1. How does tax depreciation work, generally?
2. Is tax depreciation different for foreign made equipment?
3. How does tax depreciation differ for property used outside the United States?
4. Is tax depreciation the same for "tax-exempt use property"?
5. Is the federal investment tax credit still available?
6. Are any energy related federal tax credits available?
7. What is the alternative minimum tax?
8. Can ownership increase alternative minimum tax liability?
9. Is ACE still in effect?
10. Will new tax legislation reduce AMT liability?
11. How do I get tax benefits from a lease?
12. How does a company's tax status affect the lease-buy decision?
13. How will the mid-quarter and half-year conventions affect the lease-buy decision?
14. Are there additional leasing benefits for multinational corporations?
15. How do I account for a lease?
16. How do balance sheet considerations affect the lease-buy decision?
17. Who really owns the equipment?
18. What asset ownership plans affect the lease-buy decision?
19. Is there ITC recapture as a result of a sale-leaseback?
20. Is equipment leasing prevalent in other countries?
21. Is cross-border leasing an available practice?
22. Is GE Capital set up to do leasing in foreign countries?

1.	How does tax depreciation work, generally? An owner of equipment (a lessor under a tax-oriented lease or a lessee under a non-tax-oriented lease) is entitled to a depreciation deduction (a reasonable allowance for the exhaustion, wear and tear, and obsolescence) on equipment either used in a trade or business or held for the production of income. This deduction reduces the amount of taxable income shown on the owner's tax return and thereby reduces the amount of tax that the owner must pay. The Tax Reform Act of 1986 mandated a new method of depreciation called the "Modified Accelerated Cost Recovery System" or "MACRS" (pronounced "makers") for most depreciable property placed in service after 1986. Under MACRS, personal property is grouped into six different classes of recovery periods. Depending upon classification, the cost of the equipment is recovered over a period of 3, 5, 7, 10, 15 or 20 years. For most equipment (i.e., other than 15 or 20 year property), the MACRS deductions are calculated under the double-declining balance method (also known as the 200% declining balance method), switching to the straight-line method at a time to maximize the depreciation allowance. The MACRS deductions for 15 and 20 year property are similarly calculated, but use the 150% declining balance method, also switching to straight-line. Under MACRS, depreciation deductions are determined without regard to any salvage value (any residual value for the equipment remaining at the expiration of the recovery period used). Furthermore, the "half-year convention" is used for most taxpayers; that is, only one half of the first year's depreciation deduction is allowed no matter when the equipment was actually placed in service. The half-year convention also affects the total number of tax years within which the depreciation deductions would be claimed. For example, five year MACRS assets would have their cost recovered over six tax years, one-half year at the beginning and the end. However, this convention cannot be used on current year equipment acquisitions by a taxpayer that places more than 40% of its equipment in service during the last quarter of its tax year. Such taxpayer must use the "mid-quarter convention", which assumes all equipment to have been placed in service halfway through the quarter in which it was actually placed in service. The first year's depreciation is prorated, directly affecting the final tax year within the recovery period and the intervening years' allocations too.
Return to list of questions
2.	Is tax depreciation different for foreign made equipment? No. MACRS depreciation is currently available on equipment of foreign origin. In the Tax Reform Act of 1986, the President of the United States was given the authority to issue an Executive Order which would deny MACRS depreciation on equipment imported from countries that maintain non-tariff trade restrictions or otherwise engage in policies unjustifiably restricting U.S. commerce. To date, however, no such Executive Order has been issued by the President.
Return to list of questions
3.	How does tax depreciation differ for properly used outside the United States? Generally speaking, MACRS depreciation is not available for any equipment which is used predominantly outside of the U.S. during any taxable year. For such equipment, the Alternative Depreciation System ("ADS") is required. ADS utilizes the straight-line method of depreciation (determined without regard to salvage value) taken over a recovery period equal to the "class life" of the equipment (usually its ADR [Asset Depreciation Range] class life) and employs the "half-year convention" (unless the "mid-quarter convention" is required). Accordingly, ADS, unlike MACRS, is not accelerated depreciation. ADS depreciation must also be recovered over a period which tends to be longer than that used for MACRS. For these reasons, ADS is a less-favorable firm of depreciation than MACRS.
