David Stewart 0:01

Welcome to the podcast. I'm David Stewart , editor in chief of Tax Notes Today International. This week: taxing the friendly skies. With the holiday season upon us, millions of travelers will be flying home to see family and friends. So what better time is there to talk about the debate over the taxation of air travel and its implications for the environment and questions of inequality? Here to talk to us about aviation taxes worldwide is Jeremy Cape , a tax policy partner with Squire Patton Boggs in London. Jeremy, welcome back to the podcast.

Jeremy Cape 0:33

It's great to be back in Washington D.C.

David Stewart 0:35

Now I understand that several countries, including the U. K., have enacted aviation taxes. Can you tell me about how these taxes work?

Jeremy Cape 0:43

So aviation taxes in the U.K. were introduced back in the 1990s by the conservative government. It's charged on all passengers who are leaving U.K. airports. And the U. K. was a fairly early adopter in relation to this and initially it was only charged at £5 for flights departing a U.K. airport for another U.K. or an EU or EEA airport and £10 for flights heading outside the EEA, so a very simple tax. But as is often the case, the tax became more complex over time. So you can see why you would want to tax flights that are leaving the U.K. for say Australia at a higher rate than you are if you're taxing flights that are going nearer say to Morocco. So over time the rules were changed to introduce geographical bands set at 2,000-mile intervals. Now I think when this was being introduced, although there was an environmental element to it, it wasn't quite as marked as the discussion now is in relation to aviation taxes. The U.K. government was just looking to a sector that was undertaxed and they looked at aviation where VAT doesn't apply to international passenger transport, where fuel is not taxed, and they thought, "Here's an opportunity to be able to raise some revenue." But inherent in the design of APD was also that you could charge more for more environmentally damaging flights. So that flight to Australia is going to have a greater impact on the environment than a flight to somewhere a little bit nearer. And also over time the tax was changed so that it would tax business travelers. Travelers traveling in business class more than economy travelers because you're taking up more space in the sky using more fuel, etc .

David Stewart 2:30

And understand it's kind of an unusual feature of the distance banding where it was only one price per country, which would allow for a traveler from London to Honolulu to pay the same amount that someone would be traveling to Boston.

Jeremy Cape 2:44

That's right. And that eccentricity was more accentuated, I think, with the U.S. So you have a flight from London to Boston, which should be taxed at the same rate as a flight to Honolulu or to Los Angeles because the boundaries were drawn the nearest boundary to the U.K. to determine the banding. And although yes, that may have affected flights to China, we don't generally fly to as many cities in China as we do to the U.S.

David Stewart 3:10

All right . What was the purpose of the Air Passenger Duty or APD and is it achieving its goals?

Jeremy Cape 3:16

Well, Air Passenger Duty, I think, was introduced to raise money. That's what the U.K. government was looking to do in the 1990s. And although there was a reference at the time to the environment, the main reason was to raise the revenue. It does raise revenue. It raises £3.6 billion. That's less than 0.6 percent of U.K. tax generally, so it's not a huge proportion, but 3.6 billion, it pays for various bits and pieces. Has it succeeded in reducing the number of flights that are taken by passengers in the U.K.? Well, it's very hard to be able to say with any certainty. If you look at the flights that are taken by passengers, they've gone up since APD was introduced. I think in 2017 there were about three times as many passenger departures as there had been in 1993 when APD was introduced. But would there have been more if it hadn't been? And I think you'd have to conclude looking at the elasticity of demand for flights and speaking from my own personal experience, I'm certainly less inclined to take the $20 flight over to somewhere in east Europe , sixth largest city in Poland, or something, just to see what it's like. Twenty dollars versus $40, $50, $60 as the prices have gone up, almost certainly that hasn't had an impact, but if you hope that these taxes are reducing flight demand, you've seen a lack of success.

David Stewart 4:36

I recently traveled to the U.K., but I engaged in a level of tax avoidance because I actually didn't fly out of the U.K. I ended up flying out of —

Jeremy Cape 4:43

As a lawyer, I must warn you now not to say anything that might incriminate you.

David Stewart 4:47

I believe this was legal tax avoidance. Because I was actually quite surprised when I was pricing tickets to fly to the U.K. and then fly back, or fly to the U.K. then travel to Paris and fly back from Paris, it was actually cheaper that way even though the fare was slightly more.

Jeremy Cape 5:01

Right? This is a concern where you have differentials between countries. I mean obviously we see this as part of the BEPS 1.0 project, the BEPS 2.0 project, and all the way up to 20 or however far Pascal takes it. When I was writing the column, I did a spot of googling and I saw that when one country in Scandinavia had introduced taxes on aviation, similar tax to an air passenger duty, another Scandinavian country was saying this is a huge opportunity for our aviation sector. These are countries, which I'm not going to name them, but these are countries that you might have expected to be more pro-environment. So you are seeing that now. Differentials where you can play on the Air Passenger Duty in order to have substantially cheaper tickets.

