2008 has been a busy year for French tax leasing and there has been a good flow of shipping transactions, including some using the new leasing regime created following the amendment to article 39 C of the French tax code (introduced in 2007). The main innovation has been that most shipping transactions (whatever the scheme used, i.e. the single investor lease or article 39 C lease) have employed a new exit strategy, giving the lessee the option to acquire the shares of the leasing company rather than the ship itself, resulting in a significantly increased net present value benefit for the lessee.

Both types of transactions are based on the attractiveness of the depreciation regime made available to the lessor of a ship by the French tax code. This regime has the following main features:

  • ships need to be new to be entitled to depreciation; however, if a refinancing is introduced within 24 months of the original delivery of the ship, this will also qualify for accelerated depreciation;
  • ships can be depreciated with effect from the fiscal year preceding delivery provided keel laying is achieved before the end of such fiscal year. Depreciation is then calculated on the basis of the aggregate amount of instalments that have been paid during the period on or prior to the last day of the tax year preceding delivery (subject to a cap of 50% of the acquisition price of the ship); and
  • ships are depreciated over 8 years under the declining balance regime. This period, converted into a ratio of 1/8, is then multiplied by a coefficient defined by law. This coefficient, which is normally of 2.25, results in a depreciation of 28.125% per year, to be applied on the net book value of the asset at the closing date of the preceding year. It should be noted that transactions occurring in 2009 will also benefit from a further advantage, since the new finance bill for 2009, as an incentive in the context of the current financial crisis, has increased the ratio from 2.25 to 2.75, resulting in a depreciation of 34.375% for ships acquired in 2009.

Single investor leases and 39 C leases differ in the way the tax losses generated by the SPV through the accelerated depreciation are transferred to the entity which has French tax capacity: In the case of single investor leases, the legal regime of tax consolidation requires that the leasing company be 95 per cent owned, directly or indirectly, by the bank with tax capacity. The tax losses of the SPV are thus offset against the profits of the whole tax consolidated group of that bank. On the other hand, 39 C structures are based on the use of transparent entities (such as groupement dintérêt économique (GIE) and société en nom collectif (SNC)) and therefore allow the existence of multiple partners, who will share the tax profits and losses made by the partnership pro rata to their share in the partnership. These structures, based on tax transparency, are the successors to the GIE fiscal, which could only be used following a ruling by the French tax administration, and have been introduced under specific legislation following the well publicised enquiry by the European Commission into the legality of the GIE fiscal. This is why the 39 C regime contains more constraints than single investor lease structures. T

he ability to share the tax depreciation amongst a number of parties is the main attraction of the 39 C scheme, particularly in an environment where tax capacity of banks is likely to be more restricted.

In a 39 C transaction, assets financed must meet one of the following criteria: (i) either be located in France or in an EEA country that has a double tax treaty with France (i.e. all European countries, plus Iceland and Norway, with the exception of Liechtenstein), a criterion which is relevant for fixed assets, or (ii) be operated or registered in France or in an EEA country that has an double tax treaty with France. From a French tax perspective a ship is deemed to be operated in an EEA country when it operates within the EEA for more than three quarters of the tax year. For example, a ship registered under UK flag will be eligible regardless of the effective place of operation. Similarly, a ship registered under Panamanian flag but operated in EEA countries for more than three quarters of the tax year will also be eligible, following comments issued by the French tax administration on this provision1. Most transactions carried out so far have involved ships registered under French flag, primarily using the French second register know as RIF (Registre International Français) which is the successor of the TAFF register (Terres Australes et Antarctiques Françaises, colloquially known as the “Kerguelen” Register).

In a 39 C transaction, the tax deductibility of losses at the partner level is capped at three times the amount of the rentals accrued by the SPV lessor during the first 36 months of the lease (except for the lessee if it is also a partner of the SPV. However, any losses restricted in this manner will become deductible in the fourth financial year). This restriction has not been a hurdle to transactions we have witnessed so far. Finally, the partners are prevented from deducting losses in excess of 25 per cent of their own (or their group's) taxable profits in the first 12 months of the lease. These limitations do not apply to losses derived from the depreciation of ships during the pre-delivery period.

The single investor lease structures can be contrasted with this set of rules, as they are not subject to specific constraints, except for general anti-avoidance rules.

In both structures, the SPV generally leases the asset to the lessee using a French credit-bail, which is a financial lease pursuant to which, at the end of the credit-bail, the asset is transferred to the lessee through the exercise of a purchase option, which results in a taxation of the capital gain at the rate of 34.43 per cent. After receiving confirmation from the French tax administration that this would not be seen as tax avoidance, lessors have started offering lessees the benefit of a purchase option over the shares in the SPV, since a 95 per cent exemption on capital gains has been introduced in France with effect from 1 January 2007. This new exit strategy has raised a number of interesting questions such as the value of the SPV and the method of transferring the tax advantage from the lessor to the lessee, which banks have now managed to deal with successfully.

2009 is proving to be, and will continue to be, a challenging year for the shipping finance market and in the French lease context banks will probably start using their own decreasing tax capacity more sparingly and look instead at the tax capacity of corporate investors. That said, these French tax lease structures can provide reasonably significant net present value benefits and we would therefore anticipate continued activity in these markets for those creditworthy shipowners who are prepared to adopt a more innovative approach to their financing arrangements.