The recent Budget contained a small but sensible and welcome change. In future the VAT exemption will only apply the commercial aircraft used on international routes. See Treasury note.
To be more precise, under the current law, the supply, repair, or maintenance, of an aircraft is zero-rated for VAT purposes if it weighs 8,000 kg or more, and is not designed or adapted for recreational or pleasure use. This has allowed many large private aircraft to enjoy zero rating, but was more generous than the European legislation permits.
Following a formal request from the European Commission, changes will be made on or after 1 January 2011 to align the domestic VAT legislation with the European VAT rules. From that date, an aircraft will be zero rated only if it is used by a commercial airline operating on international routes, regardless of weight.
Airlines using aircraft on domestic flights will have to pay VAT but, since air fares are still VAT-free, will be able to claim it back. The impact will be on the larger planes used privately where VAT cannot be reclaimed.