ISE17/15-16

• The Chief Executive reiterated in his 2016 Policy Address that the Government would formulate measures to "develop Hong Kong into a centre for aerospace financing". The Financial Secretary also indicated in the 2016-2017 Budget that the Government would explore the feasibility of using "tax concession to boost aircraft leasing business", with reference to the overseas experience.
• Indeed, the global aircraft leasing industry has been growing at an exponential rate over the past three decades as more and more airlines choose to lease, rather than own, their aircraft for cost savings. Amongst the global fleet of some 20 000 aircraft as at end-2015, about 40% were leased from aircraft lessors with an annual business turnover of US$179 billion (HK$1,387 billion), significantly up from the respective proportion of just 2% in 1980. It is further forecast that amongst the 10 000 new aircraft valued at around US$1,450 billion (HK$11,230 billion) to be delivered in the next decade, half of which will be financed through lease agreements.
• As at end-2015, there are 158 aircraft leasing companies in the world, mostly clustered in places with low tax regimes like Ireland and Singapore. Ireland has been the market leader in aircraft leasing over the past 30 years, while facilitative measures have been introduced in Singapore over the past decade to attract aircraft leasing companies to domicile in the country. This issue of Essentials discusses the policy practice of Ireland and Singapore in nurturing the aircraft leasing industry.

Key features of the global aircraft leasing industry

• Mutual benefits: In a nutshell, aircraft lessors (i.e. leasing companies) buy and own aircraft and lease them to lessees (i.e. airline operators) for a lease income over a long duration. This arrangement is beneficial to the lessors, providing them with an opportunity to invest its spare capital for a steady stream of lease income in return. Likewise, it gives the lessees greater flexibility in the management of its size and composition of its aircraft fleet, as well as their annual cash flows.
• Past development: The earliest aircraft leasing can be dated back to 1968 when an aircraft manufacturer in the United States allowed its customers to lease, instead of buying, their newly produced aircraft. This mode of customer financing is now commonplace. For Ireland, although it has no aircraft manufacturer, it ventured into an alternative strategy in the 1970s through attracting global aircraft leasing companies to relocate their domicile to the country, leveraging on its prime geographic location and supportive government measures. This development model is highly successful, resulting in the solid leadership of Ireland in aircraft leasing and precipitating similar policy actions from some follower places including Singapore.
• Asian region as the engine of growth: Propelled by faster economic growth in Asia especially in the Mainland, global aviation market has been shifting increasingly to Asia Pacific. While the aircraft fleet in Asia Pacific is projected to almost triple from 5 850 in 2014 to 16 180 in 2034, 45% of the additional aircraft are expected to come from the Mainland.^{1Legend symbol denoting According to Boeing's forecast, there will be a demand for 14 330 new aircraft, valued at US$2.2 trillion (HK$17 trillion), during 2015-2034 in the Asia Pacific region. The Mainland will need 6 330 new aircraft over the same period. See Boeing (2015).} As the share of Asia Pacific in the global fleet size will increase noticeably from 27% to 37% within 20 years, Asia Pacific is becoming the engine of business growth for global aircraft lessors.
• Macroeconomic benefits: Broadly speaking, aircraft leasing is global and footloose in its operation, and it tends to be located in places with clear taxation benefits. On the other way round, aircraft leasing brings economic benefits to the place of domicile as well. First, aircraft leasing helps strengthen the overall aviation position of a place and boost financing, insurance and legal services indirectly through business linkage effect. Secondly, it can create many new professional jobs mostly in highly skilled and well-paid positions. Thirdly, as aircraft leasing is a highly capital-intensive operation involving billions of dollars, additional tax revenue generated for the place of domicile from the newcomers could be substantial. Furthermore, aircraft leasing requires minimal government investment in extra infrastructural facilities, as aircraft on lease needs not stay in the place of domicile.

