New legislation is encouraging cross-border leasing. But
is it economically beneficial to lessors
Go deeper with GlobalData
Andy Thompson
There are many established patterns of leasing across borders
within Europe. True cross-border leasing – where lessor and lessee
are resident in different countries – is largely, though not
entirely, confined to the big ticket sector. There are, of course,
many multinational leasing operations in the volume leasing
business, particularly in the vendor sector, but these are
invariably structured so that the lessor party in each contract is
a locally incorporated subsidiary.
Where UK-to-foreign leases are concerned, the corporate tax
changes enacted in 2006 (see box) have changed the picture. Some UK
banks, notably Lloyds TSB Asset Finance, are currently active in
leasing direct into several other European countries. Up to last
year, this was principally confined to ships and aircraft, although
there are signs that this may be changing.
“The 2006 Finance Act did not exactly open the floodgates to
outward leasing, although it helped,” says Vasgen Edwards, managing
director of corporate asset finance at Lloyds TSB. His
company also bucks the trend of lessors only, in the main, leasing
big ticket assets cross-border. It transacts operating lease deals
of construction machinery that range in value from £100,000 to
£700,000.
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By GlobalDataFurthermore, not all cross-border deals are tax-based, despite
the general belief being that they are. However, in such deals
lessees can often claim fiscal depreciation in their own countries,
although this is dependent on whether local rules allow them to do
so.The lessor in these circumstances usually retains legal title to
the asset.
In fact, says Edwards, from a bank’s standpoint, a non-tax-based
asset finance contract with reservation of title has clear
advantages over unsecured lending to corporate customers. “This is
not just for the obvious prudential reasons, but because of the
respective risk asset weightings under the Basel II capital
regulation system. In today’s climate following the credit crunch,
liquidity is all-important and the pricing of tax benefits has
become much less critical than it once was.”
UK lessors might also be put off from leasing to countries such
as France and Sweden where tax write-offs for plant and
machinery are relatively generous. “It would be difficult for a UK
tax-based lease to compete with local lessors or other financing
options,” remarks one lessor.
Germany is a country of some importance for both inward and
outward leasing. The German leasing association, Bundesverband
Deutscher Leasing (BDL), reports that total outward leasing from
Germany in 2007 amounted to €580m (£485m). “The dominant assets
here are aircraft, ships, railway rolling stock and production
machinery, but some of this business is being displaced as German
lessors have established local subsidiaries in countries where
their leasing has reached a critical volume,” said BDL’s business
manager, Dr Johannes Sczech.
In some sectors, however, especially aircraft, major new players
are appearing in outward leasing from Germany.
Since 2006 some important ‘equity partnerships’ have been
launched to lease aircraft and some other assets to foreign
customers from a German base, comments KPMG partner,Wolfgang
Griesbach. These equity partnership deals are funded by a mixture
of syndicated bank loans and bonds marketed to retail
investors.
Probably the largest of these new German equity partnerships is
Doric Asset Finance, which has now become one of the top 15 lessors
in the world with an aircraft leasing portfolio of some $2bn (£1.05
bn), together with other assets in shipping, renewable energy
and real estate. One of Doric’s most recent deals was for an Airbus
A380 leased to Singapore Airlines, which came into service in March
this year on the Heathrow-Singapore route.
In aircraft finance, German operating leases have become a
distinct product in the international market. Typically, new civil
airliners are leased for periods of between 10 and 12 years, with
the expectation of subsequent leases for long periods in the second
hand market. “A lot of new deals from these players are currently
in the pipeline, for airline customers in many countries, including
Flybe in the UK,” Griesbach remarks.
Another example of a German based leasing international leasing
player, with a significant cross-border capacity in the railway
rolling stock sector, is CB Rail, a joint venture between Babcock
& Brown and Bank of Scotland Corporate Europe. Last year, CB
Rail joined up with the manufacturer GE Transportation in a major
initiative to lease locomotives to private operators in Poland
where liberalisation of railway operations is currently
underway.
