There are many positives
At the outset it should be noted that the content of the July Statement is positive in many aspects and that commentary on many of the issues of relevance for the aviation industry as set out in both the ALI submission and the PwC Aviation Finance submission has been taken on board by the Department in compiling the July Statement. The apparent adoption of both the "equity ratio rule" and the "group ratio rule", providing impacted groups with flexibility to limit the restriction, is particularly welcome.
However, certain key areas have not yet been addressed and as such this second consultation period will be key in ensuring that satisfactory consideration is given to these issues in the ultimate drafting of the legislation.
We comment below on a selection of the key issues in the July Statement. The full PwC Ireland response is attached at the end and includes our commentary on other questions raised in the July Statement.
Interest equivalent implicit in lease rentals
As detailed in the insight 'How will aviation finance groups be affected by the new Interest Limitation Rules?', one of the key issues for the aviation finance industry which has not been addressed in the July Statement is the meaning of "economically equivalent to interest".
It has been the view of industry stakeholders throughout the entire consultation process to date, and indeed was set out in the submissions in response to the December Statement, that this is a key area of concern for lessors, with the view of the industry that part of the operating lease rental income (the implicit interest component) earned by lessors carrying on a trade of leasing aircraft should also be treated as "amounts economically equivalent to interest".
Whilst we acknowledge the broadness of the definition of "amounts economically equivalent to interest" further clarity is required. The issue is of importance to the industry and there is a need for certainty for lessors. Specific legislation addressing the issue has been requested. In the absence of legislation clear guidance on the matter is needed.
Group ratios offer potential for increased interest deductibility
Positively, the July Statement indicates that both the "Equity Ratio Rule" and the "Group Ratio Rule" may be adopted. The equity or group ratio rule may enable a taxpayer that is a member of a consolidated accounting group to deduct interest expenses in excess of the standard 30% EBITDA limitation, potentially enabling full deductibility where either:
- the equity to assets ratio of the taxpayer is at most 2% less than that for the consolidated accounting group; or
- the relevant third-party interest expense to EBITDA at a consolidated group level is higher than that of the taxpayer
We expect the adoption of the equity and group ratios will be of significant benefit for many standalone aircraft leasing groups and a range of others.
However, in order to apply either ratio the taxpayer will need to have a set of accounts prepared for the relevant entity (or group, if the taxpayer intends to apply the rules on a group basis) under the same accounting basis as that of the parent entity. Many groups may not have readily available accounts for Irish entities (or a consolidated Irish group for this purpose) prepared on the same basis as that of the parent. The practical application of the rules could therefore involve significant additional administrative efforts for some taxpayers, with a need to weigh the time and costs involved in this exercise against the potential benefits.
Taxpayers should now review their Irish leasing structures and make an initial assessment of whether the ratios will be of any benefit and, if so, whether it is practical for them to produce the relevant local accounts to avail of that benefit on an ongoing basis.
Notional local group – treatment as a single taxpayer
The July Statement includes an option (individual entities can elect out of any group) and framework for applying the ILR on a local Irish group basis. The adoption of a notional local group approach is particularly welcome for many in the aviation finance industry as the application of the measures on an entity by entity basis presents significant administrative challenges and has the potential to increase the ultimate tax cost for a group.
PwC welcomes the notional group option though we have also put forth requests for flexibility in defining the local group. The current definition of an interest group for this purpose is limited to those entities which form an Irish corporate tax loss group. To take account of various commercially led structuring issues prevalent in the aviation finance industry, we have sought an expanded definition to cover any Irish entities included in a worldwide consolidated accounting group, with an associated request for an ability to form more than one interest group given the commercial needs for such in certain structures.
Exempting "legacy debt"
The approach to the application of the exemption to exclude loans which were concluded before 17 June 2016 from the ILR (the legacy debt exemption) has been amended favourably in the July Statement.
The language in the December draft which could have seen the legacy debt exemption limited to interest arising on principal drawdown under loans pre 17 June 2016, even where a higher principal amount for the loan had been agreed in the loan pre that date, has now been removed. The amended definition alleviates some of the concerns on the practical application of the exemption. However, uncertainty continues on some forms of debt, in particular loan facilities with a revolving feature. We have sought clarity on this and certain other aspects of the definition in our response submitted and in discussions with the Department to date, with a proposed 12-year sunset clause put forward to allay any concerns with regards to indefinite rolling revolving loan facilities the Department may have, while providing certainty for taxpayers for a set period of time.
The July Statement has completely overhauled the approach to calculating the exceeding borrowing costs and applying the interest deductibility restriction set out by the Department in December.
While we have requested clarity on certain aspects of the calculation, we welcome the revised approach as it is far simpler and removes the application of the Case IV charging mechanism for restricted interest which was a significant cause for concern for the industry in the December Statement. The response from the Department in this regard is representative of the benefits of the consultation process.
In our insight released in April we stressed the limited time remaining to assess the potential impact and consider what options exist to mitigate any negative effects that could arise for your group.
We are now only four months away from implementation of the rules. Most aviation finance groups have conducted their initial assessments at this stage and are simply refining their views and approach as more clarity is provided. If you have not yet completed that process, the time to do so in advance of implementation is now very limited.
The detail in the July Statement facilitates a focused assessment of the key issues and potential exceptions or exemptions for most aircraft leasing groups.
We are here to help you
PwC Ireland can assist you in making this assessment and, where relevant, in applying the PwC Ireland developed ILR analysis tool to better illustrate the potential impact on the corporation tax position of groups in a visual and interactive manner. Reach out to the PwC Aviation Finance team to discuss and consider your options.