Opportunities and Challenges
India, given its population size and the distances between its urban cities and its rolling countryside, has for some time been a candidate to be the world’s fastest-growing, and eventually its busiest, market for air travel. India is now firmly on the path to fulfilling its candidacy, and growth in Indian aviation is on the same fast growth trajectory as India’s economy.
One of the principal drivers of growth is the orders for new aircraft placed by Indian airlines during 2023 and 2024. These are the largest ever commercial aircraft orders for both Airbus and Boeing aircraft. Just a few days apart from each other in June 2023, IndiGo placed an order for 500 Airbus aircraft and Air India (expected to soon be merged with Vistara, an Indian premium product success story) placed an order for 470 Airbus and Boeing aircraft. In January 2024, Akasa Air, currently India’s fastest-growing airline, placed an order for 150 Boeing aircraft. These aircraft will be delivered over the next fifteen years.
The vision for India’s aviation transformation will be delivered through a combination of private enterprise and Government backing, which has committed enormous resources to provide the ecosystem that the aircraft on order will need to operate, including new airports and maintenance facilities. India’s airlines will benefit from other measures implemented to supercharge India’s growth, such as the establishment of Gujarat International Finance Tec-City (“GIFT City”), which has, amongst other things, simplified the way that cross-border aircraft finance transactions are taxed and have therefore opened new markets and sources of finance for Indian airlines.
India’s enviable economy, with low levels of debt to gross domestic product, is in a prime position to finance much more than its own growth relative to other economies that have grown at a similar rate. However, the aviation industry is inherently, understandably, international. The new aircraft which are headed for India will cost tens to hundreds of millions of United States Dollars each. Airlines almost exclusively use finance to purchase their aircraft due to the enormous capital cost of building a fleet. The most popular sources of finance are operating leasing, secured finance leasing and unsecured capital markets finance. Almost certainly, the availability of domestic finance for the purchase of these aircraft will increase, but Indian airlines will also need to rely heavily on cross-border finance to finance their new aircraft purchases.
The modern story of Indian aviation, however, has been relatively turbulent. The Indian consumer would likely be familiar with high-profile insolvencies of airlines such as Kingfisher Airliners (“Kingfisher”), Jet Airways (“Jet”) and, most recently, GoFirst. The consumer may not be aware, however, of the losses foreign investors have incurred in relation to these insolvencies. No seasoned investor in aviation has been immune to airline insolvencies, but the experience of investors on the insolvencies of these airlines are likely to rank as some of the worst in terms of investor losses, especially in the case of GoFirst, which has occurred just when successful Indian airlines are seeking to attract cross border investment for its aircraft. Regardless of the enormous opportunities India offers international investors, the losses in previous insolvencies can weigh heavy on an investor’s mind when making investment decisions.
The consequences of the international investor experience are not lost on Indian airlines, one of which is higher costs of finance for Indian airlines as investors price in the risk demonstrated by these insolvencies. These increases place pressure on airlines’ margins, and, most significantly, much of the increased cost is passed onto the Indian consumer through higher ticket prices. Paradoxically, for some, it is demonstrably the case that a more creditor-friendly regime for international investors in Indian aviation (with understandable protections for Indian stakeholders and employees) will ultimately benefit the Indian consumer.
In this article, we describe the factors which contribute to the international aircraft investor’s current view of Indian market risk, which we have drawn from our experience as international legal counsel for international investors and Indian airlines, and also as contributors to the development of international regulations and treaties focused on cross border aircraft finance. Relevant developments of domestic Indian regulation, which are the most significant for international investors of Indian aircraft, are relatively recent, the starting point arguably (and for the purposes of this article) being the ratification by India of the Cape Town Convention on International Interests in Mobile Equipment (the “Cape Town Treaty”). However, the changes, and we would propose improvements, are coming as fast as the Indian economy is growing.
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India’s Changing Regulatory Landscape for the Foreign Investor
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Deregistration and Enforcement
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In the introduction, we spoke of the experience of international investors in Indian aviation and the losses they have incurred due to the insolvencies of the unsuccessful Indian airlines. International investors are used to airlines succeeding and others failing. How quickly an investor can recover its asset competes for the top spot of investor priorities in an airline insolvency, together with what proportion of unpaid amounts an investor can recover from its debtor, these factors are the most significant drivers of losses for an investor in an airline insolvency. The most profitable airlines regard every hour of every day that an aircraft is not in the air as an hour that such aircraft is not generating revenue. The same is true for an investor when an airline is insolvent and is not paying rent. Grounded aircraft leased to a defaulting or insolvent airline can quickly result in significant losses for an investor. This is exacerbated by an aircraft being an advanced technological asset which requires regular expert maintenance. An aircraft is likely to deteriorate rapidly in value if left grounded for any significant period of time if the investor does not have possession of the asset, as it is only the investor in an insolvency scenario who is likely to have the financial means and incentive to implement the necessary maintenance related measures to protect the condition, and therefore the value, of the aircraft.