As for the flow of cross-border business from foreign lessors
into Germany, BDL cannot quantify precisely how much of this is
taking place, but Sczech suggests that it is probably growing due
to the “trade tax” burden on domestic leasing business.
“Since the beginning of 2008 German lessors face a new
disadvantage against foreign-based competitors who do not suffer
the burden of trade tax in addition to corporate income tax,” he
remarks.
“German lessors face a trade tax burden on their interest
expenses, while lessees face a similar burden on the deemed
interest within the lease rentals, which is assumed to be 20 per
cent of rentals in the case of equipment leases.”
Corporate tax factors will always be of some importance in
leasing business.At one time ‘double dips’ on fiscal depreciation
were a significant feature of tax planning in cross-border leasing.
Also, because of international variations in the eligibility rules
for tax write-offs of plant and machinery, it has sometimes been
possible for the lessor and lessee both to claim fiscal
depreciation in their respective home states, in a way which would
not be possible with domestic leasing where both parties operate
under the same national tax rules.
Yet ‘double dips’ will only give rise to a net tax advantage if
claiming fiscal depreciation in one or both countries actually
results in a tax reduction or deferral, compared with the
alternative of the relevant party being taxed in accordance with
its income profile for commercial accounting purposes.
For the UK this is rarely now the position. For large businesses
such as leasing companies, the writing down allowance rates since
April 1 2008 lag behind the true depreciation cycle.
“I do not think that double dips are very common these days,”
says Norton Rose partner, Alistair MacRae. “Where we advise the
lessor in a cross-border deal, we would not necessarily know
whether the lessee can claim fiscal depreciation under its home
state rules – but we would, of course, know if a double dip
were actually driving the deal, and it rarely now does.”
VAT a driving force
VAT is also a factor of some importance. Under a new EU VAT
Directive on the place of supply of services, adopted in April this
year and due to become effective from January 2010, lessors in some
types of cross-border equipment lease will no longer have to
account for VAT on the rentals in their worldwide portfolio in
2008. Instead, the rentals will attract a “reverse charge” on the
lessee in its own state.
The new rules are designed to prevent tax planning opportunities
in vehicle leasing, which in the past have taken advantage of
international VAT rate differences, as well as VAT frauds in other
sectors.
However, some practitioners suggest that the new rules will
actually have advantages for mainstream cross-border deals. “There
could be cashflow benefits for lessors, and although it is purely a
matter of timing this could be critical to finely priced deals,”
says Malcolm Ogle, partner of asset finance advisers, The Alta
Group.
It is likely that aircraft deals will always be a big part of
the cross-border leasing scene. German operating leases from
players like Doric now feature alongside the older Japanese
leveraged leasing product, says Colin Sach, of aviation finance
advisers Sach & Co. However, he points out that “the current
fuel price hike is limiting new orders”.
Across the market generally, some lessors feel that the
difficulties of writing cross-border business can be exaggerated.
“Obviously if you are writing a one-off deal of £150m or so for a
lessee outside Europe, perhaps with a guarantor in a third country,
you will have major overheads in advisory fees,” says Edwards. “Yet
for deals with customers in typical EU states, where the regulatory
system is generally accommodating towards asset finance, the costs
are not too heavy.”
OUT OF BRITAIN
Cross-border leasing out of the UK should be on the increase,
thanks to recent rule changes. But is it? Brendan
Malkin quizzes two partners from the law firm Norton Rose,
Alistair Macrae, an asset finance transaction specialist, and Chris
Bates, who works in lease taxation.
Is cross-border leasing, into and out of the UK, growing
and, if so, what is driving this?
The abolition of the overseas leasing rules in 2006 has allowed
UK lessors to finance plant and equipment located outside of the
UK. We have seen a number of transactions of this type and expect
to continue to do so.
The number of inbound deals has remained fairly modest in recent
years, with no appreciable growth. This may, however, change if the
benefits available to UK lessees (and risks involved) from inbound
lease structures become more attractive than those available in the
domestic UK market. This is because lessees will shop around, so if
tax-based leasing dries-up in their own country, they will go to
other places.
I understand, in some instances, lessees have been put
off cross-border deals because they often have complicated
structures, even though they could be potentially cheaper for the
lessee. Do you share this view?
