Excerpt from Insights into Shipping 2012

Leasing, the use of an asset by one party in exchange for regular payment, is an ideal structure
for use in the shipping industry because of its high-value, long-life assets. Tax-based leasing
offers additional effciency by capitalising on the fexibility around country of incorporation and
fag. While tightening tax regulations and low interest rates may have dampened interest in tax-
based leasing, creatively structured leases are still an attractive option.
Tax-based Leasing
Additional Effciency and Flexibility
A lease is an agreement between two parties where the
owner of an asset allows the use of the asset in exchange
for regular payment from the user. This separates ownership
of an asset from its effective user. Fundamentally, leasing is
a capital effcient arrangement.
For example, a small company with a weak credit profle and
high cost of capital is in need of an asset. It enters into a
lease agreement with a large conglomerate that has easy
access to capital. Through the lease arrangement, the
conglomerate purchases the asset at its funding cost and
rents it out to the company. The small company now has
access to the asset on more favourable terms than if it had
purchased the asset on its own.
Besides fnancial arbitrage, leases can also be customised
to create other effciencies through operating, balance sheet
and ownership structures. While this article focuses on only
tax effciencies, there are other types of leasing structures in
the market to meet the needs of lessees and lessors.
Tax
Tax is an often overlooked area of finance. Tax laws
change constantly and are considered uncontrollable and
unpredictable. Yet, shareholder value is measured on an
after-tax basis.
Tax rules are a means by which fscal and economic policies
are transmitted. By either giving generous tax breaks or
imposing punitive tax treatment, governments incentivise or
disincentivise certain behaviours.
Governments typically want to encourage investment and
use tax depreciation or tax credits as an incentive for
companies to invest in capital expenditure. Tax depreciation
usually follows a schedule that accelerates the deduction,
thus allowing companies to gain a beneft of reduced tax
upfront. In some instances, there may even be double
depreciation, exemption of taxable income or tax credit in
order to promote specifc areas of investment. Within this
framework, tax structures can be crafted to align the
commercial activities of companies with the goals and
objectives of the government.
Tax lease
In a tax lease, effciency is created through the different tax
capacities of two parties, one of which may have more to
gain than the other for the same dollar of tax deduction. This
may be due to different tax jurisdictions, tax treatment or tax
proftability.
Through a tax lease, the owner of an asset uses its tax
capacity to take a tax depreciation to lower its tax expense
and passes on a share of the beneft to the user of the asset.
The user pays a lower lease rate refecting this incentive.
More often than not, this beneft reverses over time so the
real value created is the net present value of the temporary
timing difference.
In order to create a tax-effcient structure, it is necessary to
have a strong understanding of the relevant tax rules, which
are often long, complex and subject to regular change.
Because each company is unique and tax rules vary from
jurisdiction to jurisdiction, not every company will beneft from
the same structure.
Russell Beardmore, Regional Head, North-East Asia, Shipping Finance
Steve Hackett, Regional Head Americas, Asset Finance and Leasing
Jeremy Tan, Director, Structured Finance
Shipping assets are ideal for tax-based leasing for the
following reasons:
The value of the asset is large, which makes the fnancial
impact of the structure more meaningful.
The useful life of the asset is much longer than most tax
depreciation schedules.
Ships are international assets with a high degree of
fexibility around the country of incorporation and fag.
The shipping industry is an area of focus for most
governments and often enjoys special tax treatment.
Many European countries offer a tonnage tax regime in place
of the normal corporate tax as a means of boosting the
maritime sector. This scheme offers the beneft of paying a
low, pre-determined amount of tax but imposes the
obligation of tax payments even if the company makes an
operating loss. As tax rates under a tonnage regime are
low, shipping companies usually have little use for tax
depreciation. Instead, ships tend to be owned by banks,
fnancial institutions and building societies, which have lower
cost of funds and abundant tax capacity to utilise the tax
depreciation on such assets. The ships are then leased out
to the shipping companies.
Since the early 2000s, tax authorities have been amending
their tax rules to prevent abuse of the system where a lessor
is owner only in name and the lease is a disguised form of
extracting value from the state. In such situations, the tax
authorities aim to recognise the tax depreciation onto
the lessee rather than the lessor, thus eliminating the tax
beneft to the lessor. However, where a lease is a genuine
commercial transaction, tax authorities continue to allow the
lessor to take the tax depreciation.
Another aspect of tax-based leasing involves cross-border
leases, which are even more complex. Tax authorities are
constantly wary of transactions where tax depreciation is
taken in one jurisdiction but income is recognised in another
(if taxed at all). This leaves the former jurisdiction out of
pocket as there is no corresponding income to match the
tax depreciation. As such, tax authorities typically impose
rules around registration, location and management of assets
in a cross-border lease.
