NAFA Administrator posted an articleOperational Control And Aircraft Leasing: What’s The Big Deal? see more
NAFA member, Greg Reigel, Partner at Shackelford, Bowen, McKinley & Norton, LLP., discusses operational control and aircraft leasing.
From the FAA’s perspective, operational control in aircraft leasing transactions is not just a “big deal”, it is “the” deal.
What Is Operational Control?
14 C.F.R §1.1 defines operational control as “the exercise of authority over initiating, conducting or terminating a flight.” In a “wet” lease situation, since the lessor is providing both aircraft and crew, the lessor maintains operational control of all flights. And in the absence of a specific exemption (such as under 14 C.F.R. § 91.501(c) the lessor who is operating an aircraft under a wet lease will need to have an air carrier certificate to legally operate the aircraft.
In a “dry” lease situation, the lessee provides its own flight crew, and the lessee exercises operational control over its flights. The lessee’s operations may be conducted legally under 14 C.F.R. Part 91 without an air carrier certificate.
It is important to keep in mind that the FAA will look beyond the actual written agreements to determine who has operational control. Although a lease may be written as a dry lease and says “Dry Lease” at the top of the agreement, for example, that does not mean the FAA cannot take the position that the arrangement is really being conducted as a wet lease. And if the FAA takes that position when the lessor who is actually operating the aircraft for the lessee does not have an air carrier certificate, then that will be a problem for the lessor, and potentially for the lessee as well.
Why Does It Matter?
If the lessor is exercising operational control, then the flight must be conducted in compliance with regulations that are stricter than Part 91 (i.e. Parts 121 or 135). Those regulations limit the types of airports the lessor may utilize, crew qualifications, crew rest and duty times, maintenance requirements etc. Additionally, the lessor under a wet lease arrangement is required to remit federal excise tax on the amount charged to the lessee.
Alternatively, if the lessee has operational control under a dry lease the lessee is permitted to operate under the less restrictive and less costly requirements of Part 91. And federal excise tax is not due on the amounts paid by the lessee to the lessor, although sales tax is often assessed on the lease rate.
How Do You Determine Who Has Operational Control?
The FAA has issued guidance for determining which party has operational control in a leasing arrangement. Advisory Circular 91.37B Truth in Leasing provides FAA inspectors with an explanation of leasing structures and how they may or may not be compliant with the regulations. Although AC 91.37B only applies to aircraft subject to the requirements of 14 C.F.R. § 91.23, and it is not regulatory in nature, FAA inspectors also use this guidance when reviewing leasing structures that are not subject to truth-in-leasing requirements.
Here are the types of questions an FAA inspector will ask when the inspector is trying to determine which party has operational control in an aircraft leasing situation:
- Who decides crewmember and aircraft assignments?
- Who accept flight requests?
- Who actually initiates, conducts, and terminates flights?
- Are the pilots direct employees or agents for the lessor, the lessee, or someone else?
- Who is responsible for aircraft maintenance and where is that maintenance performed?
- Who decides when/where maintenance is accomplished, and who pays the maintenance provider for that service?
- Prior to departure, who ensures the flight, aircraft, and crew comply with regulations?
- Who determines weather/fuel requirements, and who pays for the fuel at the pump?
- Who directly pays for the airport fees, parking/hangar costs, food service, and/or rental cars?
If properly drafted, an aircraft dry lease agreement should answer these questions and, to the extent the answer for any item is “the lessor”, then the lease should explain that answer and how it does not negate lessee’s exercise of operational control.
For example, if the aircraft is leased to more than one lessee, it may make more sense for the lessor to retain responsibility for maintenance to ensure that the aircraft is consistently maintained in an airworthy condition. Similarly, lessor maintaining an insurance policy insuring the aircraft and the various lessees may be necessary to make certain the aircraft is insured appropriately.
However, responsibility for maintenance or insurance are just two indicia of operational control. And the lessor’s responsibility for maintenance or insurance does not negate the lessee’s responsibility for ensuring that the aircraft is in an airworthy condition and the lessee’s is properly insured prior to any operations conducted under a lease. Appropriate language in the lease can explain these issues so an FAA inspector reviewing the lease does not misunderstand and draw the wrong conclusion.
Also be aware that some FAA inspectors rely upon AC 91.37B but do not fully or properly understand its guidance. For example, in one instance AC 91.37B states “[t]he FAA has taken the position that if a person leases an aircraft to another and also provides the flightcrew, fuel, and maintenance, the lessor of the aircraft is the operator.”
This language is sometimes misunderstood by inspectors to mean that a lessee does not have operational control when the lessor is responsible for maintenance. But that is incorrect.