Ireland as the global leader in aircraft leasing

• Ireland is an entrenched global leader in aircraft leasing, managing over 6 000 leased aircraft and accounting for about 55% of the global fleet in 2015. Reflecting its overwhelming competitiveness, all the top 10 aircraft lessors are now located in Ireland, and five of them even headquartered there.
• To a considerable extent, the competitive strengths of Ireland in aircraft leasing can be attributable to the following factors and supportive measures:
  
  

  (a)	Favourable geographical location and sound legal system: Ireland is situated at the transatlantic gateway between Europe and America, thereby facilitating aircraft operating lease, especially from the top two aircraft manufacturers (i.e. Boeing and Airbus).2Legend symbol denoting Under an aircraft operating lease, aircraft lessors usually need to monitor the condition and status of the aircraft annually. It will be more convenient for the lessors if such aircraft monitoring work can take place at a geographically convenient location. Furthermore, the Irish common law system is another attraction to overseas companies, as aircraft leasing is a cross-border business sometimes giving rise to business disputes across jurisdictions;
  (b)	Lowest tax rate in the world: Ireland has adopted a highly competitive corporate tax rate to attract inflows of foreign direct investment, with its rate of corporate profits tax falling to a low of just 10% during 1980-2003. This has attracted many foreign corporations including aircraft leasing companies to move to the country. Although the corporate tax rate for most of the economic sectors3Legend symbol denoting There are two rates of corporate tax in Ireland. A 12.5% rate is taxed on most trading incomes, including income from aircraft leasing. For those income derived from land dealing activities and minerals and petroleum industries, the tax rate is 25%. Non-trading incomes such as investment income and real estate rentals are subject to a tax rate of 25%. has been lifted to 12.5% since 2003, it is still among the lowest around the world, as compared to the global average of 22.9% in 2015;
  (c)	Extended period for tax depreciation: As aircraft leasing involves huge outlays in aircraft acquisition, tax treatment of asset depreciation4Legend symbol denoting In accounting, depreciation is not a deductible expense for tax purposes. However, tax depreciation (also known as capital allowances) is the depreciation that can be listed as an expense on a tax return. It is used to reduce the amount of taxable income reported by a business. is important when making a location decision by leasing companies. In Ireland, lessors are entitled to claim tax depreciation on the cost of aircraft purchased for eight years under a straight line calculation. As compared to normally five years of tax depreciable life in most countries, the longer period of tax depreciation in Ireland is more generous to help offset the book accounting income of the lessors;
  (d)	Extensive network of double tax agreements: Under the double tax agreements5Legend symbol denoting Double taxation occurs when the taxpayer is taxed twice on the same income by two jurisdictions - the jurisdiction where the income arises (i.e. the source jurisdiction) and the jurisdiction where the income is received (i.e. the jurisdiction of residence). On a bilateral basis, some jurisdictions enter into double taxation agreements with other jurisdictions that seek to eliminate the double taxation of income., aircraft lessors need not pay profits tax twice in both the countries of domicile and incorporation. At present, Ireland has already signed such agreements with 72 jurisdictions, exempting profits tax payment arising from aircraft leasing of Irish lessors in these jurisdictions.6Legend symbol denoting Of 72 jurisdictions signed the double tax agreement with Ireland, all except Botswana and Ethiopia are in effect. Even for those jurisdictions with which Ireland does not have a double tax agreement, Ireland grants tax credits to the lessors concerned to offset the profits tax payment; and
  (e)	No withholding tax on lease rental payments: Ireland does not operate a withholding tax7Legend symbol denoting Withholding tax is a tax on income imposed at source, i.e. a third party is charged with the task of deducting the tax from certain kinds of payments and remitting that amount to the government. Withholding taxes are found in practically all tax systems and are widely used in respect of dividends, interest, royalties and similar tax payments. on lease rental payments from Ireland (i.e. inbound leasing). As for foreign tax incurred on lease rentals (i.e. outbound leasing) where the benefit of a double taxation agreement with Ireland is not available, Ireland offers a unilateral credit relief to the lessors concerned. On top of this, expenditure on aircraft financing can also be exempted from the withholding tax in Ireland.

