BUSINESS LEASING NEWS
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BUSINESS LEASING NEWS |
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From: David G. Mayer, a business transactions partner of the law firm of Patton Boggs LLP and author of the book, Business Leasing for Dummies (BLFD)®. The books is out of print, so if you want to find a copy, please search the web today! Thanks for buying my book for two great years. This e-newsletter will be offer timely, concise information and analysis backed by supporting research. Please contact Business Leasing News (BLN) to provide us with your feedback. Thanks for taking your valuable time to read BLN—which does more than just report the news. |
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1. New Treasury Proposal Would Crush Leasing to Tax-Exempt EntitiesIn its continuing efforts to shut down what it considers to be abusive tax shelters and put the brakes on the ballooning budget deficit, the Treasury Department has included proposals in the administration's fiscal year 2005 budget that could crush certain types of long-accepted leasing to tax-exempt entities. See Treasury's proposal at page 124. Tax-Indifferent Parties Affected The proposal would apply new rules to leases with "tax-indifferent parties." Tax-indifferent parties would include federal, state, local and foreign governmental units, charities and foreign entities or persons. The proposal does not specifically reference tax-exempt nonprofit organizations other than charities, but it is likely that Treasury intends to include virtually all tax-exempt entities. As a result, trade associations and other large organizations like NRA, AARP and labor unions would likely be adversely affected by the proposal. Current Depreciation Under Attack Under present law, the recovery period for property leased to a tax-indifferent party is the longer of the property's assigned class life under the Internal Revenue Code or 125% of the lease term. Although computer software and qualified technological equipment (QTE) have long been exempted from this slower depreciation scheme, the Treasury proposal would eliminate the exemption from this rule. The proposal would also require that service contracts and other similar arrangements occurring after the end of a lease of property to a tax-indifferent party be taken into account in determining the lease term. See: Cost Recovery Deductions for Tax-Exempt Use Property: The Historical Context by the ELA. In a much more dramatic change, the Treasury proposal would limit a taxpayer's deductions or losses related to certain types of leases to tax-indifferent parties to the taxpayer's income from the lease (income limit). In effect, the passive loss rules would be applied on a lease-by-lease basis to all kinds of lessors. *Technical Point: A lessor's disallowed deductions would be carried forward and treated as deductions in the next year subject to the same limitations. Like the passive loss rules, the proposed rules would allow a lessor to claim any unused deductions when it disposes of the leased property. Affected Lease Transactions The income limit would apply to a lease to a tax-indifferent party if it has any of the following characteristics:
*Example: A university may finance student housing with tax-exempt bonds. Several years later, it could sell and lease back the property. In most cases, if the lessee used tax-exempt debt to acquire the property and then sold it, the debt would cease to be tax-exempt, but that is not always the case. The provision also would apply if a lessor financed a facility with tax-exempt debt and then leased it to a tax-exempt entity.
*Technical Point: Treasury would be permitted to issue regulations to allow monetizing up to 50% if the credit worthiness of the lessee would not otherwise satisfy the lessor's customary underwriting standards.
