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Use of a Special Purpose Entity for Aircraft.

Airplanes are a fact of life in modern business- providing senior management efficiency- safety and security. Nevertheless- they are also a source of worry for corporate counsel and the risk manager. They expose the company’s assets to significant liability in the event of an accident and their appearance on the company’s balance sheet may incite stockholder unrest.

To avoid these problems- creative corporate counsel often decide to set up a special purpose flight department entity with no assets other than the airplanes and no purpose other than their operation for the business of the parent company and perhaps other subsidiaries as well.

Of course- paying for the operations of this entity requires funding in some fashion by the parent or other subsidiaries. With this structure in place as a shield against plaintiffs lawyers and disgruntled stockholders- the CEO and General Counsel sleep easily. But should they?

According to the FAA- business aircraft may generally be operated under the non-commercial rules in Part 91 if compensation is not involved. However- if compensation is received- the FAA generally requires the operator to obtain a certificate and comply with the more stringent rules in Part 135 aviation registration. To the FAA- anything of value (even accounting charge-backs between affiliates) represents compensation.

How does this affect our flight department company? After all- it only flies for its parent company and affiliates- receives no cash for flying- and is never expected to make a profit.

FAA rules do permit a subsidiary company to fly an airplane carrying executives from its parent company or other subsidiaries of the parent under Part 91 without obtaining an FAA certificate. These rules even permit recovery of the costs of the operation. However- the FAA insists that this flying be incidental to- and within- the scope of some business other than transportation by air. Unfortunately- our flight department subsidiary has no business except transportation by air.

The FAA Chief Counsel has issued a legal interpretation saying that a company with no business other than the operational flight department may not fly under Part 91; rather- it must obtain an FAA certificate and comply with Part 135. The FAA has also made it clear that if it discovers a flight department company- it may bring enforcement action against both the company and its pilots. The company can be penalized as much as $11-000 per violation and the pilots may lose their licenses. Not a happy result- and now the CEO is asking his lawyer some hard questions.

An FAA violation is bad enough- but is that all that can happen? Unfortunately not. First- flights within an affiliated group are subject only to the federal excise tax on fuel used. With proper aviation tax planning- flights outside the affiliated group (such as brother/sister companies) can also be subject only to the aircraft fuel tax. However- use of a flight department company will subject all flights outside the affiliated group to the ticket tax of 7.5% on all amounts paid for such transportation. These amounts could include inter-company charge-backs or contributions to capital.

In addition- aircraft may often be acquired free of any aircraft state sales or business aviation use taxes. However- the use of a flight department special purpose entity may otherwise undermine good sales and corporate use tax planning.

In the event of an accident- this structure may increase liability exposure - exactly the opposite of what was intended. If the FAA or the NTSB determines that the flight should have been flown under Part 135 instead of Part 91- a plaintiffs lawyer may be able to use this finding to bolster his case for liability. In some states- it may also help to pierce the corporate veil of the flight department subsidiary to get at the assets of the parent.

Finally- some insurance policies cover only non-commercial operations- or exclude operations in violation of FAA rules from coverage. If the FAA determines that the flight department company failed to comply with Part 135- this may open the door for an aviation insurance company to deny coverage.

Are there alternative structures that can avoid all these problems and still provide some comfort for the CEO and his lawyer? Yes- there are. Selecting the right one requires careful analysis of each particular situation. However- with the help of an experienced aviation legal team- the right choices can be made. Call an aviation lawyer - you’ll be glad you did!

Mr. Weller’s practice emphasizes the areas of business aircraft transactions and operations. As the immediate past Chairman of the NBAA Tax Committee- he has extensive experience in negotiating and drafting aircraft purchase- business aircraft lease- corporate aviation management- and charter agreements- and providing aviation regulatory and planning services to aircraft owners- operators- and managers. As a participant in the FAA’s Fractional Ownership Advisory Rulemaking Committee- Mr. Weller helped to draft the rules proposed for fractional ownership operations. Mr. Weller worked as an attorney with the FAA and CAB.

Read more about: FAA Regulations | Special Purpose Flight Depts

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