operator is likely to own the aircraft, or enter into a synthetic lease.
Synthetic leases are hybrid structures that satisfy the accounting world’s definitions of ownership (having the benefits and risks of ownership) and at the same time qualify as operating leases. If properly structured, the lessee gets to use the depreciation, and at the same time have the aircraft appear as a lease expense and not a multi-million dollar asset. A synthetic lease requires careful analysis and understanding of the risks.
If you cannot use the tax deductions, or if you would prefer not to have an aircraft as an asset on your financial statements, then it makes sense to consider putting the aircraft into what is called a "true lease" or "operating lease" structure. Either term refers to a conventional lease where, at lease end, the lessee turns over possession to the lessor (owner), or has a purchase option at market prices.
Unless you are paying cash for an aircraft, you will need a financing intermediary whether you own or lease it. Aircraft financing and leasing options are discussed next.
There are many banks standing by, ready to finance your aircraft purchase. There are financing companies that specialize in this form of finance, as well as banks that will finance aircraft on an occasional basis, often at the request of a high-net-worth client. Your ultimate decision should be based on the loan terms, but the more experienced aircraft financier will generally meet or beat the local bank unless the local bank is relying on collateral (accounts and personal assets) that the aircraft financier is not.
Most aircraft acquisition loans are going to be secured by the aircraft itself pledged as collateral. The mortgage is specialized to aircraft assets (dealing with the details of aircraft maintenance, aircraft registration and aviation insurance). By Federal law, the mortgage on a U.S. registered aircraft will be filed with the FAA Civil Aircraft Registry in Oklahoma City, Oklahoma (much like a home mortgage is filed in local land records). Aircraft registered in other nations will benefit from similar national lien registries if the nation is a party to international conventions on the recognition of security interests. The "non-aircraft" assets associated with the aircraft (such as records, warranties and loose equipment) is taken as security with typical lien filings in local jurisdictions.
Lenders are - and should be - wary of the obvious risks associated with aircraft as collateral. They move (frequently and fast), they lose value very quickly if not properly maintained (with proper documentation of maintenance), once repossessed, they can be difficult to sell, and the fair market value can be extremely volatile. As a result, financiers will often seek credit enhancements in the form of letters of credit, lower loan-to-value ratio, personal guaranties or corporate guaranties. These are the negotiable aspects of the loan transaction. In a complex corporate structure, a financier will generally look for the supporting guaranty of a substantial parent or affiliate.
An operating lease is structured so that the aircraft owner/lessor need only consider two things: (i) cash flow in the form of rent coming in, and financing payments due to a financier of the aircraft, and (ii) the residual value of the aircraft at the end of the lease. By isolating those two elements, the owner/lessor can substantially control its risk, and offer very competitive pricing. Cash flow will include the use of depreciation by the owner/lessor, which in turn will allow the cost to the lessee to be lower.
As with a straight financing, the lessor of an aircraft will require that the lessee meet strict standards on maintenance, insurance and record keeping. In order to protect the lessor’s asset, the lessee may be asked to maintain a reserve of funds (often held by the lessor) to fund on-going maintenance costs. The purpose of these reserves is to ensure that a neglected or abandoned aircraft does not become a money pit with overdue maintenance and repairs. For similar reasons, a lessor will strongly prefer that the lessee place engines and other components under a pre-paid, or pay-as-you-go maintenance program.
Often an aircraft buyer will place itself into a lease structure by bringing a third party to act as purchaser/lessor. In this structure, the third party takes title to the aircraft and leases it to the original buyer. This may allow the financier/lessor to take advantage of tax benefits that the lessee was unable to use.
The Regulatory Twist
The decision to lease or purchase is not determined solely by considering tax and financial consequences. You must also consider the federal regulatory requirements associated with corporate aircraft ownership and operation. In a nutshell, the Federal Aviation Administration is properly obsessed with safe operation of civil aircraft. Accordingly, the FAA’s primary involvement in ownership structures is to make certain that the entity or person responsible for the safe operation of the aircraft is disclosed; and that this aircraft operator is capable of fulfilling its regulatory obligations to maintain and safely operate the aircraft.
The legal owner of a U.S.-registered aircraft will always appear on public record because the FAA requires that person or entity to file a Bill of Sale, as well as a Registration Application. If the owner transfers operational control to another party (via operating lease), then that lease must also be filed with the FAA Civil Aircraft Registry in Oklahoma City. Due to tax, public relations and liability concerns, buyers are often tempted to either own or lease an aircraft in a "shell" entity, and have it operated by the substantial corporate affiliate.
While this may accomplish tax, financial and other objectives, it runs directly contrary to the FAA’s primary objective – it masks the entity that is truly in operational control of the aircraft. There are a number of options, including corporate aircraft insurance and the use of a true charter entity, that can help you meet all objectives. In order to appease all masters (tax, financial, PR and FAA) your finance and legal specialist need to confer on all options.
Greg is an aircraft finance and regulatory attorney with 16 years of practice experience. He and his team at the law firm of Wiley Rein & Fielding represent commercial and private aircraft owners, lessors, lessees and financing institutions in structuring and documenting aircraft transactions of all types.