Marcela Correa and Isabel Andrade offer an insight into Brazil’s aviation sector, highlighting the challenges faced as a result of national taxes and recent political upheaval
1. Currently, what are the main issues (strategic and political) affecting those in the aviation sector in your jurisdiction?
The aviation sector in Brazil has faced many challenges caused by the major economic recession in connection with the political crisis. President Dilma Rousseff was impeached and removed from office by the Senate in early September 2016, and has been replaced by her former Vice President Michel Temer. The Brazilian Real has been devaluated significantly over the last couple of years, which has increased the burden on airlines in relation to aircraft leases as rents are paid in US dollars. Passenger demand fell for the first time in years both at the international and domestic levels. In addition, low oil prices in the international market and corruption scandals involving Petrobras, the state-owned oil and gas company, have deeply affected helicopter demand as Petrobras has been cutting costs and no longer charters the same amount of aircraft to transport its employees to and from oil rigs. Nevertheless, commercial airlines and other air service providers have been adjusting to the circumstances and we expect to see some improvement in the aviation sector in 2017, especially once the new government passes reforms to allow at least a mild economic recovery.
2. Where has your jurisdiction seen the most growth in the aviation sector over the past 12–18 months? And, if any, where do you anticipate growth coming from during the next 12 months?
Over the past 12–18 months, air service providers have been returning and exporting used aircraft. Many have actually felt encouraged to sell aircraft to foreign individuals or entities due to the increase in value of the US dollar.
As mentioned above, we expect some growth in the aviation sector in 2017 as the Brazilian economy starts to show signs of recovery. This should benefit the aviation market, especially the executive jet and helicopter sectors.
It is worth highlighting that, despite the economic crisis, Brazil is still the world’s second-largest market for helicopters and agricultural aircraft. Petrobras has managed to increase its cash flow little by little since the first semester of 2016. In addition, Brazil, as a producer of coffee, soybeans, corn, etc., is a major player in commodities, and their trading prices are expected to grow.
3. Does the GDS distribution model continue unchallenged as the most popular model for flight distribution?
Yes. The GDS distribution model continues unchallenged and largely dominates flight distribution in Brazil.
4. In your jurisdiction, does airport capacity require boosting and, if so (and even if not), what plans and/or processes are in place to address this (or increase or re-organise airport capacity, as the case may be)?
Airport capacity in Brazil is insufficient. President Temer has recently announced that the government will resume former President Dilma’s plans to privatise the international airports of the cities of Salvador, Fortaleza, Porto Alegre, and Florianópolis, which are currently owned and operated by Infraero, the Brazilian airports company. Unlike what has happened with the concessions of major international airports in the past, such as Guarulhos, Galeão and Brasília, there is currently no plan to require Infraero to partner with a private investor company.
In regard to regional airports, until recently 270 airports were expected to be refurbished with resources from the federal government in order to allocate more passengers; however, it has been recently announced that this number will be reduced to 53.
5. Does the national "flag" carrier carry the most passengers into and out of the national airports and: (a) if so, what competition exists and how significant is it?; and (b) if not, what are your thoughts on the reasons for this, and why do competing airlines have higher load factors?
In practice, four major national airlines control the domestic air transportation market (Azul, Avianca, Latam and Gol).
National companies, on the other hand, compete with foreign airlines for the international air transportation market.
From 2003 to 2013, the share of international flights operated by foreign airlines increased by 147%; while the national flag carriers’ share of international travel increased by 55%.
However, in 2016 many foreign airlines started to cancel some international routes due to a lack of demand; while the national flag carriers managed to increase the number of international routes by 1.9%.
6. What trends, in terms of regulatory intervention and involvement, has your jurisdiction observed over the past 12–18 months in relation to airline acquisitions and alliances? Do you anticipate a change in the regulatory environment of your jurisdiction during the coming 12 months, and if so, how?
Azul Airlines, the Brazilian low-cost carrier established by David Neeleman, the founder of JetBlue, has recently acquired convertible bonds in the amount of US$ 100 million from the Portuguese airline TAP.
In addition, Azul, Latam and Gol have entered into codeshare and other alliance agreements with over 15 foreign airlines, including Delta, Air France/KLM, Qatar, American Airlines and Korean Air.
As to the regulatory environment, a much expected change in the limit of foreign interest in national airlines has failed. By way of background information, the Brazilian Aeronautical Code establishes a 20% limit on voting shares owned by foreigners in Brazilian air transportation service providers. Last March, however, the then Brazilian President Dilma Rousseff issued an executive order which increased the limit from 20% to 49%, with the possibility of reaching 100% if there was reciprocity under the respective Bilateral Agreement. Such executive order was effective for four months only. Its permanent effectiveness required approval from Congress. In July, after the Senate submitted their suggestions on the executive order for the President’s approval, Dilma Rousseff was suspended from office, on an interim basis. The then acting President, Michel Temer, vetoed the increase of the limit on voting shares for foreigners. The limit therefore remained the same as before (20%).
Although the efforts to raise that limit failed, they indicate that there is a cry for an increase in foreign shareholding, particularly given the crisis in the aviation sector and that such a change could benefit national carriers and other air transportation services providers in the current climate.
7. What trends are being observed in relation to new technologies – such as UAVs/drones – and what impact are these technologies having on the aviation regulatory environment?
Brazilian legislation regulates the use of ‘Remote Piloted Aircraft Systems’ (‘RPASs’) (aeronaves remotamente pilotadas) for very limited purposes; that is, for use in (i) research and development, (ii) remote pilot training, and (iii) market research. The use of drones for such purposes requires ANAC’s prior authorisation.