Prompt recovery of aircraft when an airline defaults on its contract with the owner of an aircraft or when an airline becomes insolvent was at the heart of the development of the Cape Town Treaty. The Cape Town Treaty, which currently has 86 signatories, was ratified by India in 2008. It codified the cross-border recovery of aircraft assets and established an international regime that prevailed over domestic procedures. Two key concepts conceived by the Cape Town Treaty which should result in prompt recovery of an aircraft in distressed circumstances are:
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The introduction of an irrevocable de-registration and export request authorisation (an “IDERA”), which is intended to permit an investor to deregister its aircraft from a domestic aircraft registry and export the aircraft and
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Alternative A, based on section 1110a of the United States Bankruptcy Code, which places a cap of sixty days on the length of the period of a moratorium to which an investor may be subject from enforcing its remedies against an insolvent airline.
These concepts should prevail over the domestic laws of a country which has ratified the Cape Town Treaty. However, until recently, this has not transpired to be the case in India, which is responsible for the worst of the losses incurred by investors in these insolvencies.
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The IDERA
IDERA is a document granted by an airline to an investor in respect of an aircraft subject to the provisions of the Cape Town Treaty, commonly, and in the case of India, as a result of the airline being incorporated in a jurisdiction which has ratified the Cape Town Treaty. The form of the IDERA is prescribed by the Cape Town Treaty. It is a short document and its purpose is unequivocal; on a breach by an airline of its contract with an investor with respect to a financed aircraft, the financier which has been granted an IDERA should be able to present such document at the relevant registry with which the aircraft is registered, in India’s case, the Directorate General of Civil Aviation (the “DGCA”), and the registry authorities must deregister the aircraft within five business days and permit the investor to export the aircraft. The IDERA holder should be able to exercise this right without condition, subject to specific accepted industry conditions, such as the discharge of outstanding landing fees payable to relevant airport authorities. These conditions are prescribed in domestic law but are familiar to investors across jurisdictions and can be ascertained through due diligence prior to entering into a transaction.
In 2015, India passed an amendment to its Aircraft Rules 1937 (the “Aircraft Rules”) to fully implement the rights of an IDERA holder into Indian law, and therefore, the DGCA is required to deregister the aircraft and permit its export within five business days following the presentment of an IDERA. Except in circumstances of an airline which is subject, or where the DGCA is concerned that the airline may soon become subject, to a moratorium from creditor enforcement pursuant to the Indian Insolvency and Bankruptcy Code (the “Bankruptcy Code”), anecdotal evidence indicates that deregistration can occur within seven to ten business days of application by an IDERA holder. Using an IDERA might be described as the most efficient method for an investor to recover its aircraft. This method is suitable for both operating lessors and lenders under a finance lease transaction, as an IDERA should be part of the security package in operating and finance leasing. The enforcement process is as follows:
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Application Filing: The IDERA holder initiates the process by filing a deregistration application with the DGCA using the prescribed form. This application should be submitted through the online platform and must be notarised if executed outside India, with the original delivered to the DGCA. The IDERA holder can also appoint Indian counsel to sign the application through a power of attorney.
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Required Documents: Along with the application, the registered holder must provide:
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A notarised copy of the IDERA
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The DGCA’s confirmation of IDERA recordation upon delivery (recordation should be a condition precedent or subsequent fulfilled at delivery).
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A notarised priority search certificate from the International Registry detailing all registered international interests filed pursuant to the Cape Town Treaty and related to the aircraft.
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Consents from any priority interest holders consenting to the deregistration, if applicable.
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Notification and Claims: The DGCA will post the application on its website to notify potential priority interest holders of the impending deregistration and export. It will also notify domestic airport operators. Airport operators can claim unpaid dues for the aircraft for up to three months from the application date. There is no fleet lien concept, so the registered holder is not required to discharge unpaid dues for other aircraft. Other central government entities and private-public service providers can raise bills within the five-day period for amounts due specifically for the aircraft. A common liability for lessors includes unpaid General Sales Tax (“GST”) on lease rentals.
