UK VAT: Zero-Rating and Qualifying Aircraft

Alasdair Whyte
By Alasdair Whyte May 31, 2012 10:54
Since January 2012, the business jet industry has wrestled with the UK’s HM Revenue and Customs over what is a “qualifying aircraft” for zero rating. David Thompson, a partner at DLA Piper, reviews what has happened since the UK was forced to change its test for zero-rating.
UK customs

Developments in the European Court of Justice (“ECJ”) make it a good time to review what has happened since the UK was forced to change its test for zero-rating.

The old test applied zero-rating to an aircraft with a maximum take-off weight of at least 8,000 Kg (where it was neither designed nor adapted for use for recreation or pleasure).

A “qualifying aircraft” has, since 1 January 2011, been defined in the VAT Act 1994 as an aircraft “used by an airline operating for reward chiefly on international routes” (and certain other aircraft used by a “State Institution”). For these purposes an “airline” is “an undertaking which provides services for the carriage by air of passengers or cargo (or both)”.  Since the change was announced the industry has wrestled with HM Revenue and Customs (“HMRC”) over the interpretation of the test, which, in essence, requires the aircraft to be used in a business of carrying passengers and/or cargo for payment.

Many aircraft are acquired for use by the owner (which might be an individual or a business), but also chartered to third parties when not required. The sophisticated needs of an aircraft mean that it is usually cared for by an aircraft operator (“Operator”).  Where an aircraft is used to provide passenger transport on charter flights then civil aviation regulations require it to be registered with the holder of an air operator’s certificate (“AOC”). In such a case all the requirements for the aircraft to be treated as used by an airline appear to be present because the Operator acts as an “airline” in providing passenger transport for reward through a number of charters.  However, although HMRC accepts the possibility that an Operator may be an airline, particularly if it is an AOC-holder, this is on the basis that the company leases in, or owns at least one, aircraft and supplies transportation services solely to third parties and not to the owner (HMRC Notice 744C, paragraph 12.2 on “aircraft management”).

Neither the EU legislation (Article 148(e) of the Principal VAT Directive 2006/112/EC), nor the UK legislation, contains a requirement the aircraft to be used only by the airline. Fortunately it may be that the ECJ will make this clear if it follows the Opinion of the Advocate General (“AG”) delivered on 26 April this year in the case of Re A Oy. The AG’s Opinion is, in substance, a recommendation to the full Court as to the findings it should make on the interpretation of EU law, and so is not the decision of the ECJ.  The other members of the ECJ will consider the AG’s Opinion and will deliver their judgement in a few months’ time.  Re A Oy (Case C-33/11) was a VAT case considered by the Courts in Finland which referred certain questions of VAT law and the interpretation of Article 148 to the ECJ.  It concerned a company, A, which was wholly-owned by an individual, X. A  imported two aircraft from France and leased them to another company, B.  B then charged A (which in turn charged A’s shareholder, X) for passenger flights. The third question referred to the ECJ was whether it affected the exemption that the owner of the aircraft made a charge to “a private person who is its shareholder, who uses the procured aircraft for its own business and/or private use, taking into account the fact that the airline has also been able to use the aircraft for other flights”.  In other words the Court was asked whether it mattered, in determining whether the aircraft was “used by an airline operating for reward chiefly on international routes”, that the use for third party charters was only partial use. The AG’s Opinion was that, even if an aircraft was used principally by the shareholder, so long as it was also available  to the airline for use for other commercial flights, the supply on importation of the aircraft could still be zero-rated.

The airline still needs to operate for reward “chiefly on international routes”, but the law and practice on this matter is more settled.  A flight that begins and ends within the UK will not be an international flight (even if the aircraft temporarily leaves UK airspace), but every other flight outside UK airspace will be “international.”  So long as more than half the airline’s flights are international, all its aircraft should qualify. The ECJ case of Cimber Air in 2005 made it clear that it does not matter if the aircraft in question does not fly mainly on international routes, so long as the airline does so.

The case will also be helpful if the ECJ follows the AG’s lead in relation to the second question referred, which concerned whether or not he supply in question had to be made directly to the airline or could still be zero-rated if made to an intermediate party (company A), in the knowledge that the ultimate use would be by the airline (company B). If the aircraft passes the “qualifying” test, it does not matter to whom or by whom the supply is made. In the author’s view this means, for example, that if an aircraft is qualifying it does not matter if repair and maintenance contracts are with the owner, the airline to whom it is leased or in whose possession it is, or to any other intermediary, because in each case the supply will be zero-rated.

This approach finds support in the case of Société Internationale de Télécommunications Aéronautiques -v- Customs and Excise Commissioners and in  Re A Oy the AG’s Opinion. He distinguished the test for zero-rating in relation to the supply of qualifying aircraft from that which applied to bunker fuel supplied to ships where, in the cases of Velker Oil and Emelka, the ECJ had ruled that supplies had to be made directly to the ship owner. Although HMRC already accept that a limited “look through” can apply zero-rating, where supplies are made to an intermediary and not directly to the airline (see Notice 744C, paragraph 4.7 in relation to a scenario similar to that in the Re A Oy case), the author’s experience is that HMRC apply this more narrowly than is justified by the legislation.

It is hoped, then, that the European Court of Justice will follow the AG’s Opinion closely. In the meantime Operators and others will continue to ensure that their structures provide the strongest defence to the application of zero-rating of the supply of the aircraft and those ancillary services included in Group 8 Schedule 8 of the VAT Act.

In cases where an aircraft is non-qualifying it is to be remembered that some goods and services may still benefit from zero-rating if the supply is, as aircraft management often can be, treated a series or separate supplies of different services.

Alasdair Whyte
By Alasdair Whyte May 31, 2012 10:54

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