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Taxation of aircraft financing

in Germany
Briefing

1 Introduction

September 2013

German law does not define what leasing is nor is there a separate set of rules
dealing with leasing in particular. For civil law purposes, a lease is generally
treated as a special form of use agreement against consideration which is
akin to a rental agreement but may also contain elements of a loan and other
agreements which are defined by German statutory law. Practically, the
most common forms of leases in Germany are operating leases and financial
leases.

1.1 Operating lease

Operating leases are usually treated as regular rental agreements under

German law. They can be entered into for an indefinite period of time and
may be terminated by both parties. The lessor normally bears the risks
and rewards attached to the asset and is often also responsible for repairs,
maintenance and insurance. Upon termination of the agreement, the lessee
simply has to return the asset without any further obligation.

1.2 Finance lease

By contrast, finance leases are typically structured in such a way that the
lessee pays a certain amount on a regular basis to the lessor during a fixed
term for the use of the asset. The agreement cannot be terminated during
the fixed term, so that it represents a stable calculation base for the lessor.
Typically, in these cases, the lessee bears the risks attached to the asset, in
particular risk of loss, destruction, etc. As a result, it is the lessee who bears
the investment risk.
Depending on whether the lease payments during the fixed lease term cover
the lessors acquisition or production costs and his ancillary and financing
costs, full pay-out agreements are distinguished from non full pay-out
agreements.

Taxation of aircraft financing in Germany

2 Accounting principles
German accounting principles are based on the German Commercial Code (Handelsgesetzbuch
HGB). As the German Commercial Code does not contain specific rules for the accounting
of leasing assets, accountants follow the tax rules set by the German Federal Ministry of
Finance for the allocation of lease assets in the balance sheet.
The tax rules for the allocation of leases are based on the principle of economic ownership
(Section 39 General Tax Code Abgabenordnung AO). This means that economic assets are
generally allocated to the legal owner. However, where someone other than the legal owner
exercises effective control over an economic asset in such a way that he can, in practice
exclude the owner from using the economic asset during the normal period of its useful life,
the economic assets will be attributable to this person.
For the interpretation of this general principle, the German Federal Ministry of Finance
distinguishes between full pay-out leases (financial leases) and non full pay-out leases. A full
pay-out lease (financial lease) requires the following:
An agreement with a fixed leasing period during which ordinary termination is not possible;
The lease payments during the fixed leasing period cover at least the acquisition or
production costs, plus additional costs, including the lessors refinancing costs.
Where these requirements are not fulfilled, the German Federal Ministry of Finance assumes
a non full pay-out lease.

2.1 Treatment of full pay-out leases (financial leases)

Allocation of aircraft as between the lessee and lessor in the case of full pay-out leases
(financial lease)
Type of Lease

Fixed lease period

40%-90% of useful life
of aircraft*

Fixed lease period

< 40% or > 90% of
useful life of aircraft

Without renewal or
purchase option

Lessor

Lessee

Purchase price < Book

value at sale

Lessee

Lessee

Purchase price Book

value at sale

Lessor

With purchase option

With renewal option

Additional lease
Lessee
payments <
remaining book value
(determined according
to straight line method)

Lessee

Additional lease
Lessor
payments
remaining book value
(determined according
to straight line method)
* The useful life of aircraft is determined on the basis of tables issued by the Federal Ministry of Finance. The Federal Ministry of Finance
assumes a useful life of 12 14 years for aircraft.
N.B. In cases of special leasing, i.e. where the asset has been designed specifically for the lessees requirements and can reasonably only by
used by the lessee, commercial ownership is generally ascribed to the lessee.

