Buying and Flying Corporate Aircraft: A Potential Minefield for In-House Counsel
By: Michelle M. Wade

You hear rumors that the CEO is looking for a company jet, and then she suddenly drops the Aircraft Purchase Agreement on your desk and expects a thorough, immediate review by tomorrow morning. You need enough knowledge to identify issues requiring additional research or outside expertise as you navigate through the minefield of aircraft acquisition and ownership

Buying…the first step

The pre-purchase inspection is the important first step in the acquisition process. In a contract for acquisition of a used aircraft, the purchaser should have the right to perform a pre-purchase inspection and either terminate the agreement or negotiate for repair of any unsatisfactory items. The purchaser should also ask for representations from the seller concerning the damage and maintenance history of the aircraft (including the engine(s)) as well as the title to the aircraft, engines, and any spare parts. In protecting your client, you 
will also want representations that the aircraft is in compliance with all mandatory service bulletins and airworthiness directive and that maintenance under the manufacturer's recommend program is current. A representation that the logbooks delivered with the aircraft are complete and current is also important.

Beside performing the standard Uniform Commercial Code lien searches (time-permitting) for aircraft registered in the United States you should also have a title and lien search performed on the aircraft and each of the engines at the Federal Aviation Administration (FAA) Registry in Oklahoma City. You will need to know the FAA Registration Number and the serial numbers of the aircraft and engines to order the search.

If your client is receiving any spare parts with the aircraft, you should confirm that arrangements are made for pick-up or delivery if the parts are not at the same location as the aircraft on the closing date.

Involve a broker in the transaction. The advice of a good broker, on items such as your clients mission profile, the type of aircraft that best suits the profile, its performance characteristic, availability, condition and market value, can save your client thousands of dollars. Many brokers can also assist in budgeting for the fixed and direct costs of owning the aircraft. You will want to know how the brokers involved will be compensated. Careful documentation of the fee agreements and scope of the brokers representations is the best way to avoid any misunderstanding.

Aircraft financing, like financing of other personal property, can take many forms. The company may retain ownership and grant a security interest in the aircraft o the lender, or the lender may take title to the aircraft and lease it to the company. If the lender owns the aircraft and utilizes the deprecation benefits, this arrangement should be reflected in your financing terms. Return provisions are extremely important for leased aircraft. What may appear on paper to be a mere end-of-lease inspection may cost in excess of $50,000. In some locations, use tax may be due on the lease payments, so this cost should be added to your financing costs, Depending on the length of the lease, this may result in payment of higher taxes than you would have paid at the time of purchase.

Sales and Use Tax…a hidden danger

The purchase of an aircraft is generally subject to state sales tax. The state most likely to impose sales tax is the one where the aircraft is physically located at the time the title and funds are transferred. Sales tax at 6% on an aircraft valued at $15,000,000 is $900,000, so researching this issue can result in significant savings for you client. We recommend closing in a state with no sales tax, a low maximum sales tax or an express exemption from sales tax, for your transaction. Fortunately, this is possible due to the mobility of aircraft. Prior to the closing, the seller will need to fly the aircraft to the pre-purchase inspection site and the closing site, if different. You should confirm that the aircraft is insured until the closing and the purchase agreement should address which party will incur the expenses for these flights. If repairs or interior work is required before closing, the location of the aircraft will be especially important. You need to determine where the aircraft will be immobilized and whether a sales tax exemption is available in that state.

You should also research state use tax if the aircraft will be leased or used by anyone other than the owner and/or if the aircraft will spend a great deal of time in multiple states. If the aircraft will spend a significant amount of time in Europe, you should determine the applicability of any taxes imposed by foreign countries which may be assessed if the aircraft remains in some counties for an extended period of time.

Structuring…planning for the future

Determining the name of the purchaser should be simple, but structuring the ownership if the aircraft to effectively address the tax, liability, financing and shareholder concerns of publicly held companies, while obtaining optimum usage of the aircraft requires knowledge of many area of the law. Generally, there are two sections of the Federal Aviation Regulations (FARs) that apply to this type of aircraft operations, Part 91 and Part 135. Part 91 is reserved for private operators, operating their own aircraft, who do not provide "transportation" to any one else. Part 135 involves charter operations in which an entity provides "transportation for hire" to other parties. Operations under Part 135 of the FARs are more restrictive and require an operating certificate issued by the FAA. A good estimate of the average cost for obtaining a Part 135 Operating Certificate is 15 times the hourly operating cost of the aircraft. Generally six months is the minimum time period required to obtain a Part 135 Operating Certificate.

