Of Vat refunds and cabotage rules:

 - May 15, 2008, 7:13 AM

Cabotage is: (a) a cabbage soup popular in Russia; (b) the age of a guy named Cabot; (c) the transport of a paying passenger from one point to another within the same country by a foreign carrier. If your answer was (c), congratulations. But if you were not aware that U.S. cabotage rules apply to all foreign-owned business aircraft, and even some U.S.-registered business aircraft, “you are the weakest link.”

Of course, the rules of the popular television game show “Weakest Link” are far more lenient than those of the U.S. government. Instead of simply pleading ignorance and walking off the set with nothing, by violating the rules of cabotage you may instead end up owing the government a penalty equal to $1,100 for each passenger violation.

Cabotage originated in Portugal, in the age when Spanish sailing ships en route between northern and southern Spain would stop at Portuguese cabos, or capes, to pick up and drop off paying passengers and cargo. Portuguese shippers, rightly figuring that such actions cut into their own commercial profits, cried foul. And so the practice, aptly called cabotage, was outlawed.

With the growth of international air travel that followed World War II, cabotage became a subject of much discussion with regard to aviation. In 1944, representatives of 52 nations met in Chicago with the intent of producing a liberal, multilateral “free skies” agreement. While eight “freedoms of the skies” were listed, only the first two received widespread acceptance. As for the last freedom on the list, “The right of an airline to carry traffic between two points within the territory of a foreign state,” it found few advocates and no consensus agreement.

Today, virtually every country in the world has and enforces its own rules of cabotage, for the most part with regard to commercial shipping and airline service. Regarding aviation in the U.S., the Department of Transportation defines cabotage as “the carriage of air traffic that originates and terminates within the boundaries of a given country by an air carrier of another country.” And it adds, “Rights to such traffic are usually entirely denied or severely restricted.”

Gary Garofalo, an aviation attorney with the law firm of Boros & Garofalo in Washington, D.C., warns that while this definition–essentially protectionist in nature–is applied primarily to foreign airlines, it is also applicable to foreign-owned business aircraft and may under certain conditions be applicable to N-number U.S.-registered aircraft.
FAA and DOT Define Remuneration

In simple terms, a foreign-owned business aircraft may not transport passengers for “remuneration” or “hire” from one U.S. point to another U.S. point. To that end, the DOT interprets “remuneration” or “hire” in the same broad manner that the FAA interprets “compensation” or “for hire.” That would be essentially any exchange of value, such as cash, aircraft time or inter-company chargeback. Even limited cost recovery in the case of time-share programs is considered remuneration.

But as for the term “foreign-owned,” DOT has a different perspective. Key under the DOT Title 14 of the Code of Federal Regulations Part 375 is the description of foreign civil aircraft, which includes both foreign- and U.S.-registered aircraft that are “owned, controlled or operated by persons who are not citizens or permanent residents of the United States.”

As to the establishment of ownership, Garofalo, in an article for NBAA Digest, pointed out that a company may assume that it is “a U.S. aeronautical citizen” for a variety of reasons, which might include its incorporation in a U.S. state or being headquartered in the U.S. For some companies, however, the assumption may be incorrect, at least as far as the DOT is concerned. From the department’s perspective, said Garofalo, companies may be considered “foreign,” depending upon where they are incorporated, whether they are owned or controlled by U.S. citizens, or whether the company president or other key personnel are U.S. citizens.

Garofalo warns that it may be even more complex. For example, he said, U.S. cabotage rules do not apply to a foreign-owned aircraft that is dry-leased to a U.S. client. As for wet lease of a U.S.-owned aircraft by a foreign client, cabotage rules would apply, except that FAR Part 119 prohibits such a transaction, making cabotage application a moot point.

In general, U.S. cabotage rules do permit a foreign-owned aircraft “stop over” privileges. This allows a passenger on a foreign-owned business aircraft to make a stop in New York and remain for two or three days, then continue on to another point within the U.S.

Violating the Spirit of the Law

Not surprisingly, some operators–foreign and domestic–have found a way around the cabotage rules as applied in both the U.S. and Canada. For example, a French company might fly members of the company’s board of directors from Paris to New York in its own business jet. Knowing that picking up additional passengers in New York and transporting them on to Chicago would violate the rules of cabotage, the pilot flies from New York to Toronto, clears Canadian customs there, and then goes on to Chicago.