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Where the commercial features of a lease do not exactly fit the criteria set out by the German
Federal Ministry of Finance, economic ownership in general and in relation to aircraft in
particular must be determined on a case-by-case basis. Unless indicated otherwise below,
the allocation rules for assets in general can be applied to aircraft. Broadly, the key issue is
who bears the risks and rewards of the leased aircraft. Criteria for the determination of the
economic ownership are:
whether or not the lessee has an option to acquire the aircraft for a fixed purchase price at
the end of the lease term;
who bears the risk of a total loss of the aircraft;
whether the risks or rewards of a sale of the aircraft reside with the lessor or the lessee;
who is responsible for the maintenance works during the lease term.

2.2 Treatment of non full pay-out leases over aircraft

Decrees by the Federal Ministry of Finance deal with three types of non full pay-out leases
which run over a fixed period of more than 40% but less than 90% of the useful life of a
movable asset (here aircraft). The following lease terms normally should not affect economic
ownership of the lessor:
Obligation on the lessee to purchase the leased aircraft at a pre-determined price upon
request of the lessor if the lease is not renewed at the end of the fixed lease period.
Obligation on the lessee to reimburse a loss of the lessor if the aircraft is sold at the end of
the lease period at a loss. If a gain is realised upon the sale of the aircraft, participation of
the lessor in such gain of at least 25%.
Termination of the lease by the lessee after the fixed lease period in which case lessee has
to make a final payment to the lessor equivalent to the difference between lessors total
cost and payments made during the term of the lease. 90% of the sale proceeds realised
by the lessor are credited against the final payment to be made by the lessee.
Where the commercial features of a lease do not match the criteria above, economic
ownership must be determined on a case-by-case basis (cf. criteria under 2.1).

2.3 Sale and lease back

There are no specific accounting rules for sale and lease back transactions.

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Taxation of aircraft financing in Germany

3 Income taxation
3.1 General considerations regarding investment structure

There are various structural options for German aircraft lessor activity, which should be
considered prior to an investment. The options primarily depend on whether or not the
investor is resident in Germany:
(a) Non-resident aircraft lessors
Non-resident aircraft lessors can broadly choose between (i) a direct cross-border
leasing investment and (ii) a concentration of the lessors activity through a permanent
establishment, a partnership or a company.
(i) Direct cross-border leasing
A direct cross-border lease of the aircraft to a German resident lessee is the easiest
option to conduct business in Germany. The foreign investor engages in an ongoing
lease relationship without having a fixed place of business such as a permanent
establishment, a commercial partnership or a company in Germany.

This form of investment is cost saving and is obviously attractive for short-term
investors.

(ii) German resident permanent establishment or German partnership

Often, a stronger presence will be required in Germany for the fulfilment of German
market expectations and administrative requirements. In many cases, fulfilling
these requirements is only possible by establishing a permanent establishment,
a partnership or a company in Germany. All forms give rise to a German taxation
link and require tax registration in Germany and the fulfilment of German tax
duties such as the filing of annual tax declarations. Therefore, these forms are only
recommendable if the investment in Germany is medium to long-term and exceeds a
minimal business in Germany.
(A) German permanent establishment
Establishing and liquidating a permanent establishment is easier than setting
up or liquidating a partnership or company. However, the economic risk will be
assumed solely by the foreign head office because a permanent establishment has
no legal personality from a German law perspective.
(B) German partnership
A typical feature of partnerships such as a general partnership (offene
Handelsgesellschaft OHG) or a limited partnership (Kommanditgesellschaft KG)
is that one or more of the partners are general partners with unlimited liability.
Therefore, there will always be one partner which can be a company whose
business risk is not fully limited.

Partnerships are treated as transparent for income tax purposes. Therefore,

income tax is levied at the level of the partners. Special tax rules for partnerships
(e.g. for loss utilisation or the recognition of contractual relationships between
partner and partnership) which implement the transparency principle can bring
an additional complexity to the taxation of partnerships. The transparency
principle is not applicable for German trade tax purposes and does not release the
partnership from tax registration and compliance duties.

