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Efficient Air Charter Service:
Cracking the legal code…

Aircraft business charter operators can increase efficiency and reduce costs by eliminating empty flight legs and empty seats. Charter operators and fractional programs are much less efficient than airlines- which fly their aircraft 80% full and 3-000 hours each year without dead-legs- but charter companies and fractional programs continue to build business based on convenience and comfort (and some would say “dignity”).

Nevertheless- private aircraft passenger costs remain the greatest challenge to increasing charter traffic- and compel creative entrepreneurs to wrestle with an obstacle course of laws and regulations in order to increase private aircraft charter usage and fill more seats.

A few recent developments foretell a potential boom in charter usage. New on-demand charter operators- such as DayJet- and innovative online services such as Virgin Charter and Bombardier’s Skyjet- are clearing a path through Federal Aviation Association (FAA)- Department of Transportation (DOT)- Transportation Security Administration (TSA) and Internal Revenue Service (IRS) rules and regulations that apply to aircraft charter and scheduled operations.

These efforts will lead to air charter services with increased revenue at reduced passenger costs in a more environmentally friendly form.

Regulatory Encryption
The “holy grail” for charter service providers is creating predictable demand- operating from general aviation terminals and/or secondary airports- and filling planes by aggregating passenger demand or by selling seats rather than whole aircraft.

Thou Shalt Not Schedule Service
Earlier in 2007- a senior FAA attorney declared that a charter company’s publicizing available aircraft (or seats) for a specific dead-leg trip was unlawful. This surprised many charter firms- but aviation lawyers saw it as an unexpected signal that the FAA (and perhaps DOT) would no longer turn a blind eye to a practice that is in most ways beneficial to the industry- passengers and the environment.

The FAA’s position is that if you offer a departure location- a departure time- and a destination- the FAA (and presumably the DOT) will treat the charter operator as operating scheduled service requiring Part 121 (commercial airline) certification and the associated operating restrictions.

To offer a dead-leg flight or fill a seat while operating under Part 135- you must omit one of three elements - departure location- departure time or destination- and the omitted element must be the customer’s choice. The FAA believes that you are specifying a departure time if you offer less than a 48 hour departure window. Thus- to avoid scheduled service status by not specifying departure time- the best you can do is offer a 2+ day departure window- and the customer must truly have the flexibility to pick the departure time (i.e. you cannot say “no” until they hit the departure time you prefer).

If you elect to meet the FAA standard by omitting a departure location or destination- then the customer(s) must have legitimate discretion to choose their departure OR arrival airports. That means being ready to make a positioning flight on one end.

The FAA will determine if the customers were improperly “motivated” by the charter firm to pick the origination- destination or departure time preferred by the charter company. The friction here is obvious. The charter operator should be able to charge the dead-leg customer for the positioning flight the customer requires- which will inevitably motivate the customer to use the favored airport.

The ability to sell seats (rather than whole aircraft) is similarly constrained. The logical path would be to sell to a single customer- and then find people interested in taking the same trip to reduce the individual’s cost. But how do you find additional passengers without publicizing the available seats- route and time? Perhaps DayJet has cracked the code - the additional passengers have to find the charter company.

DayJet has invested heavily in a software-based system that structures individual routes to maximize load factor by reactively setting prices in response to customer requests based upon a prediction of how many other customers will subsequently seek the same flight (origin- destination and time) prior to its departure.

DayJet largely determines the originating airport. Beyond that- customers request a price for their desired flight- specifying a destination and time (desired arrival time- and acceptable travel time). The price quoted will be determined based on the aircraft’s projected load factor on the operating date. Because DayJet aircraft (Eclipse) offers only three passenger seats- load factor is going to be 33%- 66% or 100%. So the advance date- arrival/travel time and city pair will determine price. This arrangement is reactive – the customer requests the flight – and the FAA and DOT have blessed this as on-demand (versus scheduled) operation.

The DayJet model is likely to be employed- to some extent- by a number of charter operators and web-based charter brokers such as Virgin Charter and Bombardier’s Skyjet. However- disparate equipment types make the analysis more difficult- and as aircraft size increases- the range of possible ticket prices grows exponentially.

Keep Your Shoes On
Many of the new aviation entrepreneurs are executives who use business aviation and appreciate the non-commercial terminal experience. A limo takes you to the front door of the facility- you walk through (stopping for a refreshment if necessary) and out to the aircraft. These entrepreneurs seize upon the obvious – passengers will flock to a service (and pay a premium) if they can use a small terminal or FBO. But- how many passengers and flights can be operated through an FBO before you are forced to send passengers through the main commercial airport terminals?

There is no simple answer to this; however- there are charter operators testing the limits. Aircraft size and weight limits are found within a number of FAA and DOT regulations- and the interplay of these limits will determine the ability to increase the volume of passenger service from non-commercial terminals.

The federal agency that is likely to limit the origination of “large” charter flights at non-commercial terminals is the TSA. TSA requires each passenger-handling facility (including FBOs) to develop a security plan for the facility. Similarly- charter aircraft of a certain size (the lowest category being 12-500 MTOW – the “twelve-five” rule) must be subject to a security program which may affect the use of smaller terminals. While there is TSA guidance on the required elements of such security plans- TSA has broad discretion to review- accept or reject those plans before and after they are adopted.

