Companies and individuals acquire aircraft for a variety of reasons. Many companies use aircraft to supplement their operations because business aircraft allow for efficient, flexible, safe, secure and cost-effective transportation to a greater number of U.S. and international destinations when generally compared to commercial transportation. More importantly, productivity is greatly improved because employees are able to work while aboard the aircraft, rather than wasting valuable time in airports and on commercial airlines (with very limited connectivity). Business aircraft also allow employees to make several trips to different locations, then return to their headquarters or homes the same day, potentially saving thousands of dollars in lost productivity and travel expenses (hotels, meals, car rentals, taxis, etc.), which would normally be incurred over several days using other modes of transportation.
However, the decision to acquire a business aircraft is complex and requires a significant amount of planning. The first step in the planning process is to develop an acquisition plan to determine what type of aircraft is best suited for the company’s or individual’s particular operational, financial and strategic needs. This article provides an overview of the critical factors to consider when thinking about buying a business aircraft.
The first step in the process should involve an assessment of the company's operational needs, in particular, how the company intends to use the aircraft. Factors to consider include: (i) how much the aircraft will be used, (ii) what the typical destinations or distances are, (iii) the number of passengers, (iv) the need for multiple aircraft and (v) the feasibility of alternative transportation options (rail, airlines and cars).
This step should involve a comprehensive discussion among all the relevant parties to determine an operating profile based on the company's transportation needs. Thought should also be given to future operations, such as emerging markets, mergers and acquisitions, potential changes to operating structure and other unique needs, such as providing transportation to clients, officers and directors, and other guests. Many companies also allow the aircraft to be used by officers for personal use, and such use may have Federal Aviation Administration (FAA), Internal Revenue Service (IRS) and Securities and Exchange Commission (SEC) implications. Finally, companies may want to consider chartering the aircraft commercially to obtain charter revenue.
Selecting the Right Aircraft
In today's business aircraft market, companies have a wide variety of aircraft and options from which to choose. Companies narrow their choices based on their operational needs, focusing on cost, size and range. Business aircraft are divided into turboprops and jets, and jets are further divided based on cabin size and range (very light, light, medium, heavy/ultra-long-range). Companies should consider whether to buy or lease a new or pre-owned aircraft. Primary criteria that companies consider when selecting the right aircraft are performance, comfort, maintenance and market conditions. As a general matter, once a company has narrowed its choices to a particular aircraft class, it is critical to determine the operating costs of aircraft within the cabin class. The ideal aircraft is one which provides the highest level of operational capabilities consistent with the company’s needs at the lowest aggregate hourly operating cost.
It is currently an extremely favorable market for companies seeking to finance or lease a business aircraft. As with any other significant capital expenditure, several financing options exist and a careful analysis of the options is critical. The first issue a company faces is whether to simply pay cash or, given the current historically low interest rates, whether better uses of its cash exist. If the company decides to finance, the next issue is whether to enter into a loan or lease, and at what terms. Both options have very different exit strategies, disclosures and tax implications. A comprehensive financial analysis will be imperative to the decision-making process.
The analysis should consider the entire ownership cycle from acquisition to sale and include all fixed, variable, ownership and transition costs. As discussed below, tax implications such as depreciation, deductions, sales/use tax and other taxes should be analyzed thoroughly. Companies should seek advice from within the company as well as from third-party aviation professionals to ensure that a comprehensive analysis has been made, incorporating all relevant facts and assumptions. An ideal financial analysis includes a discussion of the following: (i) loan, lease or cash purchase, (ii) potential charter revenue, (iii) budget and tax implications, (iv) residual values, (v) maintenance plans and (vi) purchase of a new or pre-owned aircraft.
One of the most important aircraft acquisition planning decisions is determining the appropriate ownership structure. The structure will depend primarily on the company's needs and regulatory constraints. The most common aircraft ownership structures include (i) a company within a group of consolidated companies, (ii) a single company (S-Corp or C-Corp), (iii) two or more owners using a joint ownership arrangement, (iv) an individual or partnership (the partners must be individuals), (v) fractional ownership and (vi) owner or voting trust (primarily for non-U.S. citizens).
Each ownership structure has unique benefits, and some may be used only based on application regulatory constraints. Given the impact on public safety, the FAA heavily regulates aviation in the United States. Therefore, potential owners should carefully analyze whether their intended use is permissible under the Federal Aviation Regulations (FARs). One factor to consider is that the FARs prohibit charging or seeking reimbursements from third parties for use of the aircraft, except in limited circumstances such as intra-company operations, time sharing, interchange, or joint use arrangements. The FARs also severely limit employees' ability to reimburse for the personal use of a company aircraft.