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(C) German company

Companies such as a limited liability company (Gesellschaft mit beschrnkter
Haftung GmbH) or a stock corporation (Aktiengesellschaft AG) are separate
legal entities. This gives investors the opportunity to limit liability to the registered
share capital in order to limit their business risk. Furthermore, contractual
relationships between shareholder and company are generally recognized for tax
purposes provided they are at arms length.

Companies are also separate entities for tax purposes. Therefore, companies with a
registered office or management in Germany have to register for tax purposes and
are subject to corporate income tax (plus solidarity surcharge) and trade tax.

(b) Resident aircraft lessors

Resident aircraft lessors can elect to operate through (i) a German company or (ii) a
German partnership.
(i) German company
The comments on German companies for non-resident lessors in Section 3.1 a (ii) (C)
apply mutatis mutandis. The main disadvantage of the establishment of a German
company is the potential German trade tax liability of the German company.
(ii) German partnership
As set out in Section 3.1 a (ii) (B) German tax law has special tax rules for the taxation
of partnerships which can make handling of German partnerships complex.

However, limited partnerships are often used as an investment vehicle for German
retail investors (i.e. individuals invest jointly in an aircraft) as under certain
circumstances German trade tax liability can be avoided. Furthermore, the partners
can benefit from a special taxation regime for capital gains which exempts capital
gains from German income taxation if the aircraft is held for at least 10 years.

For the purposes of this overview, we will focus in what follows on direct cross-border leasing
of non-German resident companies and investments structured via German companies as the
most frequent forms of aircraft investments in Germany.

3.2 Corporate income tax general aspects

German resident companies are subject to German corporate income tax on their worldwide
income (unlimited tax liability, unbeschrnkte Steuerpflicht).
Profits of the company are subject to corporate income tax at a rate of 15% plus a solidarity
surcharge (Solidarittszuschlag) of 5.5% of the assessed amount of corporate income tax
(yielding a compound corporate income tax rate of 15.825%).

3.3 General determination of income base

Basically, there are seven classes of income to which German tax residents are subject. In the
case of a company, this is broadly irrelevant because as a matter of statutory law, all income
generated by a company is deemed to be trade income.

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Taxation of aircraft financing in Germany

The taxable income of a company is based on the commercial profit or loss shown in its
German GAAP financial statements albeit with certain adjustments for corporate income
tax and trade tax purposes. The company is not required to physically set up a specific tax
balance sheet; it must, however, prepare a reconciliation of taxable income which reflects tax
adjustments. In broad terms, items which are deducted in the financial statements (salaries,
office rents, other business expenses) are also deductible for tax purposes. The following
adjustments are particularly noteworthy:
Dividends received by a German corporate shareholder are generally 95% corporate
income tax and trade tax exempt, if the shareholder holds shares in the distributing
company of at least 10% as of the beginning of its fiscal year.
Capital gains derived from the sale of shares are basically also 95% tax exempt.
Interest deductions are subject to the applicable interest ceiling rules.
The use of losses is subject to certain restrictions.
(a) Depreciation of aircraft
From a German tax perspective, only the economic owner of the aircraft is entitled to
depreciate the aircraft over its expected useful economic life. The German tax authorities
issue depreciation tables for the expected tax life of movable assets and assume a useful
economic life of 14 years for aircraft with a maximum flight weight up to 20 tons and 12
years for aircraft with a maximum flight weight above 20 tons.

Depreciation of movable assets must use the straight-line depreciation method. With
effect from 1 January 2011, the declining balance method is no longer available for the
depreciation of movable assets.

(b) Interest ceiling rules

Generally, under the interest ceiling net interest expenses, i.e. interest charges in excess
of interest earned are deductible only up to 30 percent of EBITDA (i.e. earnings before
interest expenses, regular depreciation and amortization less any interest income
generated) in an assessment period. If the interest earnings of the business exceed
the interest expenses, the interest ceiling does not apply. By contrast, remaining nondeductible interest can be carried forward to the following year and then be deducted.

