The Sky Is Not Falling!

In the wake of the lease accounting and tax code overhauls, there are more reasons than ever to lease and finance equipment.

ASC 842 (“Leases”) has become effective for larger companies with fiscal years starting after Dec. 15, 2018, and the Tax Cuts and Jobs Act was passed at the end of 2017. These are two major changes for the equipment finance industry and so far during 2019 we have not seen any major fallout from these two dramatic changes.

Think about it: The last major Tax Code overhaul was about 30 years ago and the last major lease accounting “overhaul” (if you call the formalization of lease accounting standards under FASB 13 an “overhaul”) was around 1977—about 40 years ago! For those of us who were in the industry when both of those changes occurred, we recall that they did not spell the beginning of the demise of the equipment finance industry. And in my opinion, neither will these two major recent events. In fact, if anything, they simply reinforce the core reasons for equipment leasing and finance in the first place!

Remember that one of the primary reasons for leasing is the need for capital to acquire assets to continue to run businesses. And by business we mean the business of commerce, the business of shipping goods, the business of providing services by various governments, the business of generating alternative energy, the business of transportation, the business of providing healthcare and the business of providing infrastructures, to name just a few.

The last major Tax Code overhaul was about 30 years ago and the last major lease accounting “overhaul” was around 1977—about 40 years ago!

So to remind everyone that one can make an entire career out of equipment leasing and finance even starting today, we are going to restate the obvious!

Benefits of Leasing and Structured Finance Remain

A majority of U.S. businesses finance some of the acquisition of the usage of their assets using leasing or a structured financing solution akin to leasing, such as a power purchase agreement or an energy services agreement.

Let’s briefly look at some of these reasons to remind ourselves and our customers why they should continue to use these products to finance their businesses!

• Tax management – Leasing and structured financing allows users to more efficiently manage some of their federal income taxes. When entities cannot efficiently utilize all the tax deductions or credits on a current basis or even at all (for instance tax-exempt entities), financiers are often able claim the benefits and share them with the user via lower rental payments or power rates. For instance, virtually all wind and solar installations are financed using some transfer of the tax credits and deductions to an entity that can more efficiently use them. Many of these installations provide reduced-cost power to entities otherwise not able to use them, including tax-exempt entities. Also, under the new limitations for currently deducting interest expenses (currently limited to 30% of tax EDITDA), leasing an asset or buying the power rather than financing it with debt avoids the incurring of interest expense. Therefore, the new Tax Code makes tax leasing and structuring financing more beneficial than ever.
  
  
• 100% financing – Both leasing and structured financing generally provide for 100% of the financing of the assets being acquired. Most entities finance purchased assets using a combination of expensive equity along with debt. An industrial company may assume a 40-50% or more equity portion and the remainder in debt. The equity buffers a lender from loss should the business fail. Rather than needing to use this costly equity to buffer a lender from the risk of loss, leasing and structured financing assume the full risk of ownership of the asset.
  
  
• Financial reporting – Compared to reporting 100% of the value of an asset on their balance sheet, leasing and structured finance still enable a user to utilize an asset and only report the portion that they have committed to use. Often only 60-70% of it is reflected on the user’s balance sheet. This reduced balance sheet reporting provides for improved return on investment and return on assets compared to a loan, simply because the entity does not report 100% of the asset’s value. Additionally, under ASC 842’s accounting for a capitalized operating lease, the rent expense is still level compared to the front-end loading of expenses reported with ownership financed by a loan.
  
  
• Remaining more current with technological innovations – Lessees can remain more current with technology by acquiring and upgrading equipment more frequently compared to loan financing. Manufacturers of assets constantly improve models to sell the next generation of assets, either by lowering the cost of ownership (think improved fuel mileage and reliability and reduced maintenance costs) or providing greater technological advances (such as greater resolution produced by MRIs and CTs). Lessees avoid the residual risk of the asset at the end of its usage because the lessor assumes that risk. Leasing enables entities to acquire the usage of these newer, more advanced assets without dealing with the remarketing of the older assets. Just like with a car lease, they simply return the asset at the end of the lease.
  
  
• Cash flow management – Leasing often provides for lower, more manageable and flexible payments compared to a loan. Lease payment structures and power purchase agreements are notably more flexible than loans. The Tax Code allows for rent holidays as well as non-uniform rent payments and as such most leasing companies are geared towards providing much more flexibility with regards to payment plans. Because leasing also funds specific identified assets, it allows an entity to utilize general debt sources for financing those items not otherwise easily financed, such as sales development or research and development expenses.

As organizations implement ASC 842 and analyze the implications of the Tax Cuts and Jobs Act, the leasing professional may assist by reminding them of the benefits of leasing from a financial reporting, economic and tax perspective. It is time to show them again why leasing continues to make good business sense!

Disclaimer - The views expressed here are that of the author and not of the organizations or entity that the author works with or for. The author is not providing tax, accounting, legal or business advice herein. Any discussion of U.S. tax matters is not intended or written to be used by any taxpayer for the purpose of avoiding U.S. tax-related penalties. Each taxpayer should seek advice from their own independent tax, accounting or business adviser.