David Stewart 5:42

Moving on from the Air Passenger Duty, I understand there's a group called Free Ride? They proposed a frequent flyer levy , also known as an FFL. Can you tell us about this proposal and how it works?

Jeremy Cape 5:52

The way I understand it is that under the FFL everyone would be entitled to one tax-free return flight from the U. K. every year. The next flight that is taken is taxed, but at a relatively low rate. The third flight, the fourth flight, the fifth flight, the sixth flight ,and so on, the tax gradually increases until by the time you're on your hundredth flight, it's probably cheaper to buy a plane. And the thinking behind this seems to be that frequent flyers are the problem. OK, so you have an air passenger duty at the moment, but yeah , I'd think I'm probably a frequent flyer. My job requires me to fly to various places in the world. When I'm flying out to Washington D.C., when I'm flying back to London, I'm paying the same tax on that flight as the proverbial little old lady who has never flown anywhere and is flying out to D.C. for the first time because she wants to see the White House. So the idea is I'm a problem and my fellow frequent flyers are the problem when it comes to carbon emissions by the aviation sector. So if you can stop us from flying quite so much, it's fine for the little old ladies who are flying once a year, once a lifetime. Let's get those frequent flyers, let's tax them and we can solve the problem.

David Stewart 7:02

Now do you think that this sort of tax could be made to work?

Jeremy Cape 7:05

Well, let me take two points here. The first question is whether it could be made to work from a technical point of view. And quite often when these taxes are introduced, we in the tax community will look and say, "Well, that's not going to work. It's too difficult." And you can see in a way, well how would I be able to look for a flight to Washington when the website doesn't know if I'm on my first flight or I'm on my hundredth flight. I don't think that's insurmountable. I think given the details that are provided by flyers, passport details, credit card details. When I was coming out here checking in at Heathrow, they were asking which hotel I was staying in. This information exists. I think it could be calculated. I think you could have a system, it's not straightforward , but you could have a system whereby departures from the U.K. are attributed to individuals. And it wouldn't be the hardest thing in the world to work out for yourself how much tax you're going to have to pay on the next flight you're going to take. So from a technical point of view, although people criticized it, I wasn't too bothered. I think that could probably work. My broader issue with the FFL is that I think it's quite badly designed. I think it's a populist tax and you're seeing a lot of these that make it sound like there is a simple solution to a problem and it isn't going to impact on the vast majority of people. Right? So one issue with the FFL is that in terms of the flight that I took out to D. C., the amount of carbon that got admitted on the way out is exactly the same for me as it is for the little old lady taking her first flight. So that seems to me that it should be the starting point, right? Let's look at how much carbon is being emitted on that particular flight and let's make sure that is appropriately taxed and then used in such a way as to neutralize the emission .

David Stewart 8:41

So this tax would definitely raise a fair amount of revenue if it were implemented. What's that revenue supposed to do? Is it just going to be a revenue raiser or is it going to be directed towards something?

Jeremy Cape 8:51

I think there are two elements. I think the idea is by taxing frequent flyers who tend to be wealthier. There are certainly some poor people who fly a lot, but generally it's the wealthy who flies. So there's a redistributional element. It's a way of soaking the rich. In addition, one would assume to some other measures, they believe that there would be more revenue raised than from air passenger duty, and I suspect it is possible to raise more tax this way than through air passenger duty. Of course it's possible to raise more through air passenger duty by putting the rates up. There is an element of hypothecating the FFL to environmental measures. So the idea is that this would not just go into government coffers. It would be used in a way that will help to save the environment.

David Stewart 9:34

So this proposal would ramp up the tax for each flight a person takes. Would that really dissuade the truly wealthy from flying?

Jeremy Cape 9:43

It's a really good question. I'm not sure it would . Again, at the margins, you could see someone on their 30th flight deciding, "Actually this is too expensive. I'm going to be paying thousands of pounds to fly a couple of hours that I'm just going to do a video conference. I'll just stay at home." The assumption is that the wealthy won't be so affected because you could never get the super wealthy anyway. You can never get the tax at such a level that it would dissuade them from making a trip that they have to make. I'm more concerned at the other end, in fact, because the proposal is that the first flight should be tax free. Again, purely populous measure. So this means that if I'm one of the approximately 50 percent of people in the U.K. who don't fly in a year, I'm suddenly incentivized to fly . You could see the campaign . Haven't flown? Because we're not imposing APD on your flight anymore, you've actually got a tax cut. You've actually been encouraged to make a flight and you're aiming this at 50 percent of the population. Now, admittedly, a lot of them aren't going to be able to fly. They won't be able to afford it anyway . That might be not what they want to do. That's a problem. The people who are taking the first flight of the year will, I understand, be paying a lower rate of tax under FFL than they do under APD. So again, at these levels, you're seeing potentially this backfires. Now, to be fair to those who came up with the FFL proposal, they have modeled it and they think that it works. But I've seen enough tax loopholes in my time to know where something might not work and I could see this not working very well because it ends up encouraging people who never fly to think about flying as an option.