There are three exemptions from the deduction restrictions provided by the interest
ceiling (it is sufficient if one of the following conditions is fulfilled):
Exemption limit of 3 million: The interest ceiling is not applicable if the total
net debt interest (i.e. interest expenses less interest income) of the business in the
assessment period amounts to less than 3 million.
Stand-alone clause: The interest deduction restrictions do not apply to stand-alone
businesses (i.e. businesses which do not belong to a group or only partly belong
to a group). The term group is defined very broadly in sec. 4 h para. 3 German
Income Tax Code (Einkommensteuergesetz EStG). A business belongs to a group
if it can be consolidated with one or several other businesses in accordance with
the applicable reporting standards usually the International Financial Reporting
Standards (IFRS) or if its financial and business policies are governed by another
entity (corresponding to IAS 27, which, however requires a legal agreement).

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For companies the stand-alone clause applies only where the company establishes
that remuneration on the shareholder debt accounts for no more than 10 percent of
its net expenses. Shareholder debt is assumed where the company is financed via a
loan granted by (i) a substantial shareholder (shareholding of more than 25 percent),
(ii) an affiliated person or (iii) a third party having recourse against a substantial
shareholder or an affiliated person.

Equity ratio comparison: In relation to businesses belonging to a group, the interest

ceiling is not applicable if it can be shown on the basis of the financial statements
for the preceding year that the equity ratio of the business according to its individual
financial statements is the same or higher than the equity ratio of the group in the
consolidated financial statements (so called escape clause). In principle, the equity
ratio has to be determined in accordance with IFRS, alternatively, the commercial law
of a Member State of the European Union or (with certain restrictions) in accordance
with US-GAAP. The equity ratio is generally defined as the ratio of equity to balance
sheet total and may be subject to certain adjustments for goodwill, tax reserves, book
values of shares in subsidiaries, etc.

The escape clause for businesses forming part of a controlled group applies only if the
remuneration on shareholder debt accounts for no more than 10 percent of the net
interest expense. Interest expense on loans received from substantial shareholders
and affiliated persons are only counted for this purpose to the extent they are shown
as liabilities in the fully consolidated accounts of the relevant corporate group. In
addition, secured bank loans do not count towards the 10 percent threshold where
the security is provided solely by a member of the controlled group.

(c) Loss utilisation restriction

(i) Treatment of tax losses
Tax losses which cannot be set off in the current year may be carried back one year up
to an amount of 1 million.

To the extent losses exceed 1 million or cannot be fully set off against the previous
years income, they can be carried forward. Losses carried forward can be set off
without restriction against profits only up to an amount of 1 million per year. Losses
in excess of this amount may be set off only to the extent of 60 % of taxable income in
the current period.

There are no time limitations on the use of loss carry forwards.

(ii) Rules regarding forfeiture of tax losses carry forward

A direct or indirect change of control in a company can trigger a partial or full
forfeiture of tax losses carried forward. If more than 25% of the shares in a company
are (directly or indirectly) transferred to a purchaser or group of related purchasers,
the tax losses carried forward by the company will be partially forfeited. If more than
50% of the shares are (directly or indirectly) transferred to a purchaser or group of
related purchasers, the tax losses carried forward will be fully forfeited. The forfeiture
will not be triggered to the extent the company has sufficient hidden reserves
(difference between the tax book values of the assets of the company and the fair
market value of the shares/assets). These principles also apply for trade tax purposes.

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Taxation of aircraft financing in Germany

3.4 Cross-border-issues

(a) German sourced income

If a company is not resident in Germany, it is subject to limited tax liability (beschrnkte
Steuerpflicht), if and to the extent that it realises income from German sources specified in
the German Income Tax Act.

As long as the lessor maintains no German fixed place of business or provides any other
services in connection with aircraft leasing, the mere lease of aircraft does not create a
permanent establishment of the lessor in Germany.

Lease rentals derived from an aircraft lease by a non German resident company are only
subject to German corporation tax if (i) the lessor operates through a German permanent
establishment or (ii) the aircraft is registered in the German Aircraft Register or (iii) if and
to the extent that the aircraft is used in Germany and economic ownership resides with
the lessor.