Return to list of questions
4.	Is tax depreciation the same for "tax-exempt" use property"? "Tax-exempt use property" includes any property that is leased to, or used by, a "tax-exempt entity". For these purposes, a "tax-exempt entity" generally includes: any federal, state or local government (including their agencies and instrumentalities); any organization that is exempt from federal income taxes (e.g., nonprofit charitable organizations); and most foreign persons or entities, unless a significant portion of their gross income is subject to U.S. federal income tax. As a general rule, tax-exempt use property does not qualify for MACRS depreciation and instead ADS depreciation is required. However, unlike ADS depreciation for property used predominantly outside of the U.S., the recovery period for tax-exempt use property is the longer of (i) the "class life" of the equipment (its ADR mid-point life) or (ii) 125% of the lease term (after taking into account any renewal options given to the lessee and any successive leases to the same lessee). Thus, ADS depreciation for tax-exempt use property is not only slower than MACRS depreciation, it frequently is slower than ADS depreciation for property used predominantly outside of the U.S. As with most general rules, there are certain exceptions that should be considered. Equipment that would otherwise be tax-exempt use property will qualify for MACRS depreciation if the tax-exempt entity is only using the equipment under a "short-term lease". For this purpose, a "short-term lease" includes most leases having a term of less than three years. However, in determining the lease term, the IRS will take into account options to renew, as well as successive leases to the same tax-exempt entity. MACRS depreciation may be available if, instead of leasing the equipment, the tax-exempt entity is merely using the equipment under a "service contract". However, not all contracts which are titled "service contracts" qualify as such for federal income tax purposes. Care must be taken to ensure that the "service contract" would not be characterized as a lease. Finally, there are special rules for "qualified technological equipment". Such equipment generally includes computers and their peripherals, high-technology telecommunications equipment and high technology medical equipment, as long as it is not used by the federal government or is not subject to a sale-leaseback. Qualified technological equipment used by a tax-exempt entity will qualify for MACRS depreciation if the lease term (including options to renew) does not exceed five years. If the lease term exceeds five years, ADS depreciation is required, but the recovery period is five years. The rules relating to tax-exempt use property are quite complicated and vary by category of tax-exempt entity.
Return to list of questions
5.	Is the federal investment Tax Credit still available? For all practical purposes, no. Although certain projects and/or assets may still fall under the transitional rules of the Tax Reform Act of 1986, virtually all assets acquired at this time are no longer eligible for the investment tax credit ("ITC"). The Tax Reform Act of 1986 repealed the ITC for all equipment, other than transitional property, placed into service after 1985. The ITC was a direct credit against federal income taxes (equal to 6% or 10% of the cost of eligible equipment, known as "new section 38 property"). In general, the owner of the equipment was entitled to the ITC. Lessors and lessees, however, could agree to structure tax-oriented leases with the lessees allowed to claim the ITC. Such transactions were called "ITC pass-through leases". As of this date, there is no indication that a federal ITC, or any comparable federal tax credit associated with asset ownership, should be expected in the near future.
Return to list of questions
6.	Are any energy-related federal tax credits available? The residential energy tax credit expired in 1985. Most energy-related federal tax credits for business use property expired prior to 1990. Such business property energy tax credits included credits for wind property, small scale hydroelectric projects and biomass property. Energy tax credits for solar energy and geothermal property are still available.
