The IRS released a “field service advice” in late November in which it told the agent handling the audit to disallow the tax benefits claimed by the lessor.

An ownership FSC is a form of cross-border lease where an aircraft or other equipment is leased by a US lessor to a foreign lessee. The transaction is structured to take advantage of US foreign sales corporation rules that allow the US lessor to avoid having to report up to 30% of the rents as income. In the meantime, the lessor also has tax depreciation and interest deductions to claim from the transaction.

Roy Meilman, a leasing expert at Chadbourne, said “there are the usual deletions and the facts are a bit garbled, but it seems fair to say that the transaction structure under audit was substantially more elaborate than in a standard OFSC transaction.” For one thing, the transaction involved defeasance arrangements, which are atypical in a FSC lease. The IRS focused on a right the lessee had to buy the airplane at the end of the lease for a fixed price. It concluded that the transaction had been structured to make exercise of the purchase option a foregone conclusion by the lessee so that the lessee should be viewed as owning the equipment for tax purposes from inception. The IRS position is explained in FSA 200145002.