(b) Capital gains

Capital gains resulting from the sale of an aircraft are treated as income in the ordinary
course of business. In the case of non-German resident companies the capital gains
are subject to German corporation tax if (i) the lease is carried out through a German
permanent establishment or (ii) the aircraft is registered in the German Aircraft Register.
(c) Withholding taxes
Lease payments made by a resident German lessee to a non-resident lessor are not subject
to German withholding tax. Former provisions that imposed German withholding tax on
lease rentals were repealed with effect from 1 January 2009.

Please note that in the case of cross-border leases a double taxation treaty between
the lessors state of residency and Germany may provide distinct taxation rules for
German-sourced income. Thus, one should always check in these cases (i) whether
a double taxation treaty is applicable and (ii) what the specific implications for
German-sourced income are.

3.5 Trade tax

Trade tax is generally imposed on all business activity exercised in Germany. Irrespective of
their specific activities, companies are deemed to generate business income.
(a) Determination of trade income
Trade income tax base is broadly the same as for corporate income tax purposes.
However, it is modified by certain add-backs and deductions. As far as leasing is
concerned, the most important issues in this connection are:
Add-back regarding costs for long-term debt; and
Add-back regarding lease and rent payments.

To the extent add-backs are made in this respect, they increase the trade tax base and
are therefore subject to trade tax. It is therefore crucial that the effects of both issues are
addressed.

The add-backs include inter alia 25% of the sum of (i) loan remuneration (e.g. interest
expenses paid by the lessee) and (ii) 20% of lease expense in connection with an aircraft
lease.

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The add-back only applies to the extent payments exceed an exemption amount of
100,000.

(b) Treatment of trade tax losses

No loss carry back is available for trade tax purposes.

Trade tax losses (Gewerbeverlust) can be carried forward and deducted from future trade
income. The restrictions for corporate income tax also apply to trade tax. Up to a limit of
1 million, losses carried forward may be fully set off against earnings trade tax income.
Beyond this limit, losses carried forward may be set off against no more than 60% of the
trade income in the current period.

There is no time limit for the use of losses carried forward.

(c) Determination of applicable tax rate

The trade income tax base is multiplied by a basic tax rate (Steuermesszahl) of 3.5%,
resulting in the so called base amount (Steuermessbetrag). The relevant multiplier
(Hebesatz) for each local municipality is applied to the base amount. These multipliers
typically range between 200 to 490%, i.e. a factor of 2.0 to 4.9, yielding a tax rate of 7.0
to 17.15%.
(d) Cross-border-issues
As a German trade tax liability requires a trade business in Germany, the income of a
non-resident lessor is only subject to German trade tax, if the lessor maintains a German
permanent establishment and the aircraft is allocated to such German permanent
establishment.

3.6 Formal proceeding

Any income derived from a lease in Germany must be declared in an annual income/
corporation tax declaration of the lessor and in an annual trade tax declaration if the lessor
is subject to German trade tax. In principle, this applies also to a non-resident lessor who
realises income from German sources.

4 VAT
4.1 General

All entrepreneurs (individuals as well as companies and partnerships) who are

independently engaged in a trade business with the objective of earning income are subject
to German VAT. VAT liability arises irrespective of citizenship, residence, principal place of
management or place of invoicing or payment. Any person who leases an aircraft in Germany
would be considered as an entrepreneur for German VAT purposes.
The standard German VAT rate is 19%.

4.2 Registration requirements

Any entrepreneur making taxable supplies in Germany is obliged to register for VAT
purposes. This also applies if the entrepreneur is not resident in Germany.
A single tax reference number is usually ascribed to an entrepreneur for all taxes including
VAT. On application, a VAT identification number is issued for each registered entrepreneur.

