Spain’s ship finance market: special rules on finance leases
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Despite the international market’s uncertainty and volatility, the ship finance market in Spain is still experiencing rapid and steady growth. This is largely due to growing interest in the field from banks that have been traditionally wary of the sector. These banks, which often restricted their participation in ship finance transactions to the issuance of guarantees ancillary to the more substantive and central transaction, are now taking a more active role in said transactions.
Most ship finance deals in Spain are structured in accordance with the general rules in finance leases that are applicable to all types of assets in Spain and which are contained in the Spanish Corporate Income Tax (CIT) Law.
The CIT Law contains a specific tax regime for financial leasing agreements that incorporates a purchase option in favour of the lessee exercisable at the end of the lease period. If the lessee can meet several conditions required by Spanish law, it will enjoy a special tax regime in relation to the tax depreciation of the asset. Subsequently, in every tax period, the lessee will be entitled to deduct from its taxable income the following expenses:
(i) The part of the lease instalment that corresponds to the annual interest or financial expense for the lessee, which in effect amounts to the financial income (interest) for the lessor.
(ii) The part of the lease instalment that refers to the repayment of the acquisition price paid for the vessel by the lessor or leasing company. The CIT limits the tax deductibility of this amount: it cannot exceed the annual tax depreciation of the asset calculated at twice the maximum straight line depreciation rate established by the CIT regulations for such asset. However, if the lessee qualifies as a small or medium size entity for CIT purposes, the limit may be increased.
As a result of the above, the lessee will lease the vessel from the leasing company in order to subsequently acquire the vessel from the leasing company upon the exercise of the purchase option at the end of the finance lease agreement. The special regime for leasing agreements may result in a deferral of the CIT liability of the lessee.
Currently, there seems to be a trend in Spanish ship finance to use the format of operating leases which have recently been successfully implemented in the Spanish air sector. These schemes may have the advantage of enabling the operating lessee to maintain a higher degree of flexibility over the asset as well as to reduce the average cost of capital.
Under an operating lease scheme the head lessor (the lease company) enters into a financial lease with a lessee. In turn, the lessee (in its capacity as operating lessor) executes a bareboat charter with a ship owner (operating lease). The use of the finance lease agreement by the operating lessor enables it to benefit from the accelerated tax depreciation of the asset leading to a deferral of its CIT liability. Under certain circumstances, the operating lessor may transfer some of that financial benefit to the operating lessee by way of lower rental payments under the bareboat charter or as a reduced exercise price of the purchase option, if any, that may be held by the operating lessee (end-user shipowner).
Spanish GAAP, which has been recently amended to follow IAS guidelines (IAS no. 17 Accounting of Lease Agreement / Standards Interpretations Committee rule no. 27), establishes that for a lease to be deemed as financial or operative, the analysis must be focused on the economic grounds of the corresponding agreement and not its legal nature. Therefore, classification of a lease as financial or operative depends on the substance of the transaction rather than the form. Spanish GAAP defines a lease as a financial lease if it substantially transfers to the lessee all the risks and rewards incident to ownership. All other leases are classified as operating leases. Under operating leases, during the term of the contract only the lessee will be obliged to recognise an operating expense for the rental payments made under the lease contract. Upon the exercise of the purchase option, if any, the company will register the acquired asset for its purchase value, which will be the exercise price of the option.
Carlos López-Quiroga and Miguel Gordillo, Uría Menéndez