Return to list of questions
7.	What is the Alternative Minimum Tax? The Tax Reform Act of 1986 introduced the new alternative minimum tax ("AMT" or "minimum tax") for tax years beginning after 1986. AMT makes it more difficult for both corporate and non-corporate taxpayers to avoid federal income tax through the use of certain normal tax benefits, known as "tax preference" or "adjustment" items. (For simplicity, these may be referred to as "preference items" or "tax preferences".) In general, these preference items are used to determine the taxpayer's alternative minimum taxable income ("AMTI"). A rate of 20% (26% or 28% in the case of a non-corporate taxpayer) is applied against the AMTI to derive the taxpayer's tentative minimum tax ("TMT"). If the TMT exceeds the taxpayer's regular income tax, it will owe the difference as AMT. The AMT must be paid in addition to the regular tax owed. This additional tax payment, with certain limitations, becomes a tax credit for future years (the "minimum tax credit"). Generally speaking, the credit may be used by a taxpayer to reduce its regular tax liability, but not below its TMT. Given this limitation, the credit may not be fully utilized for a number of years, if ever. This minimum tax causes all businesses to maintain additional sets of records. In addition to the financial accounting books and regular tax books, alternative minimum tax records are necessary. Furthermore, all taxpayers are required to compute and pay their estimated minimum tax liability to the IRS on a quarterly basis. Taxpayers are not allowed the luxury of keeping the money until the end of each tax year without incurring stiff penalties.
Return to list of questions
8.	Can ownership increase Alternative Minimum Tax liability? Companies and individuals who are AMT taxpayers may find that it is now more expensive to own, rather than lease, their equipment. Ownership can increase their minimum tax liability in two ways: A. Depreciation Preference: For most equipment placed in service after 1986, all taxpayers, when computing AMT, are required to compute depreciation utilizing a less accelerated 150% declining balance method (versus 200% for MACRS) over the related asset's ADR mid-point life. The difference, positive or negative, between annual depreciation under this method and deductions under MACRS becomes an adjustment; thereby directly affecting AMTI and a potential AMT. B. The ACE Adjustment: Three-quarters of the excess of a corporate taxpayer's Adjusted Current Earnings ("ACE") over its AMTI, determined without regard to this adjustment, is also an adjustment for purposes of the AMT calculation. The calculation of ACE requires taxpayers to recompute their depreciation deductions–for property placed in service before January 1,1994, using a method which is even less accelerated than that used for the depreciation preference. The ACE depreciation adjustment is not required for property placed in service after December 31, 1993. Both of these adjustments or preferences can increase AMTI as a direct result of the spread between the equipment's accelerated depreciation for regular tax purposes and the slower, less accelerated method for AMT. Consequently, ownership of equipment can contribute to a relatively higher minimum tax liability as a result of both the depreciation preference and the ACE adjustment. A taxpayer's overall effective tax rate would increase as well. AMT taxpayers are also adversely affected by the ownership of equipment because estimated minimum tax liability must be paid quarterly. Lease payments (or rentals) paid by either a company or an individual are not preference items. Thus, they do not increase AMTI or minimum tax liability. For an illustration of how equipment ownership can create or increase AMT liability and result in an overall effective tax rate in excess of 34% or 35%, see the AMT Appendix. There are many other aspects of the minimum tax provisions. Your tax advisor should be able to provide you with more in-depth data as needed.
Return to list of questions
9.	Is ACE still in effect? Although the concept of adjusted current earnings or ACE was included in the AMT provisions of the Tax Reform Act of 1986, it became effective only for taxable years commencing after 1989. For taxable years beginning in 1987,1988 and 1989, AMT was instead calculated by reference to the former "book income preference". Under the old "book income preference", AMTI for that same corporate taxpayer is increased by 75% of the amount by which its adjusted current earnings exceeds its AMTI (also determined without regard to this adjustment). The ACE adjustment, like its predecessor, the book income preference, is very broad in scope. The calculations used in determining the ACE adjustment are quite complicated and include the use of another depreciation method for property placed in service before January 1, 1994. Depreciation deductions for ACE are less accelerated than those for computing regular taxes and even less accelerated than those for determining the "depreciation preference". Thus, for each unit of equipment, corporations must calculate no less than four different types of depreciation: one for financial reporting purposes; another for regular taxes; another for the depreciation preference; and yet another for the ACE adjustment. This expansion in record keeping and depreciation calculations is designed, in effect, to ensure that all taxpayers, especially profitable corporations, pay their fair share of federal income tax. (The ACE depreciation adjustment is not required for property placed in service after December 31, 1993.)