The key indicia in the language above is lessor’s providing the flightcrew. However, lessor’s responsibility for maintenance by itself does not indicate that lessor is improperly exercising operational control over lessee flights. Although it may indicate that lessor is exercising some operational control, without other indicia of operational control by the lessor, performance of maintenance alone is not conclusive.
Operational control in aircraft leasing arrangements is, and will continue to be, an area of special emphasis for the FAA. Although the terms of the lease and other transaction documents are important, the FAA is not bound by those terms when it is making an operational control determination. Rather, it will also look at the actual arrangements between the parties, as well as the responsibilities of each party, especially if they are inconsistent with the lease.
When the FAA determines that lessor is exercising operational control in what is supposed to be a Part 91 dry leasing transaction, you can expect that it will act. Depending upon the circumstances, pilots and operators could be faced with certificate action and civil penalty action. It is important to understand the indicia of operational control and to be able to determine which party is exercising operational control in an aircraft leasing transaction. Only then will you be able to ensure that you are operating in compliance with the regulations.
This article was originally published by Shackelford, Bowen, McKinley & Norton, LLP., on Feburary 5, 2021.
Tracey Cheek posted an articleTaxing Leases - When the FAA and IRS do not agree see more
NAFA member, Nel Stubbs, Vice President of Conklin & de Decker, writes about when the FAA and IRS do not agree about taxing leases.
The recent spotlight on illegal charter and who has operational control of an aircraft is generating new interest in leases: not finance leases, but “wet” and “dry” aircraft operating leases.
The FAA defines a “wet” lease as “any leasing arrangement whereby a person agrees to provide an entire aircraft and at least one crewmember.” Leasing an aircraft without the crew normally is a “dry” lease, and the lessee has operational control of the aircraft. With a “wet” lease, the lessor retains operational control.
The IRS imposes the commercial Federal Excise Tax (FET) on wet leases, and the noncommercial Federal fuel tax on dry leases. But the distinction is not simple. While passing the test for FAR Part 91 (owner use only), a wet lease operation might be considered a commercial activity (Part 135) for FET purposes.
The most common non-financial leasing arrangements and their tax ramifications are:
CHARTER – Conducted under FAR Part 135, the operator must hold a commercial operating certificate. Charter is always considered a wet lease, as the aircraft is provided with crew. “Commercial” for both FAA and IRS purposes, the FET is due, less catering, flight phones, ground transportation, etc., listed separately on the invoice. A credit or refund is allowed for tax paid on the fuel for that flight.
TIMESHARING – FAR Part 91.501 permits timesharing, a form of wet lease, which allows the owner to provide the aircraft and crew to a lessee, and charge up to twice the direct operating costs for any flights. The IRS considers this a commercial activity, and the FET is due on the amounts paid and a credit or refund is allowed for the tax paid on the fuel consumed during the trip(s).
INTERCHANGE – When “… a person leases his airplane to another person in exchange for equal time, when needed, on the other person’s airplane and no charge, assessment or fee is made, except that a charge may be made not to exceed the difference between the cost of owning, operating and maintaining the two airplanes,” it also is a wet lease, as the aircraft and crew of one company is exchanged for another’s aircraft and crew. So for FET purposes, it’s a commercial operation, and tax is due on the fair market value of any difference between the operating costs of the two aircraft. Again, a credit or refund is allowed for the tax paid on fuel. Two fair market values must be considered: the IRS’ and yours.
A “True” Dry Lease offers the aircraft without crew. Typically, the lessee hires the crew and has operational control of the aircraft. The lease is considered noncommercial, and neither lessee nor lessor are required to hold an FAA-issued charter operator’s certificate, as long as the lessee does not carry persons or property for compensation or hire. The IRS and FAA agree that no FET is due on dry lease payments.
A “Sham” Dry Lease (or “Damp” Lease) may be a purposeful attempt to confuse the issue of who has control of the aircraft. Typically, the lessor provides the aircraft under a dry lease and also provides the crew under a separate agreement. Or, the lessor leases the aircraft, but you as lessee must get your crew from the lessor or a lessor-specified source. In each case, the aircraft and the crew are too closely connected, and the FAA may determine that the lessor should hold a commercial operating certificate. The IRS likely would consider the lessor to have “possession, command and control,” and the lessee would owe FET on the lease and pilot service payments.
It’s in everyone’s best interest to understand what type of lease arrangement you are entering. Don’t be caught unaware by either the FAA or the IRS.
The original article was published in Business Aviation Advisor on August 31, 2018.