David Stewart 11:09

Now you wrote about this topic in a column for Tax Notes. Can you tell me what are your thoughts on how aviation should be taxed?

Jeremy Cape 11:17

My starting point on this as with a lot of issues is that you shouldn't be looking to the tax system to fix a non-tax problem. Now aviation contributes about 2.5 percent of global carbon emissions. Now you might say, "That's a lot because aviation, the number of flights compared to the number of factories and households, et cetera, et cetera, that's disproportionate." Or you might say, "Well, actually, 2.5 percent, let's not focus on that. Let's focus on the 97.5 percent." But in any event, if you take the view that there are too many planes flying, then governments need to respond by reducing the number of flights that can be taken. That's a hard decision for government. And I think that's why sometimes they look to the tax regime to try and fix the problem. If you can do it through tax, and yes, people don't like paying tax, but if you're putting that more onto the rich, then perhaps that's going to play out politically with more ease than if you say, "OK, we're now going to limit every person to a certain number of flights or we're going to half the number of flights that are currently taken across the world." So I think one problem is that in trying to find a tax solution to the environmental damage that's caused by aviation, governments are focusing on the wrong solution. Because aviation is a relatively small part of global carbon emissions, I do think that we need to be looking more broadly at a solution, not limiting that to aviation. So carbon taxes I think are a good idea. So if you're looking rather than taxing aviation at taxing carbon emissions, then you're not just focusing on that 2.5 percent. You're focusing on carbon emissions globally. So I think the starting point is not to focus on aviation. It's not, so you can't tax aviation separately, but for me, some of these proposals to tax aviation in a different way and frequent flyer levy outside the tax world, I've seen that some suggestion that frequent flyer miles should be abolished because they encourage people to fly. I don't think that's correct. I think again, it's a gimmicky proposal that enables governments to take away the difficult decisions that they otherwise need to make.

David Stewart 13:15

And I guess they're having it as a generalized carbon tax would encourage the airline companies to increase efficiency?

Jeremy Cape 13:20

Which has happened. If you're looking at the aircraft manufacturers, they have certainly created far more environmentally friendly planes than was previously the case. I flew out here on an ancient 747 but if I was with one of the more modern Airbus or Boeing models, then my carbon footprint on that flight would have been substantially less. Technology can create the solutions to these issues. And again, it's not really a tax point, but if you're trying as extinction rebellion sometimes seem to be doing to say, "Actually we shouldn't fly." The starting point is "We shouldn't be flying." Then that again is not something that can be fixed by tax, but also it's not realistic for the global economy as we have it today. It's just not going to change.

David Stewart 14:00

Well, Jeremy, thank you for being here.

Jeremy Cape 14:02

Thank you for inviting me.

David Stewart 14:03

Have a safe flight home.

Jeremy Cape 14:04

I will do and thank you for guilt tripping me.

Willis Weighs In

David Stewart 14:06

Now for another edition of Willis Weighs In, where Tax Notes contributing editor Ben Willis discusses tax planning issues with Executive Editor for Commentary Jasper Smith.

Jasper Smith 14:14

Thanks, Dave. So, Ben, today we're going to pick up where we left off last time and we'll continue to explore business purpose hurdles and some questions related to your October 28th article on the principle purpose threshold. You ready?

Ben Willis 14:27

Let's do it.

Jasper Smith 14:28

OK. So first question: what type of business purpose will satisfy the principle purpose threshold in the new section 245A regs?

Ben Willis 14:35

Unfortunately, Jasper, I think the answer is none. The threshold is simply just not administrable in my opinion. In order to really explain why, I'm going to have to walk you through two statutory provisions which create a gap period that we'll talk about and then the regulations that explain this.

Jasper Smith 14:52

Sounds good.