Given the large number of variables, it is diffcult to generalise
and describe a typical tax lease. However, this article
examines some of the major considerations of tax leases in
specifc jurisdictions.
UK tax lease
A UK tax lease involves a UK-based lessor buying an asset
and leasing it to a lessee (which today may be a non-UK
entity). The lessor, through its ability to utilise tax depreciation
under the UK tax system, derives a fnancial beneft that is
passed on in part to the lessee through reduced lease
payments paid by the lessee. Like most tax leases, the tax
beneft in a UK tax lease arises from the deferral, rather than
complete avoidance, of taxes.
Tax advantaged leasing has been a feature of the UK
fnancing market for many years and the most active lessors
were typically fnance company subsidiaries of major banks
and other fnancial institutions. Originally, there was no
distinction between leases of equipment to UK entities or
foreigners but over the past 30 years, the ability of UK lessors
to claim tax depreciation (known as capital allowances in
the UK) and the generosity of the capital allowance regime
have been progressively restricted. These restrictions include
reduction of frst-year allowances, reduction of the rate of
capital allowances on leases of most types of equipment
where the lessee is a non-resident, and restriction on the
ability of lessors to claim capital allowances where the
transaction is defeased or where the asset is provided to a
lessee under a fnance lease.
The UK started its tonnage tax scheme in 2000. For several
years whilst the UK tax system was in transition, there were
benefts for ship operators to establish tonnage tax
companies and enter into UK leases as lessees. However,
these transitionary rules have now expired and ship leasing
in general currently enjoys no preferential treatment
compared to other asset categories.
Prior to 2006, the UK tax lease was an attractive fnancing
structure for shipowners to consider. Although the structure
typically required the lessee to establish a permanent
establishment in the UK to act as lessee and manager of
the leased asset, the combination of the fnancial benefts
delivered by the UK tax lease and the favourable UK tonnage
tax regime tended to justify this investment. A signifcant
number of foreign shipowners entered into UK tax leases in
the period 1998 to 2005.
In 2006, the UK introduced the concept of a long funding
lease to restrict the ability of lessors from claiming capital
allowances for leases of more than fve years, even if the
lease is classifed as an operating lease for accounting
purposes demonstrating a view that the accounting rules
are not strict enough in differentiating fnance from operating
leases. The changes, however, lifted restrictions on overseas
lessees, which opened up a new set of opportunities for UK
tax leases.
French tax lease
The two most common French tax lease structures are the
Article 39C structure and the single investor tax lease
structure. The Article 39C structure replaced the former
Article 39CA structure (which required tax authority approval)
after the European Commission ruled that the approval
mechanism constituted unlawful state aid.
Under the Article 39C structure, a French tax transparent
partnership (such as groupement dintrt conomique (GIE)
or socit en nom collectif (SNC)) is allowed to transfer losses
created by accelerated tax depreciation to other members
of the partnership. The asset must be located, operated or
registered in France or a European Economic Area country
that has a double tax treaty with France. In one variant of this
structure, the French structure was combined with the
Singapore tax treatment of its Approved International
Shipping Enterprise scheme, creating a unique cross-tax
border solution linking Europe to Asia.
The single investor tax lease structure provides similar
benefts as the Article 39C structure but operates under the
French tax consolidation regime. The tax beneft arising from
accelerated tax depreciation can be used to offset taxable
profts of other members of the tax group and the tax deferral
beneft is shared with the lessee through reduced lease
payments. Compared with the Article 39C structure, there
are fewer restrictions on the tax loss transfers under the
single investor tax lease structure.
French tax leases have been widely used in recent years with
the overall fscal advantage to lessees reaching as high as
20% of vessel value. Additionally, most transactions have
been afforded the beneft of an advance tax ruling as well as
a tonnage tax treatment. Given that transactions are mostly
concluded with fnancial institutions as lessors, the availability
of tax capacity has shrunk considerably since the 2008
fnancial crisis. The underlying product nevertheless remains
robust and some French banks continue to offer the product
to select strategic clients.
German tax lease
Germany has a tax pass-through entity through the German
Kommanditgesellschaft model (German KG). Due to high
personal tax rates, high-income individuals often invest in
KG structures as limited partners to obtain pass-through
deductions from the KG entity. This ready source of fnancing
is one explanation for the popularity of the German tax leases
in the late 1990s and early 2000s. Besides gaining on the
timing difference of taxable income, KG structures in shipping
also beneft from the preferential tax rates of the German
tonnage system.
Since 2005, German tax authorities and legislators have
restricted the KG structure by only allowing tax losses to be
offset against income generated from the same source.
Restrictions on liquidity in the global banking markets in
recent years have also severely limited the volume of
transactions placed through the German KG market. These
meant that the KG model has become less effcient and less
attractive to private investors but the model is still useful as
a tax vehicle for other tax transparent transactions.