Another factor to be aware of is the "flight department dilemma," as it is commonly called. This occurs when an owner creates a special purpose entity (SPE), typically a limited liability company, solely to own and operate the aircraft. In a misguided effort to minimize personal liability, owners often receive such advice from accountants or consultants, who are unfamiliar with the FAA regulations. The SPE's sole pursuit is to provide air transportation to affiliated entities. However, according to the FAA, an SPE created exclusively to own and operate an aircraft is a commercial air carrier for which a commercial air carrier operating certificate is required. Operating an aircraft as a commercial air carrier without the required commercial air operating certificate could result in severe civil penalties and a pilot’s certificate suspension or revocation. Additionally, in the event of an accident or incident, such use may jeopardize an aircraft’s insurance and financing because such use is likely contrary to applicable permitted use provisions of the aircraft insurance policy and/or financing documents.
To address this dilemma, many owners either place their aircraft in a company with an existing business function or create an SPE that merely owns the aircraft and leases it without pilots to third-party lessees. The lessees then obtain the pilots from another source. The aircraft owner may not direct the lessee to use specific pilots.
For many companies, perhaps the most common ownership structure involves placing the aircraft with a company within a consolidated group of companies. The FARs permit an owner to charge its parent and subsidiary companies for the carriage of company officials, employees, guests or property when the carriage is within the scope of, and incidental to, the business of the aircraft operator. Many companies use this structure because it offers a great deal of flexibility as well as the ability to charge other companies within a consolidated group of companies for their use of the aircraft.
Tax planning is another important step in the acquisition process. Comprehensive federal and state tax planning enables many owners to significantly minimize their tax exposure. Initially, a company would want to determine whether a like-kind exchange (LKE) is an option. Internal Revenue Code section 1031 permits an owner to exchange business or investment property solely for business or investment property of a like kind, such as an aircraft, and no gain or loss is recognized.
A company should also determine whether it might be able to depreciate the aircraft, and at what rate, depending on whether the aircraft will be primarily used for business purposes. An owner will also certainly want to minimize state and local taxes by taking delivery in a tax-friendly jurisdiction and to take advantage of all applicable state tax minimization options. These include taking delivery of the aircraft in a state that: (i) does not assess sales or use tax on aircraft sales or re-sales/leases, (ii) has a fly-away and/or a casual/occasional sales exception, (iii) has laws favoring owning and operating aircraft and (iv) limits property taxes on aircraft.
Aircraft Use Policy
Another important ownership planning tool, particularly for a public company, is an aircraft use policy. The primary purpose of a use policy is to establish a formal policy by which companies can control the use of the aircraft. The use policy is also an ideal way to avoid aircraft abuse and embarrassing public scrutiny, as well as shareholder criticism that typically follows such abuse of company aircraft. Aircraft use policies have become very prevalent after the passage of the Sarbanes-Oxley Act of 2002 (SOX)1, which requires companies to, among other things, establish internal audit procedures and certify business aircraft use perquisites granted to executives in annual reports and proxy statements. In enacting SOX, Congress wanted to increase transparency for shareholders and thereby eliminate corporate abuse.
As a result, an aircraft use policy is an ideal tool to increase transparency because it enables companies to develop a comprehensive policy regarding the use of the aircraft, which should eliminate any potential corporate abuses. An aircraft use policy should identify the authorized users of the company aircraft and whether the aircraft may be operated for executive personal or entertainment use. The use policy can also establish whether the aircraft may be employed for other unique uses, such as humanitarian relief missions or to support political candidates. The policy should also include the scheduling process, guidelines for limiting which key executives may fly together, and use priority based on the greatest need of the company.
Most policies contain guidance for personal use, including whether reimbursement is permitted, assuming a time-sharing arrangement has been established. Use policies should also make clear how much income should be imputed to passengers and the aggregate incremental cost of the transportation provided, assuming the value of the transportation must be reported to the SEC as a perquisite. A comprehensive policy should provide guidance for family members and guests accompanying employees on business flights, including how to appropriately value their presence on the aircraft from an IRS or SEC perspective.
Other items that may be included in aircraft use policies are international operations guidance, media relations in the event of an accident or incident, security procedures, and whether third-party charters may be used for additional air transportation. Finally, most aircraft use policies are reviewed and adopted by a company’s audit committee with significant input from key stakeholders within a company.
Companies have two basic options to operate their aircraft. They can either establish an in-house flight department or outsource all or some of the necessary flight department functions to a professional aircraft management company. Many advantages and disadvantages exist with each option. For example, some companies may want to avoid the costs and regulatory and administrative burdens associated with hiring pilots, mechanics and all the related support personnel, while others may prefer the control and flexibility associated with an in-house flight department. Alternatively, some companies may simply want a turnkey operation and outsource all the necessary operations and maintenance to a professional aircraft management company. Most aircraft management companies are also FAA-certificated air carriers that operate a fleet of aircraft for other aircraft owners. Some management companies can charter the aircraft to third-party charter customers, providing owners a modest revenue stream. The decision to use a management company or establish an internal flight department requires careful consideration. Indeed, it is not uncommon for companies to start with one option and after a few years switch to the other option.
Acquiring a business aircraft is complex and requires a significant amount of planning. This article provides a summary overview of the key considerations. Given the many variables associated with acquiring a business aircraft, it is wise to have a team of professionals assist with the process, as with any major capital expenditure.