Finance Leases

Finance leases are similar to bank loans, except that the purchaser at some point then buys the aircraft from the seller. The airline would make monthly lease payments and at the end of the lease it would typically own the aircraft. Finance leasing is akin to a hire purchase arrangement.

The income tax treatment of finance leases was clarified with the introduction of the Finance Leasing Rules in 2005.These rules are applicable in those scenarios where the lessee substantially assumes all risks and rewards associated with the ownership of the asset, other than the legal title. Furthermore, the period of the lease agreement ought to exceed four years. The following arrangements shall apply in the case of a qualifying finance lease for income tax purposes:

• the lessor is chargeable to tax on the annual lease payments;
• the burden of wear and tear is assumed to be borne by the lessor, meaning that the lessor is entitled to claim capital allowances on the leased asset; and
• the lessee is entitled to deduct the full amount of the lease payments from chargeable income, as well as other relevant deductions under Article 14(1) of the Income Tax Act.

If the ownership of the asset is subsequently transferred from the lessor to the lessee with the latter making a payment exceeding the total annual lease payments, this payment shall be chargeable to tax in the hands of the lessor.

The Malta Inland Revenue Department has also issued guidelines in relation to aircraft leasing arrangements, which do not fall under the Finance Leasing Rules and which arrangements ought not to be longer than four years in duration. In such cases, the Guidelines clarify that the Malta tax treatment should be as follows:

• the lessor is charged to tax on the annual finance charge, which represents the difference between the total lease payments less the capital element, divided by the number of years;
• the lessee is allowed deductions in respect of the following expenses:
  • the finance charge;
  • any maintenance costs;
  • any repair costs; and
  • any insurance expenses;
• the lessee is the party entitled to deduct capital allowances in respect of the aircraft; and
• where the lessee exercises an option to purchase the aircraft on the termination of the lease, the consideration received by the lessor is considered to be a capital payment and no tax thereon is charged by the lessor.

Operating Leases

Operating lessors either order aircraft from manufacturers or buy them from airlines and lease them back (this is known as sale/leaseback). The operating lessor leases the aircraft to the airline, which can also be referred to as the lessee. Leases can be as short as a couple of months to cope with seasonal demand Airlines can also lease crew and pilots with aircraft. These are known as wet leases.

In an operating lease scenario, the lessor is subject to Malta tax on the full amount of the lease income and, if it maintains the burden of wear and tear, it will be able to claim tax depreciation. On the other hand the lessee is entitled to deduct the full amount of the lease payments and to claim tax depreciation if it maintains the burden of wear and tear.