US tax lease
In the US, the Inland Revenue Service (IRS) identifes two
categories of leases: True Tax Lease and Non-Tax Lease
(akin to operating lease and fnance lease respectively). The
8BCIQ;K>
5I?K;MCGA @??
6;QF?GM
8BCI F;G;A?F?GM =HFI;GQ
32 +4?LLHK,
.;K?<H;M HK
MCF? =B;KM?K
/B;KM?K BCK?
:?LL?E
7?I;QF?GM
5I?K;MCGA ;AK??F?GM
/B;KM?K?K
+4?LL??,
.;GD
2?G?K;E-
4CFCM?> I;KMG?K
1JNCMQ
0?<M
0COC>?G>-9;P EHLL
Figure 1: Basic KG structure
IRS applies its own set of rules to make the determination.
The objective is to ensure that the party that takes the tax
depreciation has a substantial stake in the asset in terms of
its cost, time of possession and residual value risk.
The US tax leasing market was extensively used by foreign
lessees in the period 19902003 to fnance large value
assets. The major lessors were large US commercial banks
and fnancial institutions. US cross-border leasing structures
tend to be complex and expensive to implement and the
underlying tax legislation was subject to frequent change. As
such, the types of leases and their applicability to specifc
asset types evolved several times. The US cross-border
leasing market declined following the introduction of
restrictions on the ability of lessors to claim tax depreciation
allowances where a lease transaction was defeased. Tax
benefts were also signifcantly reduced for transactions
involving anything other than US tax payers as lessees.
Notwithstanding the scale of the US leasing market, shipping
transactions involving the US lease market are rare because
of onerous maritime laws that put US-fagged vessels
(Jones Act vessels) at an economic disadvantage against
other countries that lack such requirements. As a result, it is
rare to fnd US tax leases in the shipping industry globally.
Japan tax lease
The Japanese Operating Lease (JOL) structure replaced the
Japanese Leveraged Lease (JLL) structure when the tax
rules were changed in 1999. JLLs were popular cross-border
leasing structures in the early 1990s as a form of re-exporting
currency generated by Japans trade surplus.
Under the JOL structure, a Japanese investor invests
through a tokumei kumiai (TK) structure, which acts as the
lessor. The equity investors in these structures are highly
proftable companies looking for transactions that generate
tax depreciation to offset their profts.
New regulations introduced after 1 April 2005 require the
investor to be active in order to enjoy the full benefts of the
tax losses generated by the structure. Passive investors
would have their tax losses capped. This meant that the JOL
investor needs to demonstrate the ability to make important
commercial decisions regarding the TKs operations. As a
result, the number of Japanese investors in JOL structures
sharply decreased and this narrowed the JOL market to
lessees that are better known to investors.
In 2010, the JOL market is estimated to have provided
USD1.85 billion of capital. Although the overall market has
been shrinking, demand for JOL from investors remains
strong and is expected to recover despite pullback from JOL
arrangers. Shipping assets share of the market has been
increasing, showing a sharp recovery from the industry
downturn of 2008.
Luxembourg tax lease
There has been increasing activity in the Luxembourg market
in recent years whereby shipping companies have
established legal entities in the financial centre of
Luxembourg to take advantage of Luxembourgs investment
tax credits. The tax credits are transferable and may be used
to create savings against a companys tax liability. The
savings may be used and shared with lessees by way of
reduced rental payments.
Luxembourg also has a range of friendly treaties with other
jurisdictions, which gives rise to additional fscal advantages.
This makes the jurisdiction an attractive location for fnancing
of vessels.
Source: Yano Research Institute, JOL (Japanese Operating Lease) Market: Key Research Findings 2010, 11 January 2011
.,,1 .,,2 .,,3 .,,4 .,-, .,,1 .,,2 .,,3 .,,4 .,-,
0,
-,,
-0,
.,,
:
N
G
?
A
K
I
B
8
;
9
D
H
O
A
L
M
G
A
H
M
J
K
I
E
A
@
M
L
5DK@K>BM
<CDJL
/+,,,
.+,,,
-+,,,
,
8
;
9
G
>
K
F
A
M
L
D
Q
A
D
H
=
<
7
G
,
8
;
9
G
>
K
F
A
M
L
D
Q
A
?
P
>
L
L
A
M
M
P
J
A
6IHM>DHAKL
/+,,,
.+,,,
-+,,,
,
Figure 2: Japanese operating lease market
Spanish tax lease
As an example of the changes taking place, most recently
on 21 September 2011, the European Commission invited
comments on the Spanish tax lease system, which has been
the subject of complaints since 2006, alleging that the
system allows Spanish shipyards to sell ships at prices 20
30% cheaper than other European shipyards.
The tax transparent vehicle in question is an agrupacin de
inters econmico (AIE), which is set up by a bank whose
investors are proftable Spanish taxpayers.
