Personal tax rates emerge as risk to Irish aviation sector

While the success of Ireland’s corporate aviation sector is clear, it is not without challenges.

Though much attention has been given to the risk of changes to Ireland’s corporate tax regime, in fact it is personal tax that is emerging as the more pressing issue for the aviation sector.

"If you put the Apple decision to one side, which in any case has absolutely no impact on air finance, you will see that the EU has no problem with our 12.5 per cent corporate tax rate. That stability has not changed. The area that is still challenged is in relation to our personal taxation regime," says Tom Woods of KPMG.

“The EU is aligning corporate profits with the country in which a company’s people are located, as is the OECD under its base erosion and profit-shifting (Beps) process, so it is crucial that the aviation talent pool remains here and that we can continue to attract highly skilled people to the country. That means personal taxation is going to be an important element in future,” he says.

This becomes even more important given the “shift to the east” the sector is currently experiencing.

“Airlines in the Middle East and Asia Pacific continue to post the stronger overall passenger traffic growth, with domestic passenger traffic growing the fastest in India and China. Also in China, significant capital for the financing of aircraft has been deployed and remains to be deployed.

Attractions

“While Chinese lessors have established operations in Ireland, alternative viable locations for air-finance activities such as the Chinese free-trade zones, Hong Kong and Singapore have obvious attractions in terms of their proximity to the Chinese mainland,” cautions Brian O’Callaghan, lead audit partner, aircraft leasing & finance,

Deloitte

.

The impact of new banking regulatory rules under Basel III and IV are likely to have an impact on the sector in the near term too. “Bank financing is going to be interesting this year, given that the new regulatory rules may mean giving greater risk weight to assets,” says Woods.

“If it becomes more expensive, with a greater need to allocate capital against aircraft, debt becomes more expensive. Aviation has done well out of the fact that more investors have come into the aircraft sector because of a low interest rate environment where returns are poor elsewhere.”

The strengthening of the dollar will also have an impact on the sector, as aircraft are financed in dollars. “If bank repayments start to get much more expensive, those buying planes are going to think more about leasing them, which might play right into the leasing community’s favour,” he says.

The strong fundamentals in the wider aviation sector are expected to continue in 2017, though likely resulting in a less profitable outcome compared with the cyclical peak of 2016, according to O’Callaghan

“Latest IATA (International Air Transport Association)projections suggest a net profit of just shy of $30 billion. The lower profitability is expected to result from projected increases in oil prices and the consequential lowering of the demand stimulus on air traffic.”

Abundance of liquidity

Lease rates are expected to remain challenged, further weakening lessor margins. “Given factors such as the abundance of liquidity, the alternative sources of funding available, low interest rates, improved health of airline balance sheets, and the extent of new entrants, it is difficult to foresee when on the horizon that this trend will reverse,” says O’Callaghan.

Competition from new entrants will remain intense, particularly in sale-leaseback transactions. “A large proportion of this capital seeking investment is from China. Further M&A activity can be expected, as many of these new entrants strive to achieve critical mass within a short timeframe.”

The appetite of new entrants has led to predictions of existing lessors actively trading their portfolios, creating capacity to buy new aircraft while reducing residual risk. Capital markets and bank debt are expected to continue to be the primary sources of funding for lessors executing growth strategies.

Overall prospects for the global air-finance sector remain positive based on medium-term projections for air traffic growth, with some caveats, he says. “There are predictions of circa $800 billion of funding required over the next five years to finance new aircraft deliveries.

“However, those prospects are exposed to a number of the underlying assumptions. These include projections regarding oil price levels, and the economic fundamentals supporting traffic growth. Challenges regarding slowing air traffic demand, geopolitical uncertainties, global economic growth, and terrorism, are all a cause of concern,” says O’Callaghan.

That said, funding required to finance new aircraft deliveries is predicted to be $126 billion in 2017 alone, with 50 per cent of aircraft expected to be leased by 2020.

Fastest growth

“Market participants expect the fastest growth for the establishment of international aircraft-leasing operations to be in Singapore, Ireland and Hong Kong. Ireland’s success vis-a-vis Singapore and Hong Kong will be dependent on the comparative outcome of all of the ingredients outlined above, including tax.”

Double-tax treaty networks, corporation tax rates and availability of tax depreciation are key factors for each of the jurisdictions, however.

“While Ireland compares favourably under these headings, the comparatively higher personal tax rates are a concern for many industry participants when it comes to choosing Ireland as a location,” warns O’Callaghan. “The ultimate outcome of the Beps process will also be a key determinant in the relative success of each of the locations. While Ireland should remain the leading global hub, significant challenges will be posed by these other jurisdictions in the near future.”

TURBO-CHARGED AIR-FINANCE INVESTMENT

Investment in air finance has been turbo-charged in recent years, fuelled by recognition that leasing a plane can be many times more lucrative than flying one. Aircraft leasing is also built around a highly mobile asset – if one market isn’t providing sufficient returns, you can bring it to another.

Compared with other technology, aircraft depreciation is different too, often retaining strong residual values through to end of an aircraft’s life cycle.

A typical narrow body plane costs around $40 million. The lifespan of a passenger plane is around 22 years, with typically another 10 as a freighter, before ultimately being broken for spare parts.

Moreover, the core fundamentals underlying the market are strong, powered by a growing desire to travel among an also growing middle class, not just in China but in developing countries worldwide.

Taking into account the number of existing planes that will have to be replaced, as well as the additional ones required to meet growing demand, it is predicted that 38,000 new aircraft will be needed over the next 20 years, at a value of almost $6 trillion.