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  • ANALYSIS: Brazil's tax-haven verdict on Ireland has airline risks

ANALYSIS: Brazil's tax-haven verdict on Ireland has airline risks

The recent move by Brazil to add Ireland to the list of countries denominated as tax havens should be a concern to the nation’s airlines. By extension, the travelling public – whose access to air travel and competitive fares depends on a continued competitive Brazilian airline sector – also have good reasons to be concerned.

If the classification endures, the reported consequence is that airlines in Brazil leasing aircraft from Irish entities will be subject to an additional 10% marginal tax on the value of the aircraft lease. At face value, perhaps, this is not such a big deal.

The ownership cost of an Airbus A320, for example, accounts for only one-third of the overall operating costs on a block-hour basis when assuming typical utilisations and current fuel prices. As a consequence, the additional marginal tax is estimated to increase the operating costs for airlines with these aircraft by about 3-4%.

But airline finances are built on fine margins. And the Brazilian airline sector in particular has been operating on the wrong side of those fine margins in the past 18 months. Azul, Gol and LATAM Airlines Brazil all recorded operating losses in 2015, the most recent complete financial year available.

A continued soft demand environment, allied with the challenge of operating in the Brazilian economy at present, means the outlook for 2016 is little better. Gol is in the process of reducing capacity in the face of continued poor financial performance, while Azul and LATAM Airlines Brazil are also facing financial challenges.

In this environment, any cost challenge is unwelcome. Even an apparently minor increase in operating cost has the potential to further worsen those airlines’ performance. And they are not operating in a vacuum. FlightGlobal schedules data for October 2016 indicated that 42% of passenger capacity originating in Brazil was being operated by non-Brazilian airlines.

Those airlines will not be subject to the additional ownership and operating cost that Avianca Brazil, Azul, Gol and LATAM Airlines Brazil may have to bear as a consequence of this tax-haven classification. This can only damage the competitive position of Brazilian-domiciled airlines subject to the additional cost, at a time when they are already struggling to perform against prevailing economic headwinds.

The potential problem is particularly acute as Latin American and Caribbean airlines have benefited more than the global average from the rise of operating lessors, with 56% of their total fleet of almost 1,400 single- and twin-aisle passenger aircraft sourced from them.

Brazilian airlines are no different from the regional average, with four passenger airlines – Avianca Brazil, Azul, Gol and LATAM Airlines Brazil – leasing 181 aircraft among their total single- and twin-aisle fleet of 318 units. More than half of these leased aircraft are known to be owned by Irish-domiciled companies and, because of the use of special-purpose companies, the actual total is probably much higher.

Perhaps Brazil’s regulators will think again about Ireland’s status, but until they do there can only be downsides for Brazilian airlines.

AIRLINE BENEFITS

The operating lease has become an increasingly popular form of fleet acquisition for airlines, with about 44% of the global fleet of single- and twin-aisle passenger aircraft currently sourced in this way.

Operating leases offer clear benefits to airlines, both in terms of flexibility and, more importantly, access to newer and more efficient aircraft, which they may find challenging and more expensive to finance directly in light of their own financial performance and creditworthiness.

For many years Ireland has been the home of operating leasing. There are significant tax and depreciation benefits associated with the ownership and leasing of commercial aircraft in Ireland, which render it extremely attractive to domicile operating-lease fleets.

Flight Fleets Analyzer lists 19 commercial passenger jet operating lessors based in Ireland. However, the ownership of significantly more lease aircraft is domiciled in Ireland to derive those tax benefits, with a conservative estimate indicating that as much as one-third of the global operating-lease fleet by value is owned by Irish companies.

With the ownership of many commercial aircraft in special-purpose companies, often specifically designed to obfuscate the domicile, there is potential that the share owned by Irish companies is actually much higher. Indeed, the majority of the new companies formed amid the recent influx of capital into the leasing space from Asia, and specifically China, have subsidiaries based in Ireland.

For our coverage of the ALTA Airline Leaders Forum taking place in Mexico City on 13-15 November, visit www.flightglobal.com/alta

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