The Future of Lease Taxation & Planning

Transcription

1 The Future of Lease Taxation & Planning October 24, 2006 Strategies and Reporting

2 Introductions Mr. David Fowler Tax Partner PricewaterhouseCoopers LLP Ph: Mr. William J Bosco, Jr. President Leasing 101 Ph: wbleasing101@aol.com Ms. Laurie Humann Asst. Tax Director USBancorp Ph: laurie.humann@usbank.com Mr. Jeff Nelson Managing Director PricewaterhouseCoopers LLP. Ph: jeff.nelson@us.pwc.com 2

3 The Future of Lease Taxation Tax Incentives & Benefits TIBs available to the leasing industry October 24, 2006 Dave Fowler PricewaterhouseCoopers LLP

4 Tax Incentives and Benefits ( TIB ) Identifying TIBs available to the leasing industry Background Lessees and Lessors have a choice between - Lease - Loan 4

5 Tax Incentives and Benefits ( TIB ) Identifying TIBs available to the leasing industry Why lease? - Lessee vs. Lessor tax position - Reduction of lessee costs (Lessor utilizes TIBs) - Improved lessee cash flows (finance full cost of equipment) - Financial reporting - Lessor tax shelter for other income 5

6 Tax Incentives and Benefits ( TIB ) Identifying TIBs available to the leasing industry Impact of - NOLs - AMT - Desired financial reporting - Pricing 6

7 Tax Incentives and Benefits ( TIB ) Identifying TIBs available to the leasing industry Lessor/Lessee Treatments - Depreciation - Rental - Principal amortization and Interest 7

8 Tax Incentives and Benefits ( TIB ) Identifying TIBs available to the leasing industry Depreciation - Accelerated Depreciation - MACRS - Bonus Depreciation 30 & 50% - Like Kind Exchange Deferred recognition of Gain 8

9 Tax Incentives and Benefits ( TIB ) Identifying TIBs available to the leasing industry Credits - Clean Fuel Vehicle Deductions (pr law) - Alternative Fuel vehicles (new iteration) Hybrid vehicles Advanced lean-burn technology vehicles Fuel cell vehicles Alternative fuel vehicles 9

10 Tax Incentives and Benefits ( TIB ) Identifying TIBs available to the leasing industry New IRC Sec Special deduction for Qualified Production Income - QPI includes any gross receipts derived from: Lease, rental, license, sale, exchange or other disposition of: Tangible personal property Computer software and other that have been manufactured, produced, grown or extracted by the taxpayer in whole or significant part within the U.S. - less cost and deductions allocable to such gross receipts 10

11 Tax Incentives and Benefits ( TIB ) Current developments and legislative updates Potential Gulf Opportunity Zone Proposals - Similar to 9/11 proposals - Secretary Snow before the Senate Finance Committee on October 6: Affected Zone specific? Raise cap on Sec. 179 expensing to $200,000 for 2 years Provide 50% bonus depreciation Provide tax relief for building new structures 11

12 Tax Incentives and Benefits ( TIB ) Current developments and legislative updates Gulf Opportunity Zone Proposal - Special NOL C/Os & C/Bs for affected businesses - Specific industries in affected states or counties? - Impacts proposed governmental spending cuts? - Most likely the next major legislation to be considered - Potential timing of passage & effective dates? House scheduled to consider in early Nov. Senate to follow closely thereafter 12

13 jtn2 The Future of Lease Taxation October 24, 2006 William Bosco Leasing 101

14 Slide 13 jtn2 JTN draft edits Jeff Nelson, 10/9/2005

15 Agenda Targeting customers for tax lease - NOL & AMT discussion - Reading a tax footnote GAAP treatment of tax benefits - Operating lease example - Direct finance lease example Understanding MISF vs. ROA for tax lease pricing 14

16 Why Do Customers Lease? To Manage Taxes! Problem Net operating loss (NOL) Alternative minimum tax (AMT) Leasing solution Manages unfavorable tax positions, while at the same time reduces aftertax cost of borrowing Leasing companies target customers by their tax position. 15

17 Net Operating Loss - NOL A tax position where a company has negative taxable income. - Can be carried back to generate a refund. - Unused NOL is carried forward but can expire. Customers with an NOL lease to lower their after-tax cost of financing equipment. - Customer can t take advantage of tax benefits currently. - The lessor will take the tax benefits currently and charge a lower tax effected rent rate. Lease vs. buy analysis determines if the trade off of tax benefits for a lower financing rate is beneficial. 16

18 Alternative Minimum Tax - AMT AMT causes companies with significant tax preferences to pay a minimum tax. - AMT tax is calculated by adding back preference items to regular taxable income and applying a 20% AMT rate to the AMT income. - The higher of AMT tax or regular tax is paid. - AMT credits (excess of AMT over regular tax) carried forward with no expiration. AMT customers can lower after tax financing cost by leasing as MACRS is a preference item, thus leasing equipment rather than buying equipment helps reduce AMT. - The lessor will take the full MACRS benefit at the higher regular tax rate (35%) currently and charge a lower tax effected rent rate. - Lease vs. buy analysis determines if the trade off of tax benefits for a lower financing rate is beneficial. 17

19 Lease vs. Buy Analysis Analysis done by the lessee to determine if a tax lease financing is more cost-effective than borrowing to buy the equipment The dilemma is that the tax lease rent rate looks better than the loan rate but the lessee is giving up potentially valuable tax benefits 18

