Tax Minimisation Options for High Flyers

Pilots and other airline crew have a distinct advantage over more "grounded" people. I am not referring here to the possibility to see the corners of the world but to the possibility to cut their taxes.

Airline crew can in some cases minimise or eliminate taxation on their employment income due to two factors: 1. That they are often more so in a position to choose the country of their residence due to their international mobility than most others working at a fixed location; and 2. That remuneration derived in respect of work carried out aboard an aircraft is under most tax treaties treated differently than regular employment income.

Factors that are relevant in determining the tax treatment of employment income of airline crew are dependent on the following six factors:

1. The country of residence of the employee (R);
2. The country of residence of the enterprise from which his employment income is derived (E);
3. The countries where the work is performed (W);
4. Whether tax treaties exist between W’s and E;
5. Whether a tax treaty exists between R and E;
6. Whether a tax treaty exists between R and W.

The applicable tax treaties will determine how the taxing rights are allocated.

Article 15.3 of the OECD model treaty deals with the allocation of taxing rights on remuneration derived in respect of an employment exercised aboard a ship or aircraft operated in international traffic.

The rationale for having a rule that differs from the treatment of regular employment income (as per model articles 15.1 and 15.2) is that it would pose practical difficulties to determine the places where the employment is exercised when an employee works on an aircraft or ship travelling through several states (‘the work states’).

Although few states effectively attempt to tax employment income derived by airline crew traversing their territories, work state taxation becomes more of an issue when take offs and landings take place in the country. Article 15.3 overcomes this difficulty by allocating the taxation right on the employee’s salary to the state where the actual management of the enterprise is located. So, if the model article has been adopted in the treaty between W and E then E is assigned the taxing rights; if E and R have a treaty with the same clause then R has to give relief. Factors 4 and 5 but not 6 are relevant in this case.

Some OECD countries have adopted a different rule in their model tax treaties. For instance the Netherlands and the US allocate the taxing rights to the country of residence of the employee (R) in their model treaties. If W and E as well as W and R have a treaty that allocates taxing rights to R then R will tax. In this case factor 5 does not come into the picture.

In case the treaties between the involved countries do not include the same article or there is no treaty then double taxation can arise. On the other hand, a mismatch can also result in double non taxation. For instance this would be the case if an employee lives in country R, which does not tax foreign source income, and works in country W that assigns taxing rights to the country where the enterprise for which he works is effectively managed (E), but country E does not tax the employment income anyway because the employee is not a resident of E. This would for instance apply if W = Germany, E = Cyprus and R is Malta or the UK (provided the individual is not domiciled there) or the UAE where there is no taxation - period.

An important area that is subject to diverging interpretation is the question as to which enterprise is in fact referred to in article 15.3. Can the enterprise be any enterprise carried out on an aircraft or ship or must it be the enterprise that conducts the business of operating the ship or aircraft? If the first applies then for instance a casino operator on board of a ship would be covered by article 15.3 but if not then he would fall under article 15.1 and 15.2 on the grounds that the business is different. The same question arises when an airline crew member is employed by a company that seconds him to work on an aircraft. In this case his employer is not carrying out the business of operating an aircraft. Is the place of effective management of his employer relevant or of the enterprise that operates the aircraft (the airline company)?

A reading of the OECD Commentary to article 15 (paragraph 9) seem to imply that the expression “enterprise” does not necessarily focus on the enterprise of operating the ships or aircraft. This is so because it suggest that contracting states can include a provision should they wish to do so. For instance the tax treaty between Belgium and the Netherlands specifies that “enterprise” means the “enterprise which operates that ship, boat or aircraft”. Absent such a specific provision it could, however, still be argued as follows that the relevant enterprise is the enterprise operating the aircraft:

• The fact that the term “enterprise” and not “employer” is used means that article 15.3 does not necessarily point to the employer.
• In the commentary to article 15.3 a connection is made with article 8 of the model treaty (which governs the taxation of profits derived from shipping and air transport). In that article it is made clear that the term “enterprise” refers to the company operating the ship or aircraft. The term “enterprise” in article 15.3 should therefore be given the same meaning.
• The assumed aim of the article 15.3 is mainly to avoid problems that could arise in determining where the relevant activities are ultimately performed and to prevent the resultant fragmentation of the right to tax. The right to tax salary by the state of the enterprise should be regarded as compensation for the fact that salary expenses reduce the profit it can tax under article 8. Taxing the enterprise in one jurisdiction on its profits but taxing the salary income in another jurisdiction would be counter to this objective.

The latter interpretation is in any case the view of the German Federal Tax Court (decision 10/11/1993, BStBl. II 1994, p 218).

However case law in most countries in this matter is still largely absent and therefore depending on the countries involved the former position can still be taken. In this case there are clearly more opportunities for tax minimisation. For instance an employment company can be established in for instance Cyprus (as in the earlier example) or in the UAE which then seconds the staff to airlines.

It will depend on the specific circumstances of the airline crew member as to what it is possible. Given that an airline crew member often has more flexibility then a home bound person to choose his country of residency this opens significant planning possibilities in those cases where either the relevant tax treaties determine that the country of residence of the employee is the determining factor as well as in those cases where the location of effective management of the enterprise is determining and the enterprise does not necessarily refer to the enterprise operating the aircraft.

If a crew member cannot shift his residence to a country where foreign source income is not taxed then planning can only be done if the second option is feasible.

www.freemontgroup.com