Many clients will desire a Part 91 operating structure, since there are fewer restrictions on airports at which aircraft can land and no restrictions on crew duty hours. Part 91 also has less stringent maintenance requirements.

Executives of some publicly held companies purchase aircraft and lease the aircraft to the company at any arms-length rate in order to avoid shareholder concerns. The initial instinct of most lawyers is to advise the executive to organize a shell entity, as a liability shield, to own the aircraft. However, if that entity employs the pilots and provides flights for compensation to the publicly held company or others, it is deemed to be providing "transportation for hire" and must obtain a charter certificate under Part 135 of the FARs. The penalty for "illegal charter operations" can include a large civil penalty or seizure of he aircraft. Federal excise tax (currently 7.5% plus a $3.10 domestic segment fee) will also be due under this structure. Failure to properly collect and remit these amounts will subject the entity to penalties and interest due to the Internal Revenue Service. Another concern if your client is operating the aircraft in violation of the FARs, is that insurance coverage can be denied if there is an accident while the aircraft is operating in violation of federal law. Your client should inform her insurance agent of all individuals and entities involved with the ownership, lease and operation of the aircraft, and the insurance company may want to review these agreements. 

In the above example, the shell entity can own the aircraft and "dry" lease it to the public company, as well as other individuals or entities. To the FAA, a "dry" lease is a lease of an aircraft without a crew. Each lessee would be responsible for obtaining its own crew under this structure. The lessor cannot provide a crew nor can it require a lessee to obtain a crew from any specific source. As a practical matter, a management company can provide pilot services to each lessee, upon that lessee's request, in accordance with the FARs. The owner can also lease the aircraft to an entity which has obtained a Part 135 charter certificate to be used in charter service when not in use by the owner. This can help offset some of the costs of owning the aircraft, especially if the owner will not be able to fully utilize all of the available hours on the aircraft.

If the executive plans to deduct any losses on her personal tax return, any proposed aircraft ownership and leasing structure should be reviewed by tax counsel with respect to the passive loss regulations and the executive's personal tax situation. 

With today's global corporations, the executive purchasing the plane may not be a U.S. citizen. If she is not, then the executive, or an entity which she owns, is not eligible to register the aircraft in the United States. The president and at least two-thirds of the officers and the board of directors of a corporation must be U.S. citizens in order to register the aircraft in the United States. There are relatively painless ways to structure the ownership of the aircraft to allow for registration in the United States, including placing the aircraft in a trust. Keep in mind that these issues must be addressed before closing and that the contract may need to be assigned.

Flying…

Occasionally, the executive will want to use the aircraft for personal trips. FAA Chief Counsel opinions state that the executive cannot reimburse the company for personal flights on a corporate aircraft. However, the IRS deems personal flights on corporate aircraft a fringe benefit and requires that a value be imputed for the flight and be deemed income to the executive. This is frequently determined in accordance with Standard Industry Fare Level (SIFL) calculations contain in 26 C.F.R. 1.62-21(g). The calculation frequently yields an amount nearly equivalent to first class airfare. The FAA's position means the executive cannot fly the aircraft to the Super Bowl with four of her friends and split the cost of the flight. However, the executive can fly to the event with the friends as guests (and not charge them for the flight), and the executive would have deemed income for 5 people. Extensive personal use of the aircraft, as well as extensive time spent outside the country, can affect deductions for depreciation and operating expenses. (See Technical Advice Memorandum 9715001 and Internal Revenue Code Section 168(g)). If political candidates or office holders will fly in the aircraft, you need to review the applicable state or federal election commission rules concerning such flights in order to avoid problems with election laws. Liability is always a concern with aircraft ownership and operation, and the best way to avoid problems is to hire a competent crew and obtain a sufficient amount of insurance coverage.

It is essential to have a comprehensive understanding of all of these issues, or involve an attorney with aviation expertise, when you advise your clients on matters involved with buying and flying corporate aircraft.

Copyright © 2004 Jackson & Wade, L.L.C., Shawnee, KS