A typical cross-border deal will, by its very nature, require
there to be an allocation of the various risks (tax and otherwise)
that arise in relation to both the lessor’s and the lessee’s
jurisdiction. The involvement of third-party debt may add yet
further potential jurisdictional risks to the equation. All of
these can potentially add to the complexity and, therefore,
to the costs of getting the transaction done. However, a clearly
drafted and detailed term-sheet can identify, and allocate, these
risks at the outset so lessees should not be put off looking at
cross border structures.
Are you seeing many tax-based deals from other EU
countries?
The French lease remains attractive and can generate significant
benefits for UK lessees. We are still seeing some inbound Swedish
and German leases, but activity is more limited. Lessors in those
jurisdictions perhaps focus more on their own domestic market.
Can you give any examples of particular sectors (eg
cars, trains, plant) where you are seeing a lot of cross-border
deals? Please separate between those into the UK and those going
out of the UK.
In terms of outbound, the majority of deals seem to be for
general industrial plant and machinery. There is also some activity
in the marine sector for assets such as containers. The 2006 rules
on cross-border leases, which provide tax breaks on five-year lease
deals, lend themselves better to these sorts of assets rather than
larger ones.
The inbound deals we have seen recently include assets such as
aircraft, rolling stock and renewable energy
equipment.
To what extent does the UK’s capital allowances regime
constrain UK lessors from leasing big ticket equipment out of the
UK?
The majority of transactions we have concluded on short-funding
leases have been for general plant and machinery assets – rather
than for high-value single assets – and mostly fall into the
medium-ticket category in terms of overall value.
Are there any continental European countries
particularly attractive to UK lessors looking to do cross-border
lease deals?
Choosing an EU member state certainly makes like easier on
things like VAT. Also,UK lessors are likely to look foremost at
countries with reasonably well-developed legal systems (which will,
for example, recognise the lessor’s right to repossess the assets
following a lessee default).
Have you seen a growth in the use of offshore-based
lease transactions. I see, for example, the Cayman Island firm
Walkers has recently launched an asset finance transaction
practice.
On more complex aircraft and shipping transactions, we often see
offshore entities involved. Offshore jurisdictions have the
attraction of offering relatively simple and low-cost tax and
regulatory regimes. Firms such as Walkers have, for many years,
assisted us with such transactions and will no doubt continue to do
so. It’s not just the tropical island taxhaven jurisdictions – for
example, countries such as Eire and Luxembourg have attracted a lot
of this type of business in recent years.
How tough is the UK taxman being in terms of clamping
down on tax-structured, cross-border deals?
There is no doubt HMRC seems intent on narrowing the scope and
availability of UK capital allowances, and it would be fair to say
they are vigorously clamping down on transactions (whether
cross-border or otherwise) they consider to be too tax aggressive.
In the past, they would be more likely to compromise by settling on
a 50-50 basis, but now they would be more likely to litigate. I
believe there will be more examples of litigation in the future.
Also, the equivalent of the Inland Revenue in other countries are
also becoming firmer in their treatment of tax-based
leasing.
CROSS BORDE LEASES: IS SPAIN IN BREACH OF EU
RULES?
Victor Mendoza
Payments related to finance leases made by Spanish resident
entities are generally treated as royalties and potentially subject
to Spanish tax. Spanish withholding tax is imposed on gross lease
payments, without any allowance for deductible expenses or costs.
Currently, a withholding tax rate of 24 per cent applies under
domestic legislation, although the rate may be reduced to 5-10 per
cent if a foreign lessor, doing a cross-border lease, is eligible
for coverage under tax legislation.
Even though the lessor’s EU member country of residence may
provide, either unilaterally or under a tax treaty, a tax credit
mechanism enabling the lessor to credit Spanish withholding tax
against the home country tax due, presumably it would not be
sufficient to recover a significant part of the Spanish withholding
tax. This is because Spanish withholding tax would most likely
exceed the incremental tax due of the residence country as a result
of the lease.
