Certain legal development in China may have an impact on aircraft financing transactions:
- The Circular on Full Implementation of Pilot Program of Replacing Business Tax with Value-Added Tax (in Chinese: «») which is published by the Ministry of Finance and the State Administration of Tax on 23 March 2016 (Cai Shui  No. 36, "Circular 36"). Business taxes levied in all industries shall be replaced with value-added tax ("VAT") on a nationwide basis from 1 May 2016, pursuant to Circular 36.
- The Notice on the Nationwide Implementation of Full-blown Macro Prudential Administration of Cross Border Financing (in Chinese:«») published by the People's Bank of China (central bank of China, "PBOC") on 29 April 2016 (the "PBOC Notice"). The PBOC Notice, effective from 3 May 2016, further expands the new macro prudential administrative regime on inbound financing on a nationwide basis (the "New Regime"). Such macro administrative regime repealed the requirement that inbound financing by Chinese entities from overseas lender should be subject to prior approval of the State Administration of Foreign Exchange ("SAFE") or the PBOC.
Circular 36 - Replacing business tax with VAT in all industries nationwide
In 2013, business tax (at the rate of 5%) in the leasing industry was replaced with VAT (at the rate of 17%) on a trial basis (the "Trial Program") in China. Circular 36 further expands the Trial Program to all industries on a nationwide basis. Before Circular 36, loan service incomes shall be subject to the business tax at the rate of 5%. After Circular 36, such loan service incomes are now subject to VAT at the rate of 6%. The standard rate applicable to leasing industry is 17% under Circular 36. However, Circular 36 also provides that the VAT rate applicable to sale and lease back finance lease is 6%, as opposed to 17%. The reason is that the PRC tax authority categorizes sale and lease back finance lease as akin to a type of loan service.
For lease agreements signed before the Trial Program (the "Old Contracts"), there is a change in the applicable tax treatment. Before Circular 36, the Old Contracts were subject to business tax at 5%. After Circular 36, the Old Contracts will be subject to VAT of 17% or a simple calculation rate of 3% (which is only applicable to selected types of services by the PRC tax authority as set out under Circular 36), at the choice of lessor.
Impact on aircraft financing transactions in China
Since all taxes are generally grossed up by borrowers in loan transactions, the increase of VAT for loan services may levy a heavier payment obligation on Chinese borrowers. Although lenders may issue VAT invoices, Circular 36 does not clearly specify whether these invoices can be applied to offset other VATs payable by the borrowers, and this is yet to be tested.
Before Circular 36, the replacement of business tax to be VAT has no impact on the Old Contracts. However, after the Circular 36, it appears that business tax will not apply to the Old Contracts either, and lessor may choose VAT to be 17% or 3%. However, since Circular 36 has just come into effect, whether or not, or how lessor may apply for such 3% of VAT is yet to be tested, as a matter of practice.
PBOC Notice - PBOC expanding inbound financing regime prevailing in FTZs to nationwide
The macro prudential administrative regime was first introduced and implemented in the Shanghai Free Trade Zone in 2015, and thereafter implemented in four free trade zones in China earlier this year. PBOC Notice has expanded the macro prudential administrative regime on a nationwide basis.
The key change of the New Regime is that, subject to compliance with the requirements set forth in the PBOC Notice, the 27 banks listed in the schedule to the PBOC Notice, other financial institutions regulated by the relevant regulators in China and the enterprises established in China (whether they are PRC domestic enterprises or foreign invested enterprises ("FIE")) (each, an "Onshore Borrower") may obtain inbound financing from offshore lenders, without any prior approval from PBOC or the State Administration of Foreign Exchange ("SAFE").
The borrowing capacity of Onshore Borrower shall be calculated according to a formula prescribed by PBOC, to the effect that an Onshore Borrower may obtain inbound financing provided that the "Outstanding" may not exceed the "Ceiling". Outstanding means, in respect of an Onshore Borrower, the sum of the amount borrowed and drawn but not yet repaid under each of its inbound financings (with risks pertaining to the tenor, type and exchange rate of each such inbound financing taken into account); and Ceiling means the maximum amount of Outstanding permitted under the Notice. PBOC may adjust the relevant multipliers and calculation methods from time to time, either generally or with respect to particular enterprise or industry.
While the Notice applies to most enterprises in China, it leaves some flexibility for FIEs and foreign invested financial institutions, so that they may elect to continue to follow the rules applicable to the existing foreign debt regime by relying on the borrowing gap available (in the case of a FIE borrower) in calculating the amount of foreign debt that they may incur or the New Regime. The election should be filed with PBOC and SAFE which, in principle, may not be changed unless approved by PBOC and SAFE. The Notice does not prescribe the exact timeframe for such election, and we believe that this could be dealt with in the implementing rules that are yet to be issued by SAFE.
An Onshore Borrower should file its inbound financing with SAFE capital account information system (in Chinese: ????????) no later than 3 business days before the drawdown. Under the current regime, the borrower is required to register the loan agreement with SAFE within 15 business days after the date of the loan agreement.
Impact on aircraft financing transactions in China
The impact of the PBOC Notice on the aviation financing is yet to be tested as a matter of practice. For onshore borrowers that are special purpose vehicles set up by leasing companies, their cross-border loans were used to be approved by and/or recorded with the National Development and Reform Commission ("NDRC"). The PBOC Notice is silent on how such inbound loans shall be dealt with after the PBOC Notice. For onshore leasing companies that are FIEs, the current regime instead of the New Regime may apply, but the PBOC Notice does not explicitly exclude the application of the New Regime either. These issues remain to be clarified.
Allen Ng is a partner in Baker & McKenzie's Aircraft Leasing & Finance team based in Hong Kong. Grace Li is a senior associate in Baker & McKenzie's Aircraft Leasing & Finance team based in Shanghai.
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