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Outstanding Payments: On the fifth day, the registered holder must pay the notified outstanding amounts. Upon receiving payment, priority interest holders must issue a certificate to the registered holder confirming that these liabilities have been discharged. The registered holder must submit this certificate to the DGCA as evidence of payment, after which the DGCA will proceed with the deregistration.
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Final Steps: The registered holder must pay parking and take-off fees incurred up to and for the ferry flight and provide evidence of payment to the DGCA
This streamlined process ensures a clear and efficient pathway for the deregistration and export of aircraft, benefiting both lessors and lenders (and ultimately the consumer through lower finance costs). It is reasonable to say investors have, however, approached this process in India with trepidation. Anecdotally, it has worked as intended in India in situations where a defaulting airline has not contested a deregistration. The time for testing whether the process in India would work as it should came during a short period preceding the application by GoFirst for creditor protection under the Bankruptcy Code in May 2023. Investors were disappointed with the failure of the process to deliver as it should have as the DGCA failed to permit the deregistration of any aircraft pursuant to the IDERA, notwithstanding at the time, the application for insolvency by GoFirst had not been granted, and there was no moratorium in effect. When it became clear that investors would not be able to recover their aircraft through the IDERA process, their remaining hope was that the Indian courts would follow the Alternative A insolvency regime set forth in the Cape Town Treaty.
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Alternative A
The Cape Town Treaty prescribed two options for states when ratifying the Cape Town Treaty as to what process would apply in the insolvency of an airline: Alternative A and Alternative B. Alternative A provides that a moratorium may be imposed on creditors of an airline which owns and leases aircraft to such airline for a maximum duration of sixty days. At the expiry of such period, the airline must either hand the aircraft back to the investor or remedy all breaches under the relevant contract, including, for example, paying all outstanding and overdue amounts. Alternative B gave more flexibility to a ratifying state to apply its own domestic insolvency and moratorium procedures. India selected Alternative A when it ratified the Cape Town Treaty, which was the most preferred amongst the international aircraft investor community as it provided the most certainty for the investor of the two options.
When the DGCA refused to deregister aircraft pursuant to the IDERA process in the case of GoFirst, the maximum duration investors should have had to wait for the return of its aircraft was a maximum of sixty days. However, the Indian courts initially applied the domestic insolvency laws and the lengthier moratorium. Investors have eventually had to wait an entire year to be granted repossession of their aircraft, and for some investors with respect to engines, the wait continues at the time of writing. The losses suffered by investors are still being calculated, but for many investors, this could be considered one of the worst outcomes in many other airline insolvencies that they might have experienced, given the number of factors which have conspired against them, including the significant number aircraft involved in the insolvency, the lack of access investors have been given to such aircraft to maintain throughout the duration of the moratorium and the hot and dusty, harsh environment to which the aircraft has been subject whilst left on the aprons of airports in India for the entire duration of such moratorium.
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Developments in the wake of the GoFirst Insolvency
The conflict between the Indian domestic insolvency laws and Alternative A, which resulted in a lengthier and more costly moratorium in the GoFirst insolvency than what should have been the case had Alternative A prevailed, was known prior to the GoFirst insolvency. Legislation to correct this conflict and implement the Cape Town Treaty’s primacy over domestic law has been drafted and is tabled in the Indian Parliament for enactment in its most recent iteration (the “Cape Town Convention Bill, 2022”) prior to the GoFirst insolvency. The failure to pass this legislation, notwithstanding its wide industry support, resulted in the Ministry of Corporate Affairs issuing a notice in October 2023, which amended s14(1) of the Bankruptcy Code and disapplied the moratorium process to transactions protected by the Cape Town Treaty (the “Notice”). The impact of the Notice was debated at the time of issue, but the prevailing view was that its effect was that instead of the moratorium prescribed under the Bankruptcy Code, Alternative A should apply. The Notice, therefore, removed the conflict between Indian domestic law and the Cape Town Treaty in this narrow respect and provided a degree of comfort for investors that they would not suffer the same fate that they had suffered in GoFirst’s insolvency in any future insolvency of Indian airline. However, the Notice was issued under a delegated authority and therefore does not provide the comfort that enacted legislation, such as the Cape Town Convention Bill, 2022, would if enacted. Also, for investors in the GoFirst insolvency, the Notice would need to have a retroactive effect in order to assist in the repossession of their aircraft.