There are also reports that some foreign-owned (non-Canadian) business aircraft operators will make a U.S. stop en route to avoid going directly point-to-point in Canada and breaking that country’s cabotage rules.

Those violating cabotage in Canada should be aware that fines (referred to by Canadian officials as “permit fees”) can be staggering compared to those levied against violators in the U.S. “The fine might equal 10 percent of the hull value of the aircraft, and they may also impound the airplane,” said Eric Ramsdell, manager of safety and operations at NBAA and former director of international operations for a well traveled Fortune 500 flight department.

Ramsdell emphasized that while such practices may avoid violating the rules of cabotage, neither he nor NBAA recommends them. “Certainly it violates the spirit of the law, if not the law itself.”

As for the DOT, a spokesman made it quite clear that while those practicing such subterfuge may believe it to be legal, the department does not. “The intent is to carry those passengers from one point in the U.S. to another point in the U.S. We would consider that a violation of cabotage.”

In an NBAA guest editorial, “Beware Part 375–A Trap for the Unwary,” on the association’s Web site, Garofalo addresses the matter of aircraft owned by U.S. companies and suggests that any such company operating its aircraft under Part 91 ask the following questions:

• Is the company that owns the aircraft incorporated under the laws of a U.S. jurisdiction? A U.S.-registered aircraft is a “foreign aircraft” if the company that owns, operates or controls the aircraft is incorporated offshore.

• Is the company itself owned by a non-U.S. citizen? A company incorporated in the U.S., with operations in the U.S., is not a U.S. citizen if it is the subsidiary of a non-U.S. citizen company. Under aeronautical laws and regulations, a company normally is considered U.S.-owned if the following conditions are met: at least 75 percent of its voting stock is owned and controlled by U.S. citizens; or at least 51 percent of its voting stock is owned and controlled by U.S. citizens.

• Is the president or the individual who manages and controls the company a U.S. citizen, and are at least two-thirds of the managing officers and directors also
U.S. citizens? If not, the corporation is considered “foreign” under DOT rules. Ultimate control of the company must be in U.S.-citizen hands.

The bottom line, Garofalo pointed out, is that if a company is not a U.S. citizen, its aircraft is therefore a foreign civil aircraft and the company forfeits the benefit of nearly all the flexibility created by Part 91 Subpart F.

For example, he explained, affiliated group operations under FAR 91.501(b)(5) permit the company operating the aircraft to charge back expenses to its parent or subsidiary on a fully allocated cost basis. The DOT, however, considers such operations to be fundamentally “commercial” since they involve an exchange of remuneration, no matter how limited, and therefore subject to the rules of cabotage.

The sole exception to the above is in the case of sales demonstration flights. Here, the DOT rationale appears to be based on a carefully limited reimbursement allowable for sales demonstration flights. This is described as “essentially out-of-pocket costs plus an additional charge equal to 100 percent of the fuel costs.” And while this should, said Garofalo, apply to time-share arrangements–the cost-recovery formula for time-sharing being exactly the same as for sales demonstration flights–“it doesn’t.”

According to Garofalo, there is little doubt that “some of NBAA’s member companies, believing themselves to be U.S.-owned, have unknowingly violated DOT Part 375 and its cabotage restrictions.”

According to association sources, NBAA, with sufficient support from its members, might encourage a change to the Part 375 cabotage rules as they apply to business aviation. Until then, concluded Garofalo, “the alternative for affected companies is to forego chargebacks and all or other forms of remuneration…or run the risk of discovery and a substantial fine.”

What are the chances of getting caught? Probably minimal in the U.S. Immigration officials (U.S. State Department) have their own particular agenda, as do customs officers (U.S. Treasury Department). By all accounts, representatives of either agency are not particularly anxious to take on the responsibility of checking for cabotage violations in the interest of the DOT.

If caught, said an aviation attorney, expect to be fined. But he also noted that any subsequent violations by the same operator might be regarded more seriously, prompting the DOT to seek a legal injunction against the violator. Any violation thereafter by that operator would see the repercussions raised to a more painful threshold.