• Aircraft leasing has brought significant economic benefits to Ireland over the years. According to an assessment made by the Irish government, the aircraft leasing industry employed some 3 000 people in Ireland in 2014. The industry paid over €300 million (HK$2.6 billion) to the Irish coffers, accounting for 7% of total corporate tax in Ireland.^{8Legend symbol denoting In Ireland, the government revenue on corporate tax amounted to €4.1 billion (HK$35.2 billion) per year during 2008-2012. "Financial and insurance activities" is the top sector in respect of corporate tax contribution, amounting to €1.1 billion (HK$9.5 billion) per year, or 26.6% of total corporate tax revenue. Of which over €300 million (HK$2.6 billion), or 36.7% came from aircraft leasing industry. See Office of the Revenue Commissioners of Ireland (2014).} In addition, aircraft lessors spent a huge sum on Irish professional services and infrastructure, estimated at more than €135 million (HK$1.2 billion) per annum.

Singapore as a regional centre in aircraft leasing

• Singapore launched an incentive scheme^{9Legend symbol denoting To incentivise the investment of aircraft lessors, Singapore launched the Aircraft Leasing Scheme in 1995 to provide a reduced corporate tax rate on income from aircraft leasing and exempt the withholding tax on prescribed payments.} in 1995 to attract aircraft lessors to relocate their domicile to the country, followed by an enhanced scheme in 2007. However, there is no publicly available information on its market size. Reportedly, two of the top 10 aircraft lessors worldwide have set up their global headquarters in Singapore at present, while more than 20 aircraft lessors operate their regional headquarters there. 
• The competitive strengths and salient features of incentive measures of Singapore are summarized below:
  
  

  (a)	Favourable geographical location and legal system: Singapore is located at the spot connecting to key destinations around Southeast Asia and the Pacific, most of which are just a few hours' flight away. Same as Ireland, Singapore's common law system is conducive to the development of the aircraft leasing industry;
  (b)	Attractive concessionary tax rate: Subject to the approval from the Ministry of Finance, government-approved aircraft lessors are taxed at a concessionary rate of 5% or 10% on the income derived from aircraft leasing or other relevant prescribed activities;
  (c)	Extended period for tax depreciation: The approved aircraft lessors have irrevocable option to depreciate the aircraft over any number of years from five to 20 years. It provides a flexibility to determine the effective commercial life of aircraft and thereby the financial management10Legend symbol denoting A lengthened depreciation period can lower the amount of annual tax depreciation. It is important in periods of falling profitability (e.g. when the fuel price is high) in order to reduce costs and improve financial results on the financial statement. By contrast, a shorter depreciation period leads to a higher amount of annual tax depreciation. It helps build up reserves from the depreciation charges to finance the rapid renewal of fleet.;
  (d)	Far-flung network of double tax agreements: Singapore has signed double tax agreements with 76 jurisdictions so that Singaporean lessors can avoid double tax in various aspects. This coverage is even more extensive than that of Ireland; and
  (e)	Exemption of withholding tax on aircraft purchase: Singapore provides for an automatic exemption from withholding tax on aircraft financing payments to offshore lenders. Furthermore, the Singaporean government has been active in negotiating with key trading partners to either remove or reduce the impact of the withholding tax on aircraft leasing payment.

Observations

• Both Ireland and Singapore share some common ingredients for success in attracting domicile of aircraft leasing business, including (a) prime location; (b) well-established common law jurisdiction; (c) robust financial infrastructure; and (d) generally low tax regime, which are also seen in Hong Kong.
• Yet Hong Kong still has a few weaknesses in terms of the domicile of aircraft lessors. First, unlike Ireland and Singapore, Hong Kong-based aircraft lessors are taxed on gross rental income, rather than profits which are taxed at a rate of 16.5%. Secondly, aircraft lessors are not entitled to tax depreciation on acquisition of aircraft, if it is leased to non-Hong Kong based airlines. Thirdly, Hong Kong has signed double tax agreements with only 35 jurisdictions^{11Legend symbol denoting Of the 35 jurisdictions signed the double tax agreement with Hong Kong, four of them are not yet in effect.} to date, just about half of those signed by Ireland and Singapore.

Prepared by YU Chun-ho
Research Office
Information Services Division
Legislative Council Secretariat
20 May 2016