On 26 April 2024, the court in the case of GoFirst issued a judgement, the time for the appeal of which has passed. On two accounts, it provided positive news for investors, both those subject to the GoFirst insolvency and future investors. The first point was that the DGCA should have deregistered the aircraft pursuant to an IDERA where the IDERA holder had made an application. This was because IDERA holders had made the applications in advance of the imposition of the moratorium. The DGCA should not have refused deregistration pursuant to the IDERA process, notwithstanding the fact that the DGCA expected a moratorium to be imposed. The second point is that the Notice is binding, and the court applied it with retrospective effect. The transactions between GoFirst and the aircraft investors were protected by the Cape Town Treaty as the necessary filings had been made with the International Registry on the inception of the transactions. Therefore, the domestic insolvency regime did not apply, and the investors could enforce their rights against GoFirst and recover the aircraft under Alternative A. They should have been able to do so after sixty days of the imposition of a moratorium.
Wider publication of detailed analyses of the GoFirst judgment will continue, and its dissemination will likely improve investor confidence in India. Notwithstanding the Notice and the GoFirst judgment, investors and industry leaders still expect the Cape Town Convention Bill 2022 to be enacted by the Indian Parliament in 2024. This should provide ultimate confidence to investors and those encouraging investors to invest in Indian aircraft that the GoFirst experience would not be repeated in any future insolvency of an Indian airline. This will contribute to a significant positive impact on the ability of Indian airlines to obtain cross-border finance for their aircraft on more debtor-friendly terms and pricing and provide access to new markets for finance for Indian airlines.
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Financial Dynamics, Economic Efficiency in Cross-Border Aviation Transactions
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Taxes Investors financing aircraft for Indian airlines would typically finance such through finance or operating leasing transactions. Cross-border aircraft transactions for Indian-registered aircraft are subject to the following taxes:
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Withholding Tax: Cross-border operating lease rental or the interest component on a finance lease being paid out of India is generally subject to withholding tax at the applicable rates unless an exemption is available. If an exemption is available, it would most commonly be pursuant to a double taxation treaty, such as that entered into between India and Ireland, provided that the recipient qualifies for such an exemption pursuant to the treaty’s requirements. The standard withholding tax rate is 10%, deducted at source under the Indian Income Tax Act. Non-Indian lessors may apply for an exemption from this tax under section 197 of the Income Tax Act. For example, under the India-Ireland treaty, operating lessors can apply for a certificate granting a ‘nil’ withholding tax rate, as Articles 8 and 12 stipulate that lessors are liable to pay tax only in Ireland.
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GST: Lease rentals are subject to GST, a consolidated indirect tax regime implemented in 2017, replacing various indirect taxes such as sales tax, VAT, service tax, purchase tax, and excise duty.
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Stamp Duty: Stamp duty is applicable on sale/purchase, lease, or financing agreements signed in India. The rate varies based on the type of agreement and the state in which it is executed. All lease agreements must be stamped at the time of execution if they are to be enforceable in India.
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Reserve Bank of India Approval
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The transfer of foreign exchange from India is regulated, and approval from the Reserve Bank of India (RBI) may be required. However, the approval process is relatively straightforward:
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Most transactions do not require direct RBI approval. Payments are processed through banks designated as “authorised dealers” by the RBI, eliminating the need for direct RBI involvement.
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Rental and other amounts payable by an airline to the lessor under an operating lease typically do not require RBI approval due to available exemptions.
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Guarantees issued in connection with operating leases are subject to a simplified approval process. If a guarantee is called, it involves cross-border payments from the guarantor to the lessor.
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For finance leases, rental and other amounts payable by an airline to the lessor do require RBI approval, though the process is not overly restrictive.
Gift City has been a phenomenal success across many financial services sectors and GIFT City incorporated entities are being used to structure commercial aircraft and engine finance transactions. GIFT City is “deemed a foreign territory”, similar to other international financial services centres (“IFSCs”), such as those in Dubai and Singapore. IFSCs allow cross-border transactions to be conducted freely in foreign currency and provide freedom from domestic regulatory ecosystems and constraints such as, in the case of India, the requirement to obtain Reserve Bank of India approval for international payments made from GIFT City.
The majority of cross-border aircraft finance transactions for Indian aircraft, especially operating lease transactions, are currently structured as transactions between the Indian airline and an investor established in Ireland, in which case the parties can utilise the benefits of the India/Ireland tax treaty. This is a common structure for aircraft finance transactions due to Ireland’s substantial and unique network of tax treaties, which has driven the development of the world’s leading aircraft finance ecosystem in India. In recent years, the multilateral instrument between India and Ireland, aimed at addressing base erosion and profit shifting under the OECD’s project, has limited the variety of transactions that can benefit from the double taxation treaty. This may lead to more transactions being structured through GIFT City in order that parties do not need to rely on taxation treaties because an entity established in Gift City can make payments cross border payments without any requirement to pay withholding taxes, whereas an Indian company making international payments without the benefit of tax treaty would. Therefore, structuring transactions using GIFT City entities increases the number of potentially tax-efficient transactions and the number of investor markets Indian airlines can access.
