Capitol Hill

By Shawn Halladay

Tax reform has been on the equipment leasing industry’s radar for several years, but, as one of the Trump administration’s signature legislative objectives, it now is garnering more focused attention.  It is worthwhile to cast at least an appraising eye on the elements of the current tax reform proposals and their potential ramifications even though they are far from complete.  Consequently, this post will provide an overview of the plan, plus some analysis so industry members can develop talking points to discuss with their Congressional delegations.

Outline of the plan

The latest tax reform proposal, like the original GOP blueprint, is light on details and represents a conceptual approach to the desired results.  Without getting into any of the economic considerations and/or political motivations, the elements of the proposal that potentially may affect the equipment leasing industry are as follows.

  • Lower the corporate tax rate from the current rate of 35% to a flat rate of 15%
  • Repeal the corporate AMT
  • Allow businesses to write off 100% of the cost of investments in tangible property and intangible assets on day one
  • Limit interest expense deductions to the amount of interest income. Any net interest expense not deductible can be carried forward indefinitely to use against future net interest income
  • Allow net operating losses (NOLs) to be carried forward indefinitely and to be increased by an inflation factor. NOLs would not be allowed to be carried back and the utilization of NOL carryforwards would be limited to 90% of the net taxable amount for the year
  • Make changes to other provisions that have peripheral impact on the industry such as pass-through entity income, foreign taxes and credits, and death taxes.

Although each element of the proposed tax plan will be discussed in this and subsequent posts, net interest deductibility is today’s topic as it is one of the more complex and, potentially, convoluted of the proposed changes.

Analysis – net interest deductibility

ELFA consistently has supported broad tax reform, but generally has done so through general statements such as promoting investment in productive assets and a level playing field between owner-lessors and owner-users.  Where it has maintained a clear and focused position, however, is in its insistence that any tax reform avoid changes to reduce or eliminate deductions for interest expense.

Although the interest expense deduction is not eliminated, it is reduced, as interest expense only can be deducted against interest income (a bane). This limitation obviously adversely affects highly leveraged companies, such as equipment lessors.  Apparently, Ways and Means is working to develop special rules for financial services companies that would take into account the role of interest income and expense in their business models, but you can see the types of wrinkles that are popping up under the current proposals.

Another of these wrinkles is the treatment of rents, as an interesting case can be made that rent should contain an interest component, particularly given how the new lease accounting rules are working.  If rent is deemed to contain interest, though, how will it be determined?  Imputed at the implicit rate, the Federal Funds Rate, or something else?  Such a juxtaposition of financial reporting and tax reporting concepts can have far-reaching effects beyond this issue.

Fortunately, for the equipment leasing industry, the proposal as it stands heavily favors leasing in the lease-buy decision, as many lessees do not have sufficient interest income against which to offset interest expense (the boon).  The indefinite carryforward of the unused interest expense also creates a selling tool for true leasing.  Additional observations of possible consequences of the net interest rules, as they stand, include:

  • Loan-heavy finance providers would be favored while asset-oriented financiers, such as high-tech and transportation lessors, would be punished (quite a nasty conundrum)
  • A disincentive to hold and fund tax deals, particularly as an independent or vendor funding partner
  • A disincentive to hold tax deals also would exist for bank lessors on a stand-alone basis, although, in a consolidated tax return environment, this disincentive would disappear

As an illustration of this problem, consider a transportation fleet lessor.  Under this business model, none of the interest expense associated with acquiring its leased assets would be deductible.

Tax Return Cash basis
Rent revenue $X,XXX $X,XXX
Interest income 0 0
Interest expense 0 (YYY)
Net income $X,XXX $ZZZ


The pricing needed to dig out of this hole would not be acceptable in today’s market, although using book income, if made part the final rules, combined with residual value insurance would solve the problem (one is allowed to dream).  A reverse play on the nonrecourse debt rules might be another possible solution.

As can be seen from just this one element, the tax reform proposals go well beyond the impact on the tax return, as the ripple effect touches acquisition decisions, usage models, and business approaches.  The mind boggles at the potential market upheaval the equipment leasing industry may experience.