History of Leasing Flashcards
**When was the oldest Leasing Record?
2010 B.B. in the Sumerian City of Ur
- Used clay tablets for documenting leases such as land, animals, ag tools, land and water rights
Around 1700- 1750 B.C. The Code of Hammurabi
-King Hammurabi acknowledged leasing of personal property in his code of laws
Made in Mesopotamia
It introduced the “eye for an eye, a tooth for a tooth.”
**(Test nugget - know the Code of Hammurabi was where lease law dates back to)
**What were Ship Charters?
Early example of a true lease
- Phoenicians were shipping and trading experts who used ship charters to obtain a ship and crew
- Other charters covered the economic life of the ship and required the lessee to assume the benefits and obligations of ownership
Chartering is an activity within the shipping industry where a shipowner hires out the use of their vessel to someone
This may include service, administration and maintenance, or may not.
**(Test nugget - the Phoenicians were shipping and trading experts who used ship charters to obtain a ship and crew. The longer-term ship charters covered the economic life of the ship and required the lessee to assume the benefits and obligations of ownership)
**What was the Statute of Wales?
English Common Law
- Used in England to deal directly with the leasing of personal property
- Further clarified in 1571 to define who owned the leased property
Also known as the Statute of Rhuddlan - The Statute of Rhuddlan helped define the roles of these officials and the means by which they were to enforce this essentially foreign system of law within the areas of English influence in Wales.
**(Test nugget - The Statute of Wales, written in 1284 AD, was used in England to deal directly with the leasing of personal property).
**Significance of the Railroad Industry
(During Industrial Revolution)
-In the UK and US, the railroad companies would only afford the track
Sought financing from private investors for the locomotives and railcars
-Accomplished through equipment trusts
- Most well-known finance plan was the Philadelphia Plan
**(Test nugget - During the Industrial Revolution in the UK and the United States, the railroad industry brought the first real growth of leasing to the United States)
What was the significance of the early 1900’s?
Independent 3rd party leasing companies were formed to provide vendor financing for manufacturers
Manufacturers saw the benefit of leasing to move product and gave rise to early captives
At the start of WWII, the government used cost-plus contracts making leasing attractive again post-Depression
~Companies realized that customers didn’t want long-term ownership, just usage which is really a precursor to true leases today
~~Bell Telephone Company was one of the first captives - no one actually owned their phone! And look where we are today… all of the cell companies are offering the same!
~~The Depression of 1929 halted the growth of leasing, but with the start of WWII, and the government’s efforts using cost-plus contracts, made leasing attractive again
~~Cost-plus contracts allowed government contractors to earn a profit over their costs
What was the Shift to Modern Leasing in 1950’s
Post WWII, there was an economic slump
- The government tried to stimulate the economy in 1953, Section 167 of the Internal Revenue Code was issued
- Gave the owner/lessor the ability to take ordinary payments into income associated with a lease and accelerate depreciation (why is accelerated depreciation attractive?)
- Designed to encourage capital spending
Why is accelerated depreciation attractive? Because it allows the tax payer to increase tax deductions in the early life
**(Test nugget - know that Governmental efforts to stimulate the economy and the Introduction of Accelerated Depreciation led to what is known as modern day leasing)
**What is IRS Revenue Ruling 55-540 (PAINEE)
P (Payments> Rental) -Rental payments are not substantially higher than a fair rental value
A (Automatic Title) Ownership of the asset does not automatically pass to the lessee at the end of term
I (Interest) No portion of the lease payment is characterized as interest
N (Nominal P.O.) The transaction does not include a nominal purchase option
E (Equity) No portion of the lease payments can be applied to an equity position of the asset
E (Excessive Payments) The amount paid under a short-term lease is not a significant portion of the purchase price (excessive lease payments)
PAINEE acronym
Talk about ownership of the collateral/assets
**(Test nugget - IRS Revenue Ruling 55-540 defines a true lease for tax purposes.)
Defines what is NOT a true lease for TAX purposes – if any of these conditions were TRUE it would be a CSC
Distinguishes between a true lease and a conditional sales contract
What is Investment Tax Credit (ITC)?
1960s
A credit that a taxpayer was permitted to claim on its federal tax return
Acted as a direct offset to tax liability as a result of ownership of qualified equipment
- In 1963, the Comptroller of Currency gave banks the go-ahead to own and lease personal property (this brought significant amount if capital help by banks into the leasing market).
~~Does anyone know what year ITC was introduced? 1962
~~The ITC became a “give and take” option - when the government needed more tax money, it took away the ITC, when it needed to stimulate capital expenditures, it gave it back
**(Test nugget - know that the ITC was a direct offset to tax liability as a result of ownership of qualified equipment)
How did Leasing Progress in the 1970’s?