Return to list of questions
10.	Will new legislation reduce AMT liability? Probably not; though no significant legislation is expected at this time, no one can predict what legislation would be ultimately enacted. Simplifying the ACE calculations, to some extent, has already occurred.
Return to list of questions
11.	How do I get tax benefits from a lease? In a non-tax-oriented lease, the lessee is treated as the owner of the equipment for tax purposes. Therefore, it can claim depreciation deductions on its tax return. On the other hand, in a tax-oriented lease, the lessee is not the owner of the equipment for tax purposes. It cannot claim depreciation deductions on its tax return. Nevertheless, because the lessor is entitled to the tax benefits on the equipment, the lessee will benefit from lower rental payments, often well below prime or market rates. The less a company can effectively utilize these tax benefits, the greater the advantage of "trading" them for lower leasing rates. In addition, the lessee normally would receive deductions for the full amount of rental payments on its tax books. Another benefit of a tax-oriented lease is the potential to avoid or reduce minimum tax. Equipment ownership can increase liability for minimum tax because of the depreciation preference. Conversely, rentals are not tax preferences for purposes of the minimum tax.
Return to list of questions
12.	How does a company's tax status affect the lease-buy decision? Companies in capital intensive industries, or in industries where depletion or similar tax reduction benefits are prevalent, often find that tax-oriented leasing makes sense for one or both of the following reasons. First, they may not be able to immediately use some or all of the tax benefits resulting from equipment purchases. In a tax-oriented lease, they can effectively get the use of those tax benefits by transferring them to a lessor in exchange for lower rental payments. Second, these companies may be required to pay minimum tax. Ownership of equipment can actually increase their minimum tax liability because of the depreciation preference. In contrast, rentals do not create preference items or increase minimum tax liability. A tax-oriented lease can reduce minimum tax liability, because the company doesn't own the equipment. That savings can be especially important because the estimated minimum tax must be paid quarterly. A taxpayer should consider its ability to optimally use all of its tax benefits and its minimum tax positions, now, as well as in the future. A forecast of operating income, as well as your capital expenditures, could assist a determination as to whether the best choice is to purchase or acquire the use of equipment under a tax-oriented lease.
Return to list of questions
13.	How will the mid-quarter and half-year conventions affect the lease-buy decision? Under MACRS, most taxpayers are required to use the "half-year convention" to calculate their tax depreciation. Under this convention, an assumption is made (regardless of the actual circumstances) that all equipment is placed in service halfway through the tax year. Thus, only one-half of a full first year's depreciation can be claimed on the tax return, no matter when the equipment actually went into service. However, the "half-year convention" cannot be used for newly acquired equipment by a taxpayer that places more than 40% of such equipment in service during the last quarter of its tax year. These taxpayers must use the "mid-quarter convention". Under this convention, an assumption is made (regardless of the actual circumstances) that all equipment is placed in service halfway through the quarter in which it is actually placed in service. Hence, 7/8ths of the first year's depreciation is allowed on equipment placed in service in the first quarter; 5/8ths is allowed on equipment placed in the second quarter; 3/8ths on equipment placed in service in the third quarter; and only 1/8th on the equipment placed in service in the last quarter. The difference between these two conventions can significantly affect the lease-buy decision in several ways. A taxpayer subject to the mid-quarter convention will usually be entitled to less depreciation in the first year than a half-year convention taxpayer for all equipment placed in service in its tax year. If the mid-quarter convention taxpayer leased this equipment from a half-year convention taxpayer, the lessor would be entitled to more first year depreciation. The benefit of that extra depreciation should be passed on to the lessee through the rental payments. Furthermore, leasing can help the lessee either avoid, or assist in becoming, a mid-quarter convention taxpayer, thereby allowing it to determine its own destiny. Because equipment under a tax-oriented lease is not counted in the lessee's computation to determine if it has placed more than 40% of its equipment in service in the last quarter of its tax year, a taxpayer that leases equipment can avoid or guarantee the use of the mid-quarter convention.