Ben Willis 14:52

So the two provisions are section 245A and section 951A. The first, 245A, gives a DRD, 100 percent DRD, and creates the territorial system allowing earnings to flow up from foreign corporations to domestic corporations. The 951A GILTI provision, or global intangible low-taxed income rules, worked provide a 10.5 percent minimum tax. Now these provisions have different effective dates, which creates the gap period. 245A allows dividends to flow up beginning January 1, 2018 while the GILTI regime is based on taxable years that begin after December 31, 2017. This gives corporations up to 11 months in order to benefit from a DRD, but not get hit with the GILTI income. That brings us to the regulations. The regulations are really focused on extraordinary dispositions. What they're trying to do is target what they perceive as abusive tax planning to generate E&P so they can benefit from the 100 percent DRD. And what they do is they define an extraordinary disposition as anyone that's not in the ordinary course of a corporation's activities. The problem is is they create a per se rule based on a principle purpose and that principle purpose is anyone in which there is a disposition designed to generate E&P. The problem is for-profit corporations are designed to generate profits and so we're left with the question that corporations will be asking myself when I sell my products for a profit, am I not also selling them to generate E&P?

Jasper Smith 16:32

That makes sense. So listening to you explain it, what transaction is Treasury really concerned with?

Ben Willis 16:38

So we have this 11-month gap period. There's really three major benefits that you can obtain if you undertake a extraordinary disposition during this period. One, you can generate E&P through a sale and make a profit that results in earnings and profits and generating a profit is a perfectly valid business purpose.

Jasper Smith 16:57

I would hope so.

Ben Willis 17:00

And so corporations can't ignore the fact that they understand generating a profit results in E&P, but that E&P allows them to distribute a dividend, which is a distribution on stock of earnings and profits. That's the first benefit. The second benefit is that during that 11-month period, they're not going to be producing any GILTI inclusions because it doesn't kick in. And then the third benefit is the sale actually steps up the basis of the asset and that actually has a long-term positive effect in that it increases the qualified basis of the depreciable tangible property that's used to determine how much GILTI inclusion one has. And so that's really the transaction that's being targeted and the benefits that are being obtained.

Jasper Smith 17:43

Got it. So the question that naturally comes from that is will 245A stand up to the legal challenges in court? What do you think?

Ben Willis 17:51

I say no. I think the regulations are overly broad and based on abuse concerns, but those concerns cannot override the plain language of the statute. Congress has various effective dates throughout the entire TCJA, some of which hurt taxpayers , some of which help. And I believe in this instance, if Treasury was allowed to modify all of the effective dates and alter the rules as it wanted, it would be able to legislate and therefore courts will strike this down as an overreach.

Jasper Smith 18:21

OK. And so what about the listener who says, "OK, Ben, I hear you. I hear you on the technical argument, but when we really focus in on the transaction, are we just talking about something that's really a loophole?"

Ben Willis 18:31

That's a great question. And we did talk about this actually a little bit on a prior podcast where we said that the effective dates can be viewed as a loophole. And this is the quintessential example of when Treasury is doing that. They're saying here a gap period was created by these effective dates and therefore a loophole exists. Now taxpayers are viewing this as "I simply followed the law as written. And so in my view, there is no clear congressional intent to indicate that wasn't intended by Congress."

Jasper Smith 19:01

So what tools do they have to address it then if they're concerned? What do you think?

Ben Willis 19:04

None.

Jasper Smith 19:05

OK. We're pretty clear on that. And thanks. We always appreciate your perspective. As usual, we'll include a link to that article that we referenced at the beginning and we'll turn the show back over to you, Dave

Coming Attractions with Faye McCray

David Stewart 19:16

And now, coming attractions. Each week we preview commentary that will be appearing in the Tax Notes magazines. I'm joined by Content and Acquisitions Manager Faye McCray. Faye, what will you have for us?

Faye McCray 19:26

Thank you, Dave. In Tax Notes Federal, B. Anthony Billings, Kyungjin Kim, and Brooke Billings discuss international loan guarantee fees between U.S. multinational companies and their international affiliates. Kate Kraus examines the ways in which the Bipartisan Budget Act of 2015 affects partnership audit rules. In Tax Notes State, Richard Ainsworth and Robert Chicoine discuss Washington's solution for sophisticated tax fraud. Roxanne Bland revisits taxing and regulating transportation network companies. In Tax Notes International, Steve Suarez provides an overview of Canada's transfer pricing regime. Hans Georg Wille discusses his problems with the OECD'S unified approach proposal under pillar 1. And in the Opinions page, Nana Ama Sarfo considers the use of taxes to target hazardous substances.

David Stewart 20:18

You can read all that and a lot more in the December 2nd editions of Tax Notes Federal, State, and International. That's it for this week. You can follow me online at @TaxStew, that's S-T-E-W. If you have any comments, questions, or suggestions for a future episode, you can email us at podcast@taxanalysts .org. And as always, if you like what we're doing here, please leave a rating or review wherever you download this podcast. We'll be back next week with another episode of Tax Notes Talk.