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Taxation of aircraft financing in Germany

4.3 VAT exemption for supplies of goods and services to international airlines

Under the German VAT Act, supplies of goods and services to approved international airlines
are exempt from VAT. Airlines which are resident in Germany have to be included in a list
of approved international companies published by the German tax authorities. According
to the official guidelines to the German VAT Act, non-resident airlines are assumed to be
international airlines for German VAT purposes.

4.4 VAT treatment of acquisition of aircraft

Unless the exemption under 4.3 is applicable, a transfer of the aircraft is subject to German
VAT if the effective transfer takes place when the aircraft is on German soil. Whether or not
the aircraft is registered in the German Aircraft register, is not relevant.
VAT is levied on the purchase price at a rate of 19%.

4.5 VAT treatment of leasing

For the VAT treatment of leasing services, it is crucial whether or not economic ownership
is transferred by the lessor to the lessee at the beginning of the lease term. For the
determination whether or not economic ownership of the aircraft is transferred, income tax/
accounting principles are generally applicable.
(a) Economic ownership resides with the lessor
The place of supply for a lease by the lessor to the lessee is normally where the lessee is
resident. Where the lessee is resident in Germany, German VAT is charged in addition to
the net rentals during the lease term. The German VAT amount on an agreed single net
lease rental normally becomes due on the 10th day of the month following the agreed
payment date of the corresponding lease rental by the lessee.

The lessee normally gets a tax credit for input VAT paid (unless he conducts a business
that is not eligible for full credit such as banking, insurance, etc.).

Where a non-German resident lessor leases aircraft to a German resident lessee and the
exemption under 4.3 does not apply, the reverse charge mechanism would be triggered.
If the lessee is entitled to a refund of input VAT, his payment obligation under the reverse
charge mechanism can be set off against the refund claim.

(b) Lessor transfers the economic ownership to the lessee

The transfer of economic ownership at the beginning of the lease term is considered as
a supply of the aircraft by the lessor to the lessee. According to the current view of the
tax authorities, the tax base for calculating VAT is equal to the aggregate amount of the
rent payable (including (i) rent for a renewal period in the case of a renewable option and
(ii) agreed purchase price in the case of a purchase). The entire German VAT amount is
triggered at the end of the month when the aircraft delivery takes place, if (i) the aircraft
is located in Germany at the time of the delivery and (ii) the transaction is not subject to
a VAT exemption. The German VAT normally becomes due on the 10th day of the month
following the aircraft delivery.
(c) Sale-and-lease-back transactions
Where economic ownership (i.e. all economic risks and rewards attached to an asset)
resides with the seller (and the lessee) throughout the sale-and-lease-back-transaction,
a supply and repurchase of the aircraft effectively is seen to take place for German VAT
purposes so that the whole arrangement should normally qualify as mere financing by
the buyer to the seller.

Financing is VAT exempt if certain formal requirements are fulfilled.

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(d) Penalties
Penalties payable for a breach of contract are normally not subject to VAT.

5 Customs duties and transfer taxes

5.1 Customs duties and import VAT

Customs duties and import VAT are applicable in accordance with European Union
principles. The import of an aircraft by a lessor from a place outside the European Union into
the European Union can trigger customs duties and import VAT. Potential import taxes and
compliance with European Union importation requirements should therefore be reviewed
prior to importation of the aircraft.

5.2 Transfer taxes

There are no specific transfer taxes such as stamp duties, registration taxes etc in connection
with aircraft leasing in Germany.
However, costs (charges of the German Aircraft Register and legal fees for advisers) in
connection with the registration of the aircraft in the German Aircraft Register may arise.

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Contacts
If you would like further information please contact:

Munich
Igsaan Varachia
Partner
Norton Rose Fulbright LLP
Tel +49 89 212148 425
igsaan.varachia@nortonrosefulbright.com
Dr. Andreas Berberich
Senior associate
Norton Rose Fulbright LLP
Tel +49 89 212148 437
andreas.berberich@nortonrosefulbright.com

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