According to the budget proposal and earlier Treasury press releases ("Treasury Announces New Budget Proposals" "New Proposals Close Loopholes, Stop Abusive Tax Avoidance"), the proposal was intended to put a stop to so-called sale-in, lease-out or SILO leases with tax-indifferent entities. The typical SILO is described as a transaction in which: (1) no interruption or change in control occurs, (2) the lessee has an option to "repurchase" the property, and (3) a substantial portion of the lessee's rental obligations are defeased. (That is, the parties create a fund from proceeds of a sale of leased property to assure payments to the lessor). As written, the income-limit proposal goes well beyond capturing SILO transactions of the type described by Treasury. In fact, the income-limit proposal could apply to certain lease transactions that meet guideline criteria as true leases. See: Leasing 101: What are the "Tax Guidelines" and "Revenue Procedure 2001-28" Business Leasing News (June 2003). *Warning: The proposal is not limited to sale-leaseback or lease-leasebacks or to transactions in which there is a purchase option. The administration proposes a retroactive effective date to January 1, 2004. Lessors and lessees would therefore become subject to the proposals for leases entered into after December 31, 2003. However, the Treasury Department has indicated that it is willing to work with tax writers to address the retroactive effective date that would limit SILOs. House Ways and Means Committee Chairman William Thomas (R-CA) and Representative Jim McCrery (R-LA) have expressed concerns that the retroactive effective date of the SILO proposal could thwart legitimate leasing transactions. Proposal Hurts Lessees and Lessors In one of several statements issued by the Equipment Leasing Association (ELA), the ELA states that the proposal would potentially deprive tax-indifferent parties of the financial benefits of tax leasing, including obtaining needed cash through certain common sale-leaseback arrangements. See: Leasing Provides an Important Source of Financing for Cities. The administration's proposal to limit tax deductions from property used by tax-exempt entities is not new. Section 476 of the proposed JOBS bill (S.B. 1637) (the Jumpstart Our Business Strength Act) as reported in the Senate last year also includes provisions that would limit deductions from such property to the amount of income generated from such property. Further, Section 472 of the JOBS bill would treat service contracts as leases for purposes of similarly limiting depreciation benefits. See: Tax-Exempt Entity Leasing Takes a Sudden Hit from Tax Shelter Legislation Business Leasing News (December 2003). ELA Takes Action Describing the "extremism" of a "poorly-thought-out provision," ELA immediately and vigorously opposed the Treasury proposal and argued that it should be dropped. Lessors have routinely made billions in capital available to tax-exempt entities. States have already been hit hard by the slow economy and face $80 billion of deficits for 2004. See: Stingers: The 2004 State Tax Survey, CFO Magazine online (January 2004). ELA argues that the proposals would limit tax benefits available to their lessors and, in all likelihood, increase pressure on cities and other tax-exempt entities to further reduce the capital and infrastructure spending at a time when they desperately need to start to recover after the economic downturn. *Comment: Although budget deficits understandably require Treasury's attention, why is it that a tax-paying lessor should not be able to enter into a routine and long-accepted tax lease with a tax-exempt entity? See: Cost Recovery Deductions for Tax-Exempt Use Property: The Historical Context by the ELA. While the lessee may be tax-indifferent, the taxpayer-lessor is not. Lessors take the tax benefits and, based on market forces, share their tax savings with lessees, thus driving down the cost of capital for valuable capital expenditures by the lessees. The analysis is exactly the same for lessors for taxable lessee entities, such as private hospitals. Lessors pay taxes on their taxable income regardless of the lessee's tax bill. Moreover, lessors provide a source of funds to many cash-strapped tax-exempt entities that have few, if any, other source of capital for infrastructure and capital asset programs. If the Department of Treasury is concerned about defeasance structures, it should limit the scope of its income limit proposal to defeasance structures without regard to the status of the lessee. As proposed, the Treasury proposal seems to raises tax revenue on the back of tax-exempt entities rather than target truly abusive aspects, if any, of leasing to tax-indifferent parties. Some Deals Unaffected At least one group of lessors in certain tax-exempt leasing transactions seems to be unaffected. According to the Association for Government Leasing & Finance lessors who enter into typical Section 501(c)(3) and municipal lease-purchase transactions do not take the tax benefits and therefore would be unaffected by the Treasury proposal. Lessors and lessees alike who participate in this market should consider taking immediate action on the JOBS legislation and the Treasury budget proposal if they want to avoid overbroad and transaction-limiting legislation. For more information and to support the ELA's effort to fight the legislation and budget proposal, contact Federal Government Relations at ELA at 703-527-8655. David H. Fenig is the newly appointed Vice President of this part of ELA. I would like to thank one of my tax partners, George Schutzer, for his extensive assistance in drafting this article. If you would like to consider taking action regarding this proposal, please feel free to call or e-mail me or George to discuss the resources at Patton Boggs LLP available to address your concerns and assist you. 2. Business Aircraft Prospects Look Up For Lessors and LendersIn the last several months the market in business aviation has begun to take a positive turn. Economists predict a healthier economy is at hand. Sustained growth in business aviation, which is expected to develop over the next eighteen months to two years, would give leasing and financing of business aircraft a much-needed lift. Lessors, lenders and brokers have already begun to experience increased buying and selling activity, as well as renewed interest in financing business aircraft. The signs have provided reason for cautious optimism in 2004 and beyond. Business Jet Market Prepares for Takeoff to Sustained Growth, Business Leasing News (January 2004). Consequently, lessors and lenders have begun to reevaluate the market prospects for business aviation. Variations in approach vary depending on whether a lessor or lender desires to enter the market for the first time or has inventory on hand coupled with troubled aircraft lessees or borrowers. Positive Impact on Leasing and Financing of Business Aircraft In the past, growth in financing and leasing in business aviation generally trail the uptick in the economy. As a general rule, lessors experience growth markets for leasing within six to nine months after the economy begins sustained growth. Yet, for some players, prospects have already begun to gel for greater volume in financing and leasing in 2004. What factors will propel these opportunities?