The advantages of structuring aircraft finance transactions through GIFT City are numerous and include the following principle advantages from an international investor point of view:
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Jurisdictional Risk Mitigation: Indian airlines have recently established subsidiaries in GIFT City and are using these entities when structuring finance lease transactions. This eliminates the need for investors to establish their own entities and, therefore, avoids them from incurring the cost of doing so, part of which would be costs incurred with the analysis of, and pricing in, any perceived risk of having such a subsidiary as well as the cost of maintaining the entity. In these structures, the international investor leases to the airline’s GIFT subsidiary instead of the airline, but through structuring, it has recourse to the airline as its credit, and therefore, the commercial analysis and risk profile are very similar to previous transactions, which have not been structured through GIFT City.
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RBI Approval and Tax Benefits: Payments from a GIFT SPC to a foreign entity do not require RBI approval. Although RBI approval is required in respect of payments from an Indian entity to an entity established in GIFT City, the existing processes with respect to obtaining RBI approvals are applicable for these payments.
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Enforcement Rights: structuring a transaction through GIFT City does not affect the financier’s enforcement rights compared to traditional structures. The international investor will receive an IDERA.
The authorities which administer and promote GIFT City have a vision for Gift City beyond simply structuring transactions through GIFT City. They are also encouraging international investors, particularly aircraft operating lessors, to establish their own subsidiaries in GIFT City and make Gift City a global aircraft finance and leasing hub. This initiative will bolster the civil aviation sector in India and provide further support to Indian airlines and their growth plans. Gift City offers a compelling opportunity for foreign banks, aircraft lessors, investors, and other stakeholders to establish operations in India and transact in freely convertible foreign currency. This “off-shore” setup provides relief from India’s regulatory and tax regime, along with several additional benefits:
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Tax Incentives:
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A 100% income tax holiday for any ten consecutive years within the first fifteen years of the entity’s operation.
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A reduced minimum alternate tax
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An exemption from capital gains tax on the transfer of specified securities during the tax holiday period.
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Stamp Duty Waiver:
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An exemption from stamp duty for aircraft leasing entities on all activities related to setting up its entity in GIFT City, including aircraft acquisition, for ten years.
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Reduced GST on Lease Rentals:
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GST on lease rentals is reduced to five per cent for entities established in GIFT City. GST on lease rentals paid by an Indian airline to a GIFT City entity is also applied through a forward charge mechanism rather than a reverse charge mechanism.
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Streamlined Regulatory Approval:
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The unified International Financial Service Centre Authority provides regulatory clearance for all purposes, eliminating the need to approach separate regulators for approvals related to banking, insurance, pension, and foreign exchange regulations.
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The development of GIFT City as an international leasing hub, not just for leasing aircraft into India, but also throughout South Asia and beyond, is likely to take some time to develop. Whilst Ireland is likely to remain as the world’s leading aircraft finance centre for many years to come, there is opportunity for other centres, including GIFT City, to take market share.
Conclusion
The macro and micro ambitions for India and its aviation industry are clear for all to see. The recent regulatory changes in India, and those expected in the near term, were and are necessary in order for airlines in India to achieve their ambitions. Aircraft and airlines require infrastructure to be successful, and a facilitative and dependable regulatory and legal framework is only part of the story. It is, however, a vital part. The enactment of the Cape Town Convention Bill 2022 should be seen as the final chapter of the full development of India’s legal framework to an international standard for aviation investors. This will allow India to fulfil its true potential in the aviation sector, and combined with the success of Gift City and the demand for financing and investment, the Indian airlines require, will supercharge investor sentiment and investment into India at pricing appealing to all involved.
Authors:
Watson Farley & Williams is the largest global asset finance legal platform and has extensive experience in transactions in India across its network. Please contact Richard Williams or Randeep Bubbra for more information on any of the topics discussed in this article or any aviation matters.
Editorial Team:
Managing Editor: Naman Anand
Editor in Chief: Abeer Tiwari and Harshita Tyagi
Senior Editor: Naman Anand
Associate Editor:
Kaushiki Singh
Junior Editor: Mansi Kapoor
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