“"Not everything can fly. We will not install a swimming pool or a fireplace. That is not possible."”
One seemingly enticing opportunity for business jet owners presented by the Federal Aviation Regulations (FARs) is the interchange agreement. The rule lets you "interchange" your jet with someone else's, allowing you, in the FAA's words, "to augment or more fully utilize" your aircraft. Ideally, the interchange would maximize use of both jets, and in many cases allow you to target a more appropriate aircraft for a given mission.
The origin of the interchange idea requires explanation. Unless your airplane is on a commercial certificate, you ordinarily can't use it to provide transportation in exchange for compensation. You could lease it to someone who provides his own pilots, but if you furnish the airplane and even one crewmember and compensation is involved, the FAA will deem the flight commercial. Traditionally, this was true even if the compensation wasn't money; it could have been any valuable benefit, including your passenger providing you with transportation on his aircraft. In other words, trading time on your aircraft for time on someone else's required a commercial certificate from the FAA.
But then in 1972, when the agency recognized that these time-trading arrangements were going on, it decided to legalize them. Because the FAA had been using the term "time sharing" to refer to a quite different arrangement, it chose to call the arrangements "interchanges." According to FAR 91.501, in an interchange agreement, "a person leases his airplane to another person in exchange for equal time, when needed, on the other person's airplane, and no charge, assessment or fee is made."
That sounds simple. But say I'm trading time on my Global 5000 for time on your Cessna Citation Bravo. The hourly operating cost (never mind the fixed costs) is almost four times higher for my Global than for your Bravo, so if we trade hour for hour, you're making out like a bandit.
Luckily, the FAA took this problem into account. In an interchange agreement, the agency lets me charge you an amount "not to exceed the difference between the cost of owning, operating and maintaining the two airplanes." That can clearly mean more than direct operating costs.
However, the FAA's largess has confused many jet owners. Say hourly flying costs are $10,000 for my Global and $2,500 for your Bravo. We sign an interchange agreement in which I fly 10 hours on your Bravo and you fly 10 on my Global. Since my Global costs four times more to operate than your Bravo, I just bought the most expensive Bravo flight time in history. But here's what saves the day: Our interchange agreement can provide that you pay me the difference between the cost of owning, operating and maintaining the two aircraft, which in this case will be $75,000 ($7,500 per hour times 10 hours).
Now let's change the example slightly. Suppose you fly five hours, not 10, on my Global during the term of our agreement. The FAA's true-up provision still lets you adjust for the hourly cost difference for those five hours but not for the fact that you flew only five hours. At the end of the deal, you're just out of luck. I sometimes think that's exactly what makes interchange agreements work for the FAA: it's hard to think of such a bad deal as providing compensation.
To show how serious the FAA is about this, consider its response to an aviation lawyer who recently asked the agency whether a deal that begins as an interchange agreement "could legally be converted into a time-sharing agreement if there was a usage differential between the two lessees." In my example above, because you didn't use all the hours you were entitled to, you'd have the right to lease my Global under a time share (and pay two times the fuel expense of trips, plus incidental expenses permitted by the FAA) for some number of hours. This isn't exactly a great deal for you, since instead of getting free hours, you have to pay for them, but if you can time share enough hours, it might be worth it. At least, it's better than forfeiting the unused interchange hours.
But that's just what the FAA wants you to do. Responding to the lawyer, the FAA said that letting the parties convert an interchange into a time-sharing agreement "would defeat the purpose" behind the lines it had drawn.
The lesson here may be to avoid the conundrums of the interchange agreement altogether by entering into back-to-back time-sharing agreements. Such agreements will often produce a fairer result, though if both parties to an interchange really do use each other's aircraft for the same number of hours, the "true-up" provision should make the deal equivalent for both parties.
Time-sharing agreements also offer a tax advantage. The federal 7.5-percent transportation excise tax is due on interchanges, but how do you calculate it? In a private ruling, the IRS suggested that the tax applies to a flight's "fair market value." (Similarly, an IRS Audit Technique Guide says the tax is due on "the fair market value of the barter as well as any payment made.") This could be a big number. For this reason, reciprocal time-sharing agreements, under which the "amount paid" is limited to two times fuel and certain incidental expenses, may be the wiser choice.