Through a combination of tax measures such as tax
depreciation during construction of a ship, a tonnage tax
regime and certain exemptions on capital gains, AIE investors
are able to reduce their tax base without carrying out any
shipping activities because all features of the structure are
fxed and passed on in advance. Like the French Article
39CA structure, the European Commission has ruled that the
Spanish tax system is unlawful and may seek to recover
illegal aid from recipients. However, the product remains
available and is promoted selectively by the few remaining
proftable Spanish fnancial institutions.
Conclusion
Besides a tightening of tax regulations, other factors have
also caused a decrease in the attraction of tax leasing. A low
interest rate environment (which lowers the net present
value effect), reduction of corporate tax rate, lower capital
allowance rate and decreased proftability of lessors have
weakened the tax impact of tax depreciation, which in turn
decreases the benefts that can be passed on to the lessees.
Yet, there is an increasing trend of banks offering leasing
rather than lending. For example, this is useful in situations
where a mortgage is ineffective. Under a lease, the bank may
choose to be the legal owner of the asset rather than a
mortgagee. There are also other opportunities to customise
a lease to meet the needs of the lessee. Banks are rapidly
developing their internal capabilities to become genuine
asset operators in order to combat the threat of leasing as
an alternative to traditional forms of fnancing. This implies
that banks need to take on more responsibility for the risks
in owning real assets, developing capabilities such as
remarketing and residual value risk management, thus
creating new opportunities in the tax leasing business.
The concepts of leasing are simple but the art lies in the skill
and creativity of the structurer. By working within the tax,
accounting and legal frameworks, structured leasing is akin
to modern day alchemy creating value from basic
economic elements.
.6E:7B6G 8BAGE68G
3HG 6A9 86?? BCG>BA
0A>G>6? F=>C7H>?9>A<
8BAGE68G +A:G CE>8:,
4=>CBJA:E
4=>CK6E9
1:6F>A< 8B@C6AK
1:6F>A<
8BAGE68G
/DH>GK
5E6AF;:E
B; ?BFF:F
2BI6G:9 F=>C7H>?9>A<
8BAGE68G +<EBFF CE>8:,
0AI:FGBEF
-0/
Source: Offcial Journal of European Union C 276/5, 21 September 2011
Figure 3: Spanish tax structure
S
e
p

2
0
1
2
Russell Beardmore
Russell Beardmore joined Standard Chartered in August 2008 and is responsible for the banks shipping fnance activities in
the North East Asia region. Previously, he was based in Dubai where he covered the banks shipping fnance activities in the
Middle East. Mr Beardmore has developed a wealth of knowledge in asset fnancing, leasing transactions and infrastructure
fnancing, involving a wide range of asset classes, typically structured as cross-border transactions. He has worked in a number
of international banks including Barclays Capital, Citibank and Macquarie Bank, in the latter of which he established the banks
business in the Middle East. He holds a Law degree from the University of Birmingham, UK, and is a chartered accountant and
chartered secretary.
Steve Hackett
Steve Hackett is based in New York and joined Standard Chartered in 2011. He is responsible for all Structured Finance activities
in the Americas covering shipping fnance, aircraft leasing and tax-based transactions as well as the development of the banks
global Asset Finance and Leasing platform. Prior to joining Standard Chartered, Mr Hackett was Head of Structured Asset
Finance, Europe, for the Royal Bank of Scotland based in London with responsibility for the growth and management of the
banks pan-European activities. Mr Hackett has more than 20 years of experience in the big-ticket, cross-border leasing industry
and previously held senior positions with UBS and Dresdner Kleinwort Benson. He has concluded transactions across all
industry sectors. He holds a diploma in Financial Studies and is NYSE Series 7 registered.
Jeremy Tan
Jeremy Tan is responsible for product development within the Structured Finance team and in particular for the Asset Finance
and Leasing business. As part of its build-out of a full asset fnance capability, the team covers a wide range of assets in the
transportation and infrastructure sectors by offering solutions ranging from traditional debt fnance to customised lease solutions.
Prior to joining the Structured Finance team, Mr Tan worked in a variety of roles within Standard Chartered, Citibank and PwC.
An accountant by training, he obtained his MBA from Harvard Business School, US.
This communication is issued by SC Group. While all reasonable care has been taken in preparing this communication, no responsibility or liability is accepted for any errors of fact, omission
or for any opinion expressed herein. You are advised to exercise your own independent judgment (with the advice of your professional advisers as necessary) with respect to the risks and
consequences of any matter contained herein. SC Group expressly disclaims any liability and responsibility for any losses arising from any uses to which this communication is put and for
any errors or omissions in this communication. SC Group means Standard Chartered Bank and each of its holding companies, subsidiaries, related corporations, affliates, representative
and branch offces in any jurisdiction.