While market improvements may occur slowly, the pieces of the sustained growth puzzle seem to be lying on the table for lenders, lessors, buyers and sellers to put together over the next two years. 3. FIN 46R Clarifies Off-Balance Sheet IssuesIn December 2003, the Financial Accounting Standards Board (FASB) completed its deliberations and published a new interpretation on off-balance sheet transactions that replaced FIN 46, FASB Interpretation No. 46 - Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51" (FIN 46). The new interpretation, referred to as FIN 46R, supersedes and arguably complicates FIN 46. FASB published a markup to show the exact changes from FIN 46. Despite FASB's changes, FIN 46R does not seem to significantly alter the impact of FIN 46 on leasing. FASB decided, in making these changes, to:
*Tip: Although FASB tried to illuminate and illustrate the ins and outs of FIN 46R, the new interpretation remains difficult to apply and understand. For lessors, lessees and lenders, each transaction should still be analyzed anytime an entity may have characteristics of a VIE or special purpose entity. You would be prudent to perform this analysis in any new or restructured multi-party transaction. Consider workouts as well as any new lease transaction involving a partnership, trust or other special purpose entity. Consult knowledgeable accountants early in your transactions so you don't get a surprising rechacterization of a transaction when you least expect it. 4. Despite the Improving Economy, Challenges Persist in Business Aviation PortfoliosMany existing borrowers and lessees of business aircraft have also seen their fortunes deteriorate due to the slow economy over the past three years. As a result, lessors and lenders have experienced an increase in defaults, returns of aircraft, early terminations and poor aircraft maintenance practices. Lessors and lenders consequently have had to repossess aircraft and develop workout strategies to survive until the market recovers. Inventories have grown, and remarketing efforts have faced frustrating delays or lack of activity. Despite improvement in the economy in general and business aviation in particular, lessors and lenders still face challenges with their aircraft inventory. Fortunately, solutions exist that provide ways to manage inventories of aircraft built up from problems with troubled lessees or borrowers. Challenges for Financing and Leasing in the Growing Economy As the market slowly strengthens as discussed in Article 2, lessors and lenders who still hold aircraft in inventory for sale or lease should consider strategies that anticipate an improving business aviation market. These players may want to take some or all of the following steps to manage their portfolios over the next year to eighteen months:
*Tip: Use appropriate experts such as appraisers, aviation consultants, lawyers and equipment management professionals to assist you in implementing these strategies. Some news reports indicate that business aviation markets for used aircraft have begun to develop positive momentum. As a result, lessors and lenders with a portfolio of aircraft to market may find that 2004 is finally their year to move their inventory out and get their business aviation efforts off the ground again. 5. Leasing 101: What is "Article 2" - "Sales" in the Uniform Commercial Code?Article 2 of the Uniform Commercial Code applies to transactions involving the sale of goods, which includes most types of moveable, leased property, ranging from health care equipment to transportation assets, such as trailers or business aircraft. Article 2 also contains many provisions on warranties of goods and how to limit or disclaim them. Article 2 does not apply to any security transaction although the purported sale takes the form of an unconditional contract or sale accomplished by making a contract, called a present sale. *Tip: As a lessor, you generally buy equipment and/or take assignments of a seller's warranty or contract rights with respect to equipment. Consequently, you need to understand Article 2. This Article may provide the terms of a sale incorporated into your leasing transaction. Lenders also should understand Article 2. The value of your collateral may be affected by rights your customer obtains under Article 2. Article 2 has been under revision since 1989 by the National Conference of Commissioners on Uniform Laws (NCCUSL) and the American Law Institute (ALI). The NCCUSL and ALI memberships approved a redraft of Article 2 in 2002 and 2003, respectively. The changes will eventually be adopted in the states and include provisions relating to the scope of, and warranties, performance and breach and remedies and third party rights under, Article 2. These changes will, in turn, affect how the buy-sell portion of equipment leasing and financing transactions will be