UK operators of owned and managed fleets are now carefully evaluating the potentially adverse impact of a European Commission decision on Value Added Tax (sales tax). The EC has instructed the UK to amend its VAT legislation in respect of aircraft that weigh more than 8,000 kg.

Initial reactions suggest that uncertainty about how the instruction will be applied and worries about cashflow are among major concerns. It is thought that the change may be bad for private owners and operators, but it could increase business for aircraft managers.

Graham Brearley, an aviation specialist and senior VAT manager at Grant Thornton UK LLP, points out: "Until now, such aircraft have not been subject to VAT at the standard rate in the UK. Other than cash flow, the impact on AOC operators should be fairly minimal as they are clearly operating in a business capacity and should be entitled to reclaim any VAT that they incur on their flight activities."

But: "In an already difficult market, the addition of VAT to the cost of buying and flying private jets is likely to sound the death knell for a significant number of owners, operators and manufacturers. Currently, the cost of acquiring, maintaining and handling qualifying aircraft in the UK is VAT free. The addition of the standard rate of VAT (currently 15% due to rise back up to 17.5%) to these costs will have a significantly damaging impact on the industry, and could make the difference between whether to continue flying or not."

The main impact, Brearley predicts, will be on private operators. "If the law is changed so that VAT is payable, the big question to resolve is whether the VAT can be reclaimed. If the aircraft is used wholly for business purposes, this should not be an issue. However, in the majority of cases, the aircraft is also used for non-business purposes or for the private purposes of the owners. In such circumstances, this non-business or private use will give rise to a potentially significant VAT cost which cannot be reclaimed."

The recession has reduced demand for private flying but managed fleets in the UK tended to feel under a lesser financial pressure because the owners had made the capital outlay on the jets. "However many owners on AOCs use their jets for private owner purposes as well as business charter purposes and this could be an area for concern."

If the law is changed, owners and operators will only be able to reclaim the VAT incurred on these costs if the aircraft is used wholly for taxable business purposes. "Where an aircraft is used partly for business and partly for private purposes, which is quite often the case, the VAT incurred will not be claimable in full. Aircraft owners and operators should therefore review their budgets and forecasts with their VAT advisers."

But Brearley points out: "Until such time as HMRC (the UK tax authority) makes it clear what the new law will be and who will be affected, it is difficult to comment with any degree of certainty. What is clear however is that the UK's arbitrary 8,000 kg weight limit, which has been in place since VAT was introduced in the UK in 1973, is no longer acceptable to the EU Commission. For an aircraft to qualify for exemption from VAT, the EU directive stipulates that the aircraft must be 'used by airlines for reward chiefly on international routes.' This exemption must be construed narrowly so that only those aircraft which meet this strict criteria will qualify. The main questions to be resolved are firstly, whether AOC operators will be regarded as 'airlines operating for reward', and secondly, are the standard business jets of a kind used by airlines?"

Will Curtis, Rizon ceo, is outspoken on the UK VAT issue. "This is typical of the way that the EU legislates - from a position of comprehensive ignorance and without consultation of any description."

James Dillon Godfray, head of marketing and development at Oxford Airport, sees an upside. "This is potentially bad news for the Manx register, Cayman, Bermuda, Aruba etc. but good news for UK AOC operators who will now have private operators wanting them to put their aircraft on an AOC in order for the operation to be deemed 'commercial' and therefore facilitate re-claiming VAT."

He refers to the EC explanation that the exemption only applies to an airline 'operating for reward chiefly on international routes' and adds: "That is exactly what the likes of LEA or Hangar 8 do. The definition of an 'airline' does require further clarification though as it is open to some ambiguous interpretation in the context of business aviation. Furthermore the European Commission has extended these exemptions to aircraft operating on domestic routes, so this would benefit them even further because currently any internal flights that they operate carry VAT. Assuming the EC does force the UK's hand then I would imagine that more privately owned aircraft above the weight threshold would want to be involved with AOC operators."

The EC says it has formally requested the UK to amend its legislation governing the VAT exemption for transactions related to aircraft, since it is based on criteria different from, and inconsistent with, those employed in the VAT Directive.

The request is communicated in the form of a 'reasoned opinion'. This is the second step of the infringement procedure provided for in Article 226 of the EC Treaty. "If, within two months, the relevant national rules are not amended in order to comply with the reasoned opinion, the Commission may decide to refer the matter to the European Court of Justice," it warns.

Article 148 of the VAT Directive exempts from VAT certain supplies of goods and services related to aircraft. The essential condition for those exemptions to apply is that the aircraft must be "used by an airline operating for reward chiefly on international routes". In Case C-382/02 the European Court of Justice ruled that the exemptions apply even for an aircraft operating on domestic routes, as long as it is used by such an airline.

But the EC says: "The UK applies the exemptions according to different criteria, those of the weight of the aircraft and of its design. Any aircraft under 8,000 kg is not exempted even where it is used by an airline meeting the relevant conditions. Conversely, aircraft of a weight over 8,000 kg and not designed nor adapted for private pleasure flying is exempted, and that even where the aircraft is not used by an airline operating for reward chiefly on international routes. In view of the above, the Commission has formally requested the United Kingdom to change its national rules."

Additional paperwork

Gama Aviation's gm Dave Edwards points out that business aviation contributes over £3.5 billion to the UK economy and employs more than 50,000 in the country.

Edwards says the addition of 15% or 17.5% to the purchase and operating costs of private aircraft will have a severe and deep impact on the industry in the UK and will favour competitors from outside Europe. "Although there is the possibility of claiming back the VAT, this will still cause potentially huge cash flow issues for operators and will be yet another nail in the coffin of smaller operators without substantial resources. To implement this change in such a rapid manner, with virtually no industry discussion, opinion or debate would be, frankly, ill-considered at this time."