Return to list of questions
14.	Are there additional leasing benefits for multinational corporations? Multinational corporations may find that it is better to lease assets used in the U.S. rather than purchasing those assets with borrowed funds. This benefit is related to the foreign tax credit. Generally speaking, the foreign tax credit permits U.S. taxpayers to reduce their U.S. tax liability by the amount of income taxes paid in foreign countries. However, this credit is subject to a limitation (the "FTC limitation") which depends upon the percentage of a taxpayer's foreign source taxable income as compared to its worldwide taxable income. By increasing its foreign source taxable income or reducing the amount of deductions allocated to foreign sources, the FTC limitation is less restrictive and more foreign tax credit can be utilized. One problem that leasing solves is that, after the Tax Reform Act of 1986, taxpayers generally must allocate interest expense between U.S. source (i.e., domestic source) and foreign source based upon the proportionate value of their assets located in the U.S. versus abroad. At the same time, this allocation must be made as if all members of an affiliated group are a single corporation (rather than on a corporation-by-corporation basis as permitted under prior law). Thus, companies with assets in foreign countries must now allocate a portion of their interest expenses to foreign sources even if the debt is incurred to acquire assets in the U.S. Such allocation reduces foreign source taxable income and thereby reduces the amount of foreign tax credits that can be claimed because of the FTC limitation. On the other hand, rental deductions for a lessee under a tax-oriented lease are allocated between domestic and foreign sources on the basis of where the leased assets are located. If the assets are located in the U.S., then all rental deductions are allocated to the domestic source. Such allocation would not reduce foreign source taxable income and should permit more foreign tax credits to be utilized by the lessee. For these and other reasons, multinational corporations may want to consider leasing (as opposed to traditional debt financing) to acquire new assets that will be used in the U.S. They may also want to consider using a sale-leaseback to convert existing interest deductions into rental deductions (i.e., using the sales proceeds to pay off any existing debt financing).
Return to list of questions
15.	15. How do I account for a lease? A lease (whether a tax-oriented lease or a non-tax-oriented lease) may be classified as a capital lease or an operating lease for book reporting purposes as defined in the Statement No. 13 published by the Financial Accounting Standards Board ("FASB 13"). According to FASB 13, a capital lease must have one or more of the following characteristics: 1. a bargain purchase option; 2. transfer of ownership of the property to the lessee by the end of the lease term; 3. a term equal to 75% or more of the estimated economic life of the property; or 4. 90% or more recovery of the fair market value of the property, at lease inception, through the present valuation of "minimum lease payments" using the lessee's incremental borrowing rate unless the lessor's implicit lease rate is known and is lower. Given that a lessee is usually not aware of the lessor's implicit rate, the lessee's incremental borrowing rate is required for the present valuing of such payments. The incremental borrowing rate is defined as "the rate that, at the inception of the lease, the lessee would have incurred to borrow over a similar term the funds necessary to purchase the leased asset." (FASB 13, paragraph 5.1.) A lease having none of these characteristics is accounted for as an operating lease. This is the simplest type of lease to account for, since the lessee only has to expense the rentals. There is no necessity to add the asset to the balance sheet. FASB 13 does require disclosure of the aggregate non-cancelable minimum rentals (usually placed in financial statement footnotes). On the other hand, a capital lease goes on the lessee's books as though it were a purchased asset. A corresponding liability, equal to the present value of the lease payments, is also recorded. Each month the asset is amortized in accordance with the lessee's normal depreciation procedure and the liability is reduced and expensed according to the "interest method". In other words, it's as though the asset were bought and financed with debt. For tax purposes, of course, there is no balance sheet consideration, and monthly rentals for a tax-oriented lease are fully expensed.