done. 6. BLN Briefs: Patriot Act Provision Ruled Unconstitutional; Truck and Rail Leasing Rolls; Boeing May Tank on British TankersPatriot Act Provision Ruled Unconstitutional. A U.S. District Court in Los Angeles declared a portion of the USA Patriot Act unconstitutional. The court ruled that the Act's prohibition on anyone "providing expert advice or assistance" to terrorists as impermissibly vague under the First Amendment right to free speech. See: Humanitarian Law Projects et. al v. John Ashcroft. *Comment: The USA Patriot Act requires financial institutions to obtain and disclose information about the customers or others using bank accounts and completing certain financial transactions. The USA Patriot Act also imposes duties on lenders and lessors that make compliance extremely expensive and difficult. The Court in the instant case agreed that the USA Patriot Act contained a vague provision that did not meet constitutional standards. Could provisions of the USA Patriot Act affecting lenders and lessors face constitutional or other challenges like the one in this case because those provisions are also overbroad and vague? Truck and Rail Leasing Rolls. The National Truck Equipment Association and the American Association of Railroads (AAR) expect the accelerating economy and capital expenditures to have a positive affect on growth in their industries. If their predictions come true, lessors and lenders should experience a substantially increased volume of truck, trailer and rolling stock transactions this year. Boeing May Tank on British Tankers. In another potential tanker setback, Boeing Co. may lose its bid to provide the British government refueling tankers under a long-term lease arrangement valued at approximately $24 billion. See: Boeing may lose British tanker deal, Associated Press on Harold Net (January 24, 2004). This transaction is even larger than Boeing's proposed $17 billion deal to lease 20 - 767 KC-767A aerial refueling aircraft to the U.S. Air Force which remains in hot water with the Pentagon. *Comment: Despite these troubles with Boeing, lessors should take note that not only will the U.S. government consider huge and complicated leases, the British government will also do so. See: Boeing May Be Out of Running for British Contract, The Wall Street Journal (S.W. Ed.), Section A:9, Col. 3 (January 23, 2004). 7.Training Offered; Recent Publication; Upcoming SpeechesTraining — Substance the Easy Way! To help improve your business operations, deal processing and risk management, I offer private training seminars tailored to your specific needs at your designated location. My interactive and informative training includes topics I cover in BLN. I customize the format and content for your specific training needs— no canned programs. Feel free to call me at (214) 758-1545 to discuss the possibilities. Recent Publications Besides BLN, I write other articles on leasing and financing topics with a current emphasis on energy, tax and terrorism issues. Check out Tax Lessors Get a Bonus From New Depreciation Regulations, Monitor (November/December 2004). Upcoming Speeches Please consider attending the Large Ticket Conference of the ELA in Dana Point, California from April 25-27, 2004 where I will provide an update critical insurance issues that affect the structure of financing transactions, including the new limited use of residual guarantee insurance, terrorism and war risk issues, and insurance risk management with respect to business aviation. For lawyers and contracts experts, please consider attending the ELA Legal Forum in New Orleans, Louisiana from May 2-4, 2004. At this conference, I will help lead a panel on recognizing a "true lease" and structuring lease transactions to take into account new case law and practice as it relates to accounting, bankruptcy, UCC and tax law affecting meaning of a "true lease." New challenges to true leases status may generally impact your understanding of lease transactions. A Message From the Publisher, David G. MayerWho Moved Our Cheese? During the past Holiday Season in 2003 I received as a gift the best seller, Who Moved My Cheese? by Spencer Johnson, M.D. It presents a simple story that applies to everyone. With all the significant changes occurring in the leasing industry, the ideas in the book seemed to apply to many of us who rely on leasing for our livelihood. Who Moved My Cheese? is a story about four characters who look for "cheese" in a "Maze." The cheese represents what you want out of life, including happiness in your job and at home. The Maze is the place where you look for the cheese—for the aspects of your life that make you happy. As we move into 2004, you may already be aware that the cheese is moving in the leasing business in important and unpredictable ways. For example, as I discussed in Article 1 above, the Treasury and Congress want