As a result- the ability to pass a large volume of passengers through a non-commercial facility will vary from location to location- and is subject to change. As a favorable illustration- Indigo- a division of NewWorldAir Holdings- Inc.- recently offered charter-like service between Teterboro Airport- New Jersey- and Midway Airport in Chicago- Illinois. The service did not survive- but it was a scheduled service offered to the public under the auspices of a DOT “public charter” (14 CFR Part 380).

The VLJ Victory
In addition to satisfying FAA- DOT and TSA regulations- aircraft charter activity is normally subject to Federal Excise Taxes (FET) of 7.5%- plus a flat rate per each domestic flight segment. However- in a recent Internal Revenue Service (IRS) private ruling- the IRS agreed that a Very Light Jet Operator (VLJO) will not be required to collect FET on the air transportation services that it provides to customers.

The VLJO in question operates jet aircraft with a maximum take-off weight of under 6-000 pounds and targets regional business travelers for air travel service for same-day travel- multi-city same-day trips- and complex travel schedules. The VLJO provides two services. First- a “Pure Charter” in which the entire aircraft is chartered- and the client designates departure and arrival locations and times. VLJO also provides a “Per Seat” service in which the client reserves only an aircraft seat- but also designates a desired departure and arrival location and times.

In order to co-ordinate and provide these services- VLJO uses a customized logistics system that tracks aircraft availability in real-time and immediately confirms or rejects a reservation at a fixed price. The exact flight time is confirmed 24 hours before the flight.

Under the Internal Revenue Code of 1986- as amended- aircraft operators providing “taxable transportation” are required to collect FET. If an exemption did not apply- VLJO would have to collect and remit FET to the IRS on both the Pure Charter and Per Seat services. However- the FET does not apply to transportation by an aircraft having a maximum certificated take-off weight of 6-000 pounds or less- unless the aircraft is operated on an “established line” (the “Small Aircraft Exemption”). Since VLJO’s aircraft are under 6-000 pounds- the IRS needed to agree that VLJO was not using its aircraft in established line operations in order to qualify for the Small Aircraft Exemption.

Treasury Regulations define “operated on an established line” to mean operated with some degree of regularity between definite points- which implies that the person rendering the service maintains and exercises control over the direction- route- time and number of passengers carried. The IRS can treat operations as being on an “established line” even if a strict regular schedule is not maintained- a particular route is not always followed or a full run is not always made.

The Small Aircraft Exemption generally applies to an “air taxi” which has been described by the courts as “an airplane for hire- subject to the whims of a particular customer. Except to the hiring customer- its route is wholly unpredictable and unreliable.”

VLJO argued that it has no schedule and no control over when and where it will fly because these decisions are dictated by customer demands and the logistics system- and so the Small Aircraft Exemption should apply and FET be avoided. The IRS agreed that the Pure Charter service is a traditional charter subject to the whims of a particular client- and so the Small Aircraft Exemption applies to Pure Charter.

More importantly- the IRS also ruled that the Small Aircraft Exemption applies to the Per-Seat service- even though the Per Seat destinations are chosen by clients from a set of definite points determined by VLJO. The IRS concluded that the Small Aircraft Exemption applies to the Per Seat service because VLJO does not maintain flight schedules and any perceivable pattern is due to client demand. Therefore- “some degree of regularity” of flights does not exist and VLJO is not operating “on an established line” even though VLJO maintains and exercises control over the Per Seat flights.

Accordingly- the IRS ruled that both the Pure Charter and Per Seat service were exempt from FET.

The Future for Higher Volume Charters
There is strong industry incentive to fill business jets and small charter aircraft. In addition to economics- it is a very “green” initiative. However- successfully navigating the regulatory environment is necessary to make future chartering activity more efficient. A charter operator may hold an FAA Air Carrier Certificate authorizing it to conduct on-demand operations under the Federal Aviation Regulations (FAR)- but its status as a charter operator under the FAR is not determinative for purposes of determining whether Federal excise taxes apply.

Likewise- a charter operator may not be operating on an “established line” for purposes of Federal excise tax- but could still be engaged in “scheduled service” under the FAR. Higher volume charters must satisfy the FAA (as to safety)- the TSA (as to security) the DOT (as to consumer protection and public interest) and the IRS (as to taxes).

The current web of laws and regulations present a formidable obstacle- and efforts to “crack the code” have not been entirely successful (yet). As a result- there is a constant dialog between interested parties and federal regulators attempting to bridge the gap between commercial air travel and pure on-demand- whole-aircraft charter.

However- the “code” is being “cracked” because of the great potential for the private aircraft charter industry to give its clients more options and flexibility at lower costs.

Greg Cirillo is a Partner and Gary I. Horowitz is Special Counsel with the Washington- D.C. law firm Wiley Rein LLP- representing private and commercial operators- owners- lessors and financiers in structuring the sale- acquisition- ownership- management and operation of aircraft- and providing Federal tax and state sales and use tax planning services.
Greg can be reached at Tel: +1 703-905-2800- email: gcirillo@wileyrein.com. Gary can be reached at Tel: +1 202-719-7413- email: ghorowitz@wileyrein.com.


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