Navigating China’s Aviation Market and Free Trade Zones: Key Opportunities for Lessors and Lenders

Projected to jump from second largest to the largest aviation services market in the coming decades, the civil aviation market in the People’s Republic of China has been bolstered by various recent and anticipated developments, including the region’s expanding free trade zone network and the projected announcement of Civil Aviation Law amendments in 2026 bringing regulatory clarity, among other advancements.

The civil aviation market in the People’s Republic of China (PRC) currently stands as the second largest globally, with rapid growth in fleet capacity, passenger numbers, and air routes contributing to an industry that the International Air Transport Association expects will surpass the United States as the world’s largest aviation services market by 2043.

While international passenger volumes continue to remain below prepandemic highs, year-on-year traffic in the domestic market has surpassed 2019 levels despite competition from a growing high-speed rail network and resolute downward pressure on airfares.

Supporting these developments is an aviation finance industry buoyed by two key trends:

• The dynamism of the PRC’s free trade zones (FTZs), which continue to offer foreign lessors and financiers with access to attractive fiscal incentives and logistics efficiencies
• The anticipated announcement in 2026 of welcome regulatory clarity as the revised Civil Aviation Law proposes to codify the existing legal framework for aviation finance

The success of state-led infrastructure projects, which include the ongoing construction of new airports in Guangzhou, Xiamen, and Shanghai, alongside the expectation that the PRC will more than double its commercial aircraft fleet by 2043, provides a strong foundation for the aircraft leasing industry and other foreign exporters who are well positioned to market their maintenance, repair and overhaul (MRO), ground support equipment (GSE), and technology services.

FREE TRADE ZONES

The Regulatory Architecture

The process for establishing a special purpose vehicle (SPV) for aircraft leasing within an FTZ in the PRC is divided into two parallel regulatory tracks:

• NFRA-Regulated Lessors: This track applies primarily to banking-associated lessors. These entities were supervised by the China Banking and Insurance Regulatory Commission prior to its replacement in 2023 by the National Financial Regulatory Administration (NFRA)
• MOFCOM-Regulated Lessors: This pathway applies to non–banking associated lessors regulated by the Ministry of Commerce (MOFCOM), or the local FTZ administrative committee that functions as a delegated authority

The NFRA’s activity since its establishment reinforces its commitment to promoting leasing products which are subject to appropriate corporate governance and risk management. The proposals set out in the consultation paper “Measures for the Administration of Financial Leasing Companies,” which the NFRA published on 5 January 2024 and which entered into force on 1 November 2024, were designed to raise the barriers to entry for leasing companies as well as improve transparency across the industry.

As an example, banking-associated lessors are required to have a minimum registered capital of one billion yuan, whilst a further requirement for incorporation is the establishment of effective corporate governance, internal control, and risk management systems.

Taken together, these measures are designed to improve the credit profiles of in-scope lessors, promote greater responsibility by major shareholders towards their leasing subsidiaries, and ultimately support the long-term growth of these platforms in the PRC.

Establishing SPVs in the FTZs

NFRA-Regulated Lessors

An SPV that has been established in an FTZ for asset management or leasing transaction purposes is not required to obtain a separate licence from the NFRA to conduct such activity if the SPV

• exists solely to finance individual aircraft or asset portfolios;
• does not independently source customers or provide financial services; and
• is consolidated into the accounts of its parent company.

If these conditions are met, only the parent leasing company is required to be licensed to conduct asset management and leasing activity.

MOFCOM-Regulated Lessors

Incorporating a MOFCOM-regulated SPV is typically the preferred pathway for foreign lessors seeking to establish an onshore platform within the PRC. In contrast to an NFRA-regulated SPV, which qualifies as exempt from the need to secure regulatory licensing, a MOFCOM-regulated entity must obtain the approval of the relevant FTZ administrative commission which acts as the supervisory authority under MOFCOM’s delegated authority.

The steps taken to gain such approval are as follows:

• The initial preapproval and feasibility phase involves determining whether the FTZ in question has included aircraft leasing on its “negative list.” The “negative list” provides a record of the industries in which foreign investment is restricted or prohibited.
• The constitutional and foundational documents—to include the articles of association, the resolution of the parent company authorising the incorporation of the SPV, and relevant shareholder information—are prepared and submitted to the local FTZ administrative commission.
• Upon approval, the administrative commission will issue the business licence, thereby evidencing the formal legal existence of the SPV.
• Once the business licence has been secured, the SPV must complete post-incorporation registrations and filings:
  • Registering with the local tax authority to obtain a taxpayer identification number and confirm eligibility for the reduced VAT and CIT regimes
  • Registering with the State Administration of Foreign Exchange, allowing the SPV to open foreign-currency accounts and receive capital via pooling its parent company’s foreign debt quota
  • Opening a domestic and foreign currency bank account to facilitate the subsequent drawdown of any loan
  • Registering with the local branch of the General Administration of Customs to allow the SPV to submit import declarations, bonded-zone applications, and lease-related customs documentation

Commercial Benefits

The PRC has pursued a strategy of expanding its FTZ network beyond the initial four zones (Shanghai, Tianjin, Guangdong, and Fujian) established between 2013–2015, creating a broader network that now encompasses 22 FTZs and one separate Free Trade Port in Hainan, all of which are located in a different province or autonomous region.

