In an agreement to ensure the survival of the troubled regional carrier, ministers allowed Flybe to defer payment of Air Passenger Duty (APD).
There will also be a review of the tax on domestic flights.
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The chancellor, Sajid Javid, said: “The reviews we are announcing will help level up our economy. They will ensure that regional connections not only continue but flourish in the years to come – so that every nation and region can fulfil its potential.”
IAG, which owns British Airways, Aer Lingus and Iberia of Spain, is challenging the deal under EU state aid rules.
Although the firm is not revealing details of its complaint, The Independent understands it will argue that Flybe will gain an unfair advantage through the deferral of tax – which amounts to state aid.
The government has allowed the troubled regional airline to defer handing over up to £100m in APD that has been collected from passengers but not yet passed on.
The arrangement, says IAG, will harm rivals in two ways.
The first is on direct competition on some routes, such as London City to Edinburgh, on which British Airways goes head-to-head with Flybe.
Aer Lingus is also a direct competitor on some links.
The second concerns the consortium that has taken over Flybe. It is led by Virgin Atlantic, BA’s long-haul rival. The complaint says that the alleged state aid will allow Flybe – or Virgin Connect, as it will soon become – to enhance feed to Virgin Atlantic and Delta routes at Manchester airport.
The European Union rules prohibit government support of companies unless it is justified by reasons of “general economic development”.
State aid is defined as “an intervention by the state or through state resources which can take a variety of forms (eg grants, interest and tax reliefs)”.
But the EU concedes: “In some circumstances government interventions is necessary for a well-functioning and equitable economy.”
Meanwhile, a Labour Party spokesperson said: “The support for Flybe appears to be corporate welfare for one individual company that is not part of an industrial strategy that would support jobs, regional economies and environmental sustainability.
“Jeremy Corbyn and the Labour party have been arguing for years that we should have a far more active government role intervening in the economy, setting a strategic direction and providing an industrial strategy. That should be done in a serious and strategic way, not as ad hoc welfare which once again benefits Richard Branson.”
Asked if it was a “bung for Richard Branson”, the spokesman said: “Yes.”
The Rail Delivery Group has also responded to the deal. John Thomas, the director of policy for the train operators’ body, said: “Any review of Air Passenger Duty that encourages more people to fly domestically would limit efforts to tackle the climate crisis.
“Rail companies are working together to deliver £20bn investment this year to run more and improved services.
“Analysis of our fares reform proposals shows that we can prevent an extra 1.2 million tonnes of CO2 emissions.”
The Department for Transport (DfT) said in a statement: “In a sign of the Prime Minister’s commitment to levelling up all regions of the UK, a review of regional connectivity will ensure all nations and regions of the UK have the domestic transport connections local communities rely on – including regional airports.
”As part this work and ahead of the March Budget, the Treasury will also be reviewing Air Passenger Duty to ensure regional connectivity is strengthened while meeting the UK’s climate change commitments to meet net zero by 2050.”
Darren Shirley, chief executive of the Campaign for Better Transport, said connectivity improvements should focus on sustainable transport: “Better bus and rail connections, including reopening disused rail lines and stations, and better connections with a new generation of transport interchanges will bring social, economic and environmental benefits to communities across the country.”