Other uses of drones still require regulation. In 2015, the Brazilian Civil Aviation Agency (ANAC) submitted to public consultation a draft resolution for the regulation of the use of RPASs and model aircraft, popularly known as ‘drones’. The draft resolution was subject to public participation. The new regulation, however, has yet to be issued by ANAC.
Despite the lack of regulation, revenues for the drone market in Brazil for 2016 are expected to reach R$ 200 million. Most of these revenues are expected to be generated by a fragmented market of small and medium-sized businesses.
São Paulo held the DroneShow Latin America fair in May 2016, which was attended by 3,200 people and 52 exhibitors, most of the them small and medium-sized importers, manufacturers, and drone-related service providers.
8. Legal issues in the “lease-to-part out” market. A major market development is the interest of investors purchasing mid–end life aircraft on lease for the purposes of making returns on a leasetail and component margin model. What challenges are inherent in this segment of the aviation finance market, and what techniques and disciplines are required to manage the risks involved?
The “lease-to-part out” model is in fact a new product for aviation investors to observe. Due to new technologies and aircraft efficiency, the number of aircraft to be “out-of-market” within the next two decades is extremely high and the possibility to turn airframes into spare parts and assign engines to airworthy and operating airframes (or to be used as a spare part for another engine) is a reality.
In Brazil, we have seen airlines undergoing bankruptcy processes dismantling grounded aircraft to benefit from the existing and useable parts. We have also seen aircraft abandoned by bankrupt airlines in airports for years, such as the B727 operated by Varig Linhas Aéreas at GIG – Rio de Janeiro. These were later sold to metal companies for an insignificant value, as depreciation had already consumed the entire aircraft.
The main legal issue to be faced in Brazil would be import/export procedures and related taxes. Airlines based in Brazil benefit from the Special Regime of Temporary Admission, where import taxes are suspended, as long as the aircraft is not permanently imported (“nationalised”). In this case, there are also no taxes on the lease payment (except for capital gains taxes, when applicable). For this reason (tax), the necessary spare parts and engines are (in most cases) leased to Brazil (by a foreign lessor) and subject to the same regime.
This means the “lease-to-part out” market for a Brazilian entity (acting as a “part-lessor”) is still complicated. The import taxes (II, IPI, ICMS, PIS/COFINS) and the local taxes (IRPF, ISS, PIS/COFINS) reach very high levels and it is very unlikely that a local lessor would be competing with a foreign company with better tax incentives. The certification process for the “part-lessor” to work on the aircraft and parts, and the certification of the spare part itself, are handled by the Civil Aviation Agency and subject to the criteria provided by the IATA rules, under the proper international standards.
On the other hand, a foreign “part-lessor” may explore a large market in Brazil. The Brazilian airline fleet is mainly composed of popular narrow-bodied aircraft (B737 and the A320 family), fully distributed worldwide through their many product generations, and many opportunities could arise for the delivery of airframe and engine spare parts.
Such foreign “part-lessor” delivering parts and equipment in Brazil must pay attention and be made aware of the import/export taxes and the Central Bank regulation for remittance of funds into and out of Brazil.
A proper lease agreement, with the required provisions necessary for it to be a lease agreement, must be put in place with the Brazilian party, allowing its registration with the Brazilian Central Bank, the Customs Authorities and the Aviation Authority.
9. Manufacturer support in the new cycle of new OEM products, e.g. MRJ, E2, C-series, etc. In an increasingly sophisticated and competitive environment, in what way is the type of OEM financial and product support for this new era of aircraft more complex and far-reaching than in previous cycles?
It is likely that no great changes shall occur in relation to financing of such new products from a Brazilian perspective. General financing of such products (i.e. corporate jets) in Brazil are commonly limited to wealthy individuals with a solid relationship with financiers. The collateral serves as security for the financing, however, under a simplified financing structure. The new OEM products are likely to impact existing aircraft’s residual value and create a certain amount of instability in financing and financiers’ appetites, as we are already seeing with used aircraft in the market. The contractual structure, however, should not be affected and will continue to aim to shield the lessors and financiers as much as possible.
10. The advent of cheaper oil and the knock-on effects. What are the consequences that arise as a result of the unexpected purchasing power of a number of third/fourth-tier airlines? What will challenge lessors and suppliers in particular as they are faced with speculative judgments on an airline's longer-term financial viability?
Oil has not actually become cheaper in Brazil lately. Its costs are normally comparatively higher in Brazil, mostly due to taxation, and represent 38% of the operational expenses against an average of 28% for the rest of the world.
Other factors also contribute to keeping the prices high (e.g. as the Brazilian Real has devalued, it is now more expensive to import oil; the freight costs to transport oil are not low either), but taxes represent the largest impact.
The airlines have long been pushing the Brazilian authorities to obtain tax benefits. VAT rates may reach 25% depending on the State, and airlines are pushing the government to set a 12% cap on VAT nationwide.
11. Iran and the market return. What remain as barriers, including sanctions-related issues to navigate, where Iran and aerospace and aircraft transactions are concerned? What sort of jurisdiction is Iran from a risk perspective, and what techniques from a supply perspective are likely to be needed so that Iran's potential and promise for OEMs, lessors, suppliers and service providers is realised and does not become the latest example of a disappointing gold rush?
The only information currently available in Brazil regarding Iran and the market return is that Iran Air ordered 50 aircraft to Embraer after sanctions were lifted last January. In this respect, the scenario therefore seems to be very optimistic.