Whilst the advantageous tax, administrative, and regulatory treatments differ between zones, aircraft lessors that establish platforms in an FTZ are able to benefit from the costs and logistics efficiencies offered by these preferential regimes:

• Reduced Import Value-Added Tax: For aircraft with an empty weight exceeding 25 tonnes which are imported by the FTZ-incorporated SPV and leased to a PRC airline, the import VAT is often significantly reduced.
• Corporate Income Tax Incentives: Certain FTZs offer a reduced CIT rate for entities operating in “encouraged” industries, such as financial leasing.
• Withholding Tax on Rental Income: When a foreign lessor directly leases to a PRC airline via an offshore entity, the rental payments are typically subject to WHT. By using an onshore SPV incorporated in an FTZ, the lease rental payments from the PRC airline to the onshore SPV are generally not subject to WHT in the PRC.
• Foreign Debt Quota Sharing: To assist with accessing overseas capital for the financing of aircraft acquisitions, FTZ-incorporated SPVs may be able to share the foreign debt quota of their parent company. This allows the corporate group to use the credit rating and larger capital base of the parent company to finance multiple aircraft purchases through small SPVs.
• Simplified Customs Regimes: FTZs are considered special customs supervision areas, offering a “bonded” environment which suspends or defers the requirement to pay duties or taxes while the aircraft or equipment remains in the FTZ. Import duties and taxes are only triggered once the asset is released from the FTZ and into the PRC.

The two most established FTZs for the incorporation of SPVs for aircraft leasing in the PRC are Tianjin and Shanghai (Lingang Special Area). Known for having accumulated the highest numbers of aircraft-leasing SPVs and the largest volume of leased aircraft, these SPVs benefit from a mature policy environment and compelling fiscal and financing incentives.

PROPOSALS TO REVISE THE CIVIL AVIATION LAW

The amended Civil Aviation Law is expected to enter into force in 2026, marking a significant step in the codification of the legislative architecture governing the aviation finance industry. Historically, aviation finance in the PRC was governed by a multilayered, fragmented framework due to the former Civil Aviation Law not containing a comprehensive regime for aircraft mortgages, leasing structures, repossession remedies, or aviation-specific security rights.

As a result, lessors and lenders relied on a patchwork of administrative measures issued by regulators and general principles of domestic contract law. The absence of a coherent statutory regime was further compounded by the PRC’s treatment of the Cape Town Convention (CTC), which involves requiring that any remedy obtained under the convention must first be approved by a local PRC court before its implementation.

This approach to the CTC’s self-help remedy mechanism, which allows creditors to exercise certain rights without obtaining leave of the courts, hinders lenders from drawing comfort from widely accepted repossession processes in a default scenario.

However, the codification of the patchwork legal system provides the market with greater certainty and a more robust legal foundation, especially in relation to the rights registration system. Lenders relying on aircraft as collateral will welcome the predictability that such revisions shall bring.

The headline points of particular concern for lessors and lenders contained in the proposed draft are:

• An explicit definition of a financial lease that clarifies and clearly distinguishes between the lessor’s ownership rights and the lessee’s possessory rights
• A reinforcement of the requirement that aircraft ownership, rights under a lease exceeding six months, and mortgages are to be registered with the Civil Aviation Administration of China (CAAC)
• A reaffirmation of the principle that unregistered interests cannot be asserted against a bona fide third party. CAAC registration remains the primary and authoritative registry for aircraft ownership, long-term leases and mortgages

CONCLUSION

As the PRC’s civil aviation industry continues to recover strongly post-pandemic, with state-backed infrastructure investments and growing air traffic in Asia Pacific contributing to sustained consumer demand, lessors and lenders operating in the various FTZs are well positioned to benefit from the market’s optimistic outlook.

While lingering concerns remain, particularly with regard to airline overcapacity and domestic competition from the high-speed rail network, foreign lessors and exporters can expect continued demand from carriers for new aircraft, as well as MRO and GSE services, as the PRC is projected to show continued fleet growth over the next two decades.

Trainee solicitor Arthur Graham contributed to this Insight.