20 Lease vs. Buy Analysis The calculation is a discounted cash flow analysis: - Calculates the PV of the after tax cash flows of the lease - Rent to be paid less the tax benefit of deducting the rent - Tax deductions are adjusted for impact of NOL & AMT - Calculates the PV of the after tax cash flows of a loan - Loan payments to be paid less the tax benefit of deducting the interest on the loan & the depreciation on the asset net of the after tax gain on sale of the asset - Tax deductions are adjusted for impact of NOL & AMT - Must assume the asset is either sold under the loan or bought under the lease assumptions to be comparable The lowest PV of the 2 choices = the lowest after tax cost & therefore it is the best choice 19

21 How Do We Know the Lessee s Tax Position? Read the tax footnote in their annual report before we contact the customer - Tax position is a factor in determining the structures we present to the customer - The text of the footnotes will disclose any negative tax positions - The current tax provision in the P&L is not a good indicator We should ask! - Often the leasing decision maker/customer contact doesn t know - the customer s tax department knows best! - Tax considerations are often not focused on in mid/smaller ticket deals 20

22 XYZ Inc. and Subsidiaries Notes to consolidated financial statements Note 15 Income Taxes The effective tax rate varied from the statutory federal corporate income tax rate as follows: Percentage of Pretax Income Year Ended December 31, 2003 Three Months Ended December 31, 2002 Year Ended September 30, 2002 June 2 through September 30, 2001 January 1 through June, 2001 (successor) (successor) (successor) (successor) (predecessor) Federal income tax rate 35.0% 35.0% 35.0% 35.0% 35.0% Increase (decrease) due to: State and local income taxes, net of federal income tax benefit (0.3) Foreign income taxes (0.4) Goodwill impairment (36.1) Interest expense TCH (4.2) Goodwill amortization Other (0.7) (0.2) Effective tax rate 39.0% 39.0% -5.9% 45.8% 49.8% 21

23 XYZ Inc. and Subsidiaries Notes to consolidated financial statements Note 15 Income Taxes The provision for income taxes is comprised of the following ($ in millions): Year Ended December 31, 2003 Three Months Ended December 31, 2002 Year Ended September 30, 2002 June 2 through September 30, 2001 January 1 through June, 2001 (successor) (successor) (successor) (successor) (predecessor) Current Federal income tax provision $ - $ - $ - $ - $ - Deferred Federal income tax provision Total Federal income taxes State and local income taxes Interest expense special transaction (4.2) Foreign income taxes Total provision for income taxes $365.0 $92.0 $374.0 $157.4 $

24 XYZ Inc. and Subsidiaries Notes to consolidated financial statements The tax effects of temporary differences that give rise to significant portions of the deferred income tax assets and liabilities are presented below ($ in millions). Percentage of Pretax Income December 31, 2003 December 31, 2002 September 30, 2002 (successor) (successor) (successor) Assets: Net operating loss carryforwards $834.1 $849.9 $834.4 Provision for credit losses Alternative minimum tax credits Purchase price adjustments Goodwill Other comprehensive income items Accrued liabilities and reserves Other 14.1 Total deferred tax assets 1, , ,710.5 Liabilities: Leasing transactions (1,311.7) (1,189.6) (1,215.6) Securitization transactions (633.0) (614.4) (590.0) Market discount income (1.4) (1.5) Total deferred tax liabilities (1,944.7) (185.4) (1,807.1) Net deferred tax (liability) ($527.2) ($159.5) ($96.6) At December 31, 2003, XYZ had U.S. federal net operating losses of approximately $1,937.7 million, which expire in various years beginning in In addition, XYZ has various state net operating losses that will expire in various years beginning in Federal and state operating losses may be subject to annual use limitations under section 382 of the Internal Revenue Code of 1986, as amended, and other limitations under certain state laws. Management believes that XYZ will have sufficient taxable income in future years and can avail itself of tax planning strategies in order to fully utilize these losses. Accordingly, XYZ does not believe a valuation allowance is required with respect to these net operating losses. 23

25 GAAP Treatment of Leasing Tax Benefits Muni Leases Tax benefit is the interest income is exempt from Federal Income taxes. The GAAP treatment is a reduction in tax expense. Tax Credits Tax credit is a direct reduction of income taxes payable. Tax credits like ITC are amortized over the lease term for direct finance leases Temporary Differences Book income vs. tax income for direct finance leases MACRS vs. book depreciation for operating leases. Temporary differences create deferred tax balances. 24

26 GAAP Tax Benefits - Operating Lease Example An example comparing book income to taxable income for an operating lease: 1. Assume an operating lease for GAAP purposes and a true lease for income purposes. - Lessor enters into a 60-month FMV lease of material handling equipment, having a cost of $1 million, monthly rent of $18,500, a residual of $200,000, and an implicit interest rate of 10%. - The first basic rent date is April 1, There is no automatic transfer of ownership. - There is no bargain purchase option. - The equipment has an economic life of 10 years, therefore the lease term of 5 years is less than 75% of the economic life. The PV of the rents at the implicit rate of 10% is $878,000, which is less than 90% of the cost the equipment. Therefore, the lease is an operating lease for financial reporting purposes. 2. Material handling equipment (generally) is five-year class property. MACRS depreciation rates (from the IRS table) are: Year %

27 GAAP Tax Benefits - Operating Lease Example From the