Cross-border leasing
Encyclopedia
Cross-border leasing is a leasing
arrangement where lessor and lessee are situated in different countries. This presents significant additional issues related to tax avoidance
and tax shelter
s.
Cross-border leasing has been widely used in some European countries, to arbitrage
the difference in the tax laws of different jurisdictions, usually between a European country and the United States
. Typically, this rests on the fact that, for tax purposes, some jurisdictions assign ownership and the attendant depreciation
allowances to the entity that has legal title to an asset, while others (like the U.S.) assign it to the entity that has the most indicia of tax ownership (legal title being only one of several factors taken into account). In these cases, with sufficiently long leases (often 99 years), an asset can end up with two effective owners, one in each jurisdiction; this is often referred to as a double-dip lease.
Often the original owner of an asset is not subject to taxation in any jurisdiction, and therefore not able to claim depreciation. The transaction often involves a city selling an asset (such as a sewerage
system or power plant) to an investor (who can claim depreciation), and long-term leasing it right back (often referred to as a sale leaseback
). However, since 2004 cross border leasing has been effectively eliminated by the passage of the JOBS ACT of 2004, which made the vast majority of cross border leases unprofitable.
One significant evolution of the leasing industry involved the collateral
ization of lease obligations in sale leaseback transactions. For example, a city would sell an asset to a bank. The bank would require lease payments and give the city an option to repurchase the asset. The lease obligations were low enough (due to the depreciation deductions the banks were now claiming) that the city could pay for the lease obligations and fund the repurchase of the asset by depositing most but not all of the sale proceeds in an interest-bearing account. This resulted in the city having pre-funded all of its lease obligations as well as its option to repurchase the asset from the bank for less than the amount received in the initial sale of the asset, in which case the city would be left with additional cash after having pre-funded all of its lease obligations.
This gave the appearance of cities entering into leasing transactions with banks for a fee. By the late 1990s many of the leasing transactions were with cities in Europe, and in 1999 cross border leasing in the United States was "chilled" by the effective shutdown of LILOs (lease-in/lease outs). (LILOs were significantly more complicated than the typical lease where a municipality (for example) would lease an asset to a bank and then lease it back from the bank for a shorter period of time; LILOs relied on arcane rules of tax accounting to yield significant returns and are currently on a list of transaction types that the U.S. tax authority considers abusive.) Since 2004 cross border leasing has been effectively eliminated by the passage of the JOBS ACT of 2004, which made the vast majority of cross border leases unprofitable for the parties to the leasing transaction.
Leasing
Leasing is a process by which a firm can obtain the use of a certain fixed assets for which it must pay a series of contractual, periodic, tax deductible payments....
arrangement where lessor and lessee are situated in different countries. This presents significant additional issues related to tax avoidance
Tax avoidance
Tax avoidance is the legal utilization of the tax regime to one's own advantage, to reduce the amount of tax that is payable by means that are within the law. The term tax mitigation is a synonym for tax avoidance. Its original use was by tax advisors as an alternative to the pejorative term tax...
and tax shelter
Tax shelter
Tax shelters are any method of reducing taxable income resulting in a reduction of the payments to tax collecting entities, including state and federal governments...
s.
Cross-border leasing has been widely used in some European countries, to arbitrage
Arbitrage
In economics and finance, arbitrage is the practice of taking advantage of a price difference between two or more markets: striking a combination of matching deals that capitalize upon the imbalance, the profit being the difference between the market prices...
the difference in the tax laws of different jurisdictions, usually between a European country and the United States
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
. Typically, this rests on the fact that, for tax purposes, some jurisdictions assign ownership and the attendant depreciation
Depreciation
Depreciation refers to two very different but related concepts:# the decrease in value of assets , and# the allocation of the cost of assets to periods in which the assets are used ....
allowances to the entity that has legal title to an asset, while others (like the U.S.) assign it to the entity that has the most indicia of tax ownership (legal title being only one of several factors taken into account). In these cases, with sufficiently long leases (often 99 years), an asset can end up with two effective owners, one in each jurisdiction; this is often referred to as a double-dip lease.
Often the original owner of an asset is not subject to taxation in any jurisdiction, and therefore not able to claim depreciation. The transaction often involves a city selling an asset (such as a sewerage
Sanitary sewer
A sanitary sewer is a separate underground carriage system specifically for transporting sewage from houses and commercial buildings to treatment or disposal. Sanitary sewers serving industrial areas also carry industrial wastewater...
system or power plant) to an investor (who can claim depreciation), and long-term leasing it right back (often referred to as a sale leaseback
Leaseback
Leaseback, short for sale-and-leaseback, is a financial transaction, where one sells an asset and leases it back for the long-term; therefore, one continues to be able to use the asset but no longer owns it...
). However, since 2004 cross border leasing has been effectively eliminated by the passage of the JOBS ACT of 2004, which made the vast majority of cross border leases unprofitable.
History
Leasing techniques have been used for financing purposes for several decades in the United States. The practice developed as a method of financing aircraft. Several airlines in the early 1970s were notoriously unprofitable and very capital intensive. These airlines had no need for the depreciation deductions generated by their aircraft and were significantly more interested in reducing their operating expenses. A very prominent bank would purchase aircraft and lease them to the airlines. Because the bank was able to claim depreciation deductions for the aircraft, the bank was able to offer lease rates significantly lower than the interest payments that airlines would otherwise pay on an aircraft purchase loan (and most commercial aircraft flying today are operated under a lease). In the United States, this spread into leasing the assets of U.S. cities and governmental entities and eventually evolved into cross-border leasing.One significant evolution of the leasing industry involved the collateral
Collateral (finance)
In lending agreements, collateral is a borrower's pledge of specific property to a lender, to secure repayment of a loan.The collateral serves as protection for a lender against a borrower's default - that is, any borrower failing to pay the principal and interest under the terms of a loan obligation...
ization of lease obligations in sale leaseback transactions. For example, a city would sell an asset to a bank. The bank would require lease payments and give the city an option to repurchase the asset. The lease obligations were low enough (due to the depreciation deductions the banks were now claiming) that the city could pay for the lease obligations and fund the repurchase of the asset by depositing most but not all of the sale proceeds in an interest-bearing account. This resulted in the city having pre-funded all of its lease obligations as well as its option to repurchase the asset from the bank for less than the amount received in the initial sale of the asset, in which case the city would be left with additional cash after having pre-funded all of its lease obligations.
This gave the appearance of cities entering into leasing transactions with banks for a fee. By the late 1990s many of the leasing transactions were with cities in Europe, and in 1999 cross border leasing in the United States was "chilled" by the effective shutdown of LILOs (lease-in/lease outs). (LILOs were significantly more complicated than the typical lease where a municipality (for example) would lease an asset to a bank and then lease it back from the bank for a shorter period of time; LILOs relied on arcane rules of tax accounting to yield significant returns and are currently on a list of transaction types that the U.S. tax authority considers abusive.) Since 2004 cross border leasing has been effectively eliminated by the passage of the JOBS ACT of 2004, which made the vast majority of cross border leases unprofitable for the parties to the leasing transaction.