This is assuming the lessor is taxed on net income in its
residence country and, therefore, is entitled to tax allowance of
expenses such as funding costs and other operating expenses, and
maybe even to capital allowances.
In contrast, no Spanish withholding tax generally applies to
payments related to domestic leases and resident lessors are taxed
on net income, thus deducting applicable costs and expenses. Under
financial leases, the tax basis will generally be the net financial
margin less any operational costs.
Evidence shows direct cross-border inbound leases (except where
a 0 per cent withholding tax is achieved) are scarce or almost
non-existent in the Spanish market. This is mainly because the
Spanish withholding tax acts as a deterrent from entering into such
leases because it represents a tax burden that increases the costs
of the transaction. Leases into Spain are often structured through
permanent establishment, or special-purpose vehicles, in such a
manner that withholding tax costs are minimised.
This situation suggests there is, indeed, a true discrimination
in place against nonresident banks in the Spanish market and that
the Spanish withholding tax on crossborder leases is preventing
Spanish companies from full access to funding from other EU member
states.
Recent European Court of Justice (ECJ) decisions, concerning the
levy of withholding tax, support the basic proposition that
national rules must not impose a greater tax burden on
non-residents on Spanish-source income than Spanish entities.
Thus, while direct tax is not within the area of competence of
the EC, there is a substantial body of ECJ jurisprudence that
establishes that national tax law must be consistent with the
fundamental freedoms.
Article 56 of the EC Treaty prohibits all restrictions on the
movement of capital between member states.
Finance leasing granted by financial institutions should be
deemed a transaction within the scope of capital movements. This is
supported by the nomenclature and explanatory notes in Annex I to
Council Directive 88/361/EEC of June 24 for the implementation of
Article 67 of the EC Treaty (now Article 56).
In analysing whether the Spanish rules breach EU law, it is
typically necessary to consider the following questions:
● Is there discrimination or a difference in treatment?
● Can the discrimination or difference in treatment be
justified?
● Is the domestic rule proportionate to its aims?
The minimum requirement for an infringement of EU law is that
the legislation in question is likely to hinder the exercise of the
freedoms guaranteed by the EC Treaty. There does not need to be an
absolute restriction.
The ECJ interpreted the concept of discrimination as meaning
different treatment of subjects in comparable situations, or the
same treatment of subjects in different situations. Notwithstanding
that taxation rates applied to residents are higher than those
applied to non-residents, tax on non-residents is levied on gross
payments, which makes the overall Spanish taxation on non-resident
lessors generally more onerous.
In our view, the Spanish tax authorities should not be
able to argue successfully that there are grounds to defend or
justify the existence of discrimination or a difference in
treatment. In the past, the ECJ has considered a number of
justifications put forward by member states to defend or justify
the existence of discrimination or difference in treatment, such as
the need to fight against tax avoidance and the need to ensure
fiscal cohesion etc. Without entering into the details of each of
the arguments, our view is that none of them should have high
chances of success in the present case.
The principle of proportionality, as it has been interpreted by
the ECJ, requires that prohibitory measures be appropriate and
necessary in order to attain the objectives legitimately pursued by
the legislation in question.
Where there is a choice between several appropriate measures,
recourse must be to the least onerous and the disadvantages caused
must not be disproportionate to the aims pursued.
In the context of a cross-border lease,we believe the ECJ will
scrutinise whether the objectives pursued by Spanish legislation
are in proportion to the disadvantages caused. We believe the ECJ
will give relevance to the fact that current tax measures in Spain
discourage EU lessors from leasing into Spain directly from another
EU member state. As a consequence of this, Spanish companies are
constrained in their access to EU capital markets.
It should be noted that ECJ jurisprudence on Article 56
(prohibitions of all restrictions on the movement of capital
between member states) can be invoked under certain conditions also
in an EU-third country context. Thus, this may also benefit foreign
lessors established outside of the EU.
To date, the EU Commission has initiated infringement procedures
against Spain (and other member states) in respect of their tax
rules on dividend payments made to EU pension funds. Will tax rules
on cross-border lease payments be next?
The author is a tax partner at KPMG Abogados, S.L.