to dramatically limit tax-oriented leasing to tax-exempt entities. The International Accounting Standards Board (IASB) and FASB have undertaken joint convergence projects that could end most off-balance sheet leasing with a shift to the asset/liability model from the current risk/reward model. Consolidation fever is hot again as demonstrated by the mergers of Fleet Boston with Bank of America and of Bank One with J.P. Morgan Chase, reducing further the ranks of lessors. Last, but not least, the Basel II Accord could become effective in 2006 and potentially cause internationally active banks and leasing companies to face new constraints on leveraged leasing as well as the types and quantity of leasing that they can do worldwide. You'll have to read Who Moved My Cheese? to learn more about its characters (if you have not done so). You may see yourself in one or more of them. But now, as we make a fresh start in this New Year and face the challenges at hand, take a look at "The Handwriting on the Wall" based on this book. Depending on your character, how will you see these events and cope with them? Dr. Johnson offers the following axioms: (1) change happens and will keep moving the cheese; (2) anticipate change— get ready for the cheese to move; (3) monitor change as you need to understand when your cheese will move; (4) adapt to change; (5) change yourself because by doing so you move with the cheese; (6) enjoy change by taking the challenge and taste the new cheese; and (7) be ready to change again as change is a constant in our lives. The characters in Who Moved My Cheese? illustrate how we each deal with change and help us learn some important lessons about change in simple, yet powerful, terms. Be aware of change, embrace it, work with it, adapt to it and realize that change has generally been good for the creative and resourceful people in the leasing industry. Have a great February as you move through your maze looking for the cheese. Feedback From You Here are comments I receive on Business Leasing News. One reader sent me some humor and quipped: "I thought you might enjoy this from one Dummy to another! Best wishes for the New Year and keep the information coming - its very useful and timely." Another reader commented: "You write a great news letter for the leasing industry!!" I don't disclose the names or titles of people who comment on BLN, but these readers come from many different disciplines and seniority levels in the financial services, power, equipment, aviation, professional services and other industries. As always, thanks for your comments and do let me know what topics you think BLN should discuss this year. About the Web Site of Business Leasing News If you have bookmarked BLN, please use BLN’s current address at Patton Boggs LLP: http://www.pattonboggs.com/newsletters/bln. Stayed tuned for new developments in web site access to BLN. About Patton Boggs LLP and My Practice As you may be aware, I am a part of the Patton Boggs LLP Business Transaction Group in our Dallas office. Patton Boggs LLP is a law firm of about 400 lawyers located globally in six locations with extensive capabilities in over fifty areas of legal practice that include leasing, secured transactions, securitizations, syndications, project and mezzanine financing, bankruptcy, public policy, litigation, intellectual property and technology law and much more. The leasing and secured transactions practices regularly involve the buying, selling, financing and leasing of real and personal property of all kinds, including business aircraft, energy, facility, production, power plant, technology and healthcare assets. We also structure, negotiate and close secured transactions of all kinds, tax exempt, state and federal leasing arrangements and corporate and portfolio acquisitions, among a full range of financing and acquisition transactions. Despite the improving economy, we continue to assist our clients with troubled deals and bankruptcies, including repossessions, lift stay actions, deficiency litigation, workouts and forbearance agreements. Please feel free to call me at (214) 758-1545 or e-mail me at dmayer@pattonboggs.com for information about any of these areas or the many others available at Patton Boggs LLP, or to discuss anything I have written in Business Leasing News. I welcome the opportunity to build a relationship with you! Thanks to the BLN Staff I extend a special thank you to my editors at Patton Boggs LLP for their comments on this edition, Adrian Nicole McCoy, Steve Reagan and our primary web site review partner, Jeff Turner. The technical team, consisting in part of George Barber and Winston Jackson, provide you the easy-to-use e-mail navigation and artistic appearance of BLN. All the best, David David G. Mayer The "For Dummies" part of my book, Business
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