Return to list of questions
16.	How do balance sheet considerations affect the lease-buy, decision? The lease-buy decision is affected in two ways by the financial position of your company. First, some companies seek to reduce their balance sheet debt and improve their financial ratios to preserve overall borrowing capacity, while others have loan covenants prohibiting additional debt. The debt-to-equity level is closely monitored by lending institutions in determining credit strength or cost of credit. Compared with debt financing, an operating lease reduces balance sheet debt because the lease obligation is not, as compared to a capital lease, reported as a liability. At the very least, an operating lease with a leasing company represents an additional source of capital and preserves credit lines at your primary lending source. Second, some companies may find that their current and/or future years' tax liability would be increased as a result of being an AMT taxpayer. An increase in tax liability would adversely affect a company's working capital and related ratios. Because ownership of equipment generally increases the amount of minimum tax liability, these companies may desire a tax-oriented lease to conserve cash. Additionally, some companies may find that they are not able to realize the benefits of all their tax loss or credit carry forwards. (Reference: FASB Statement No. 109, Accounting for Income Taxes.) If future deductible amounts cannot be projected to be utilized within the carry back and carry forward periods under applicable tax law, a current period earnings adjustment (through a valuation allowance) must be made. Leasing, via a sale-leaseback of depreciated assets, will result in a taxable gain, thereby reducing loss carry forwards and aiding utilization projections.
Return to list of questions
17.	Who really owns the equipment? For federal tax purposes, the lessor is the owner of the equipment under a tax-oriented lease; the lessee is the owner under a non-tax-oriented lease. For state tax purposes, the nature of the contract and specific state statutes would govern.
Return to list of questions
18.	What asset ownership plans affect the lease-buy decision? Your plans for the acquired equipment will affect your decision to lease or buy: How long will you need the equipment? What is the expected life? Will new technology cause the asset to become obsolete? How will inflation affect its market value, particularly if you have to replace it? What is the value of cash savings from leasing to your company? Is your company now, or potentially, an AMT taxpayer? Is the expected value of the equipment at lease maturity offset by benefits of lowerrentals during the lease term and the avoidance of minimum tax?
Return to list of questions
19.	Is there ITC recapture as a result of a sale-leaseback? The general rule is that when property, which was eligible for federal ITC, is sold or disposed of before the end of its ITC vesting period, a recalculation (or "recapture") of the ITC earlier claimed becomes necessary. Sale-leaseback transactions are an exception. When a party sells its equipment to another party and immediately leases it back, no recapture of ITC is required. [See Income Tax Regulations 1.47(g).]
Return to list of questions
20.	Is equipment leasing prevalent in other countries? Although leasing practices and tax laws vary significantly from one country to another, leasing activity is found in many countries. You will even find "leasing rates" published, just like "Bond Rates", in some countries. GE Capital's Canadian operation advises that Canada currently does not consolidate a leasing company (or other subsidiaries) with its respective parent for tax purposes. This apparently has led to relatively fewer lessors than in the U.S. Our United Kingdom office advises that major banks and specialty leasing operations are active there and elsewhere in Europe. Leasing products and services are growing in use in Southeast Asia, India and the Pacific Rim countries as well. If you want to consider lease financing to assist in the sale of your products outside the U.S., or want to consider leasing assets used by your company or one of your foreign-based affiliates, please make sure that you check with someone familiar with the laws and practices in the countries involved.
Return to list of questions
21.	Is cross-border leasing an available practice? Yes. Cross-border leasing does occur but on a limited basis. The leasing of assets by a lessor situated in one country to a lessee located in a different country can create special concerns. A lessor must be aware of the application of tax treaties between the respective countries, including whether or not the lease payments would be subject to withholding tax (which may be prohibitive as to the use of cross-border leasing). Recognizing these problems, lessors such as GE Capital have set up foreign-based operations to supplement U.S. operations.
Return to list of questions
22.	Is GE Capital set up to do leasing in foreign countries? Yes. Through selective application of cross-border leasing and the establishment of foreign-based operations, frequently in concert with established foreign companies, GE Capital is able to serve a global customer base. Whether U.S. companies with foreign affiliates, foreign companies with U.S. affiliates, foreign companies acquiring U.S. or foreign-manufactured capital assets, GE Capital can meet a variety of customer's financial services needs.