Congress introduced the Asset Depreciation Range (ADR)- Lessors no longer had to guess the useful life of the asset
Revenue Procedure 75-21 was created- in response to requests whether the lessor could be treated as the owner for tax purposes
FASB13 was issued- provided consistency in financial statement reporting
Because of IRS 55-540 only defined a contract of sale, not a lease, the IRS was deluged (flooded) with advanced ruling requests which led to Revenue Procedure 75-21
Pay close attention that 55-540 was a RULING; 75-21 was a PROCEDURE
There was a large inconsistency in financial statement reporting, so FASB introduced FASB 13
**What is the Revenue Procedure 75-21 Criteria?
Initial minimum investment
lease term and renewal rights
purchase and sale rights
no investment by lessee
no lease, loans or guarantees
profit requirement
~~Requested for advanced rulings to determine if the attributes of specific transactions, especially qualified leveraged leases qualified to be an equipment owner (must understand each item on here)
-> this is subordinate to the Rev Ruling 55-540
determine whether a lease is to be considered a “true” lease and respected as such for Federal income tax purposes
~~Initial minimum investment – at least 20% risk
~~Lease Term – between 1 and 20 years
~~Purchase and sale rights – no bargain purchase option
~~No investment by lessee – Lessee cannot also be an investor
~~No lease loans/guarantees – Recourse
~~Profit requirement – lessor must expect profit outside of ITC
established guidance which is used by the leasing industry as a “safe-harbor” for single-investor leases
~~(non-tax leveraged leases) in the leasing industry
**What is ASC 842?
(Up to date FASB13)
1. Title to the property automatically transfers to the lessee by or at the end of the lease term
2. The lease contains a bargain purchase option
3. The lease term is equal to or greater than 75% of the estimated economic life of the leased property
4. The present value of the minimum lease payments at the beginning of the lease term is equal to or greater than 90% of the fair market value of the property
5. The underlying asset is of a specialized nature
Brite lines are still being used as guidance -> new addition is the underlying asset is of a specialized nature.
Criteria 5: The underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term.
Could be a piece of manufacturing equipment that was made to produce a very specific customized part.
New 5th test – Is the asset so specialized in nature that it provides no alternative use to the lessor once the lease is complete?
The 5th test was added in ASC 842. However, typically, we notice that if a lease triggers the 5th test, that it also likely had triggered one of the other “weak form” tests. This is because, for example, a shrewd landlord would factor in the future use for the asset when establishing the lease payments, and as such, typically the 4th test would be triggered.
Economic Recovery Tax Act (ERTA) 1981
Revision to the Internal Revenue Code; it replaced the more complex Asset Depreciation Range (ADR) System
- Created the Accelerated Cost Recovery
System ACRS
-Only 5 classes of assets, ranging from 3-15 year life spans
-The owner/lessor could now fully depreciate an asset without having to estimate useful life and salvage value
Tax Reform Act of 1986 (TRA ‘86)
Strengthened and expanded the reach of the Alternative Minimum Tax (AMT)
- A company must do a third calculation using the AMT formula and pay the greater of the regular tax calculation or of AMT
- Under AMT, there are limits to depreciation
Eliminated the Investment Tax Credit (ITC)
Changes in Leasing in 1990’s
Credit Scoring Innovation
-Independents led the charge, followed by some captives and finally banks
Third Party Originators
-TPOs were not accepted by banks
Creative Financing Structures & Large-Ticket Leasing
-FMV, PUT, 1st Amendment Leases and other creative leasing structures grew
-Independent and captive leasing companies sought to distinguish themselves from the banks
~~What would be an example of a credit-scoring innovation? App-Only programs
~~AACFB was formed during this time to create an Association for TPOs
**(Test nugget - know that Credit Scoring Innovations, Acceptance of TPOs, Creative Financing Structures, and Large-ticket Leasing were all factors of growth in leasing during the 1990s)
**A. Synthetic Lease
B. Leveraged Lease
C. Double-Dip Lease
A. Designed to be a loan for tax purposes, but an operating lease for accounting purposes (Still in existence today)
B. Unique mix of tax and accounting benefits
Up to 97% of recourse and nonrecourse debt is used to finance the assets
Created high returns on equity to the lessor which allowed the lessor to offer lower rates
C. Based on cross-border leases, but structured to take advantage of tax benefits in both the lessee and lessor’s country
DD Lease - A tax avoidance arrangement that allows either party in a lease agreement to be considered the legal owner of leased equipment. In most European countries, the holder of a legal title is considered the owner of property for tax purposes. To avoid taxes, a company in one of these countries may sell equipment to a company in another country and then lease it back.
LL - For example, suppose a car dealer (lessor) extends a lease to someone buying a car (lessee). The lessor may take a loan from a bank in order to receive capital from the lease of the car while the lessee drives away with the car. The lessee then makes payments on the lease, which the lessor then uses to repay the loan to the bank. Importantly, the lessor may take the leased asset away from the lessee if the lessee defaults, and the bank may do the same if the lessor defaults.
While synthetic leases are still in existence, after Enron, the rules for them changed it to make it more difficult to gain the off-balance sheet treatment
**(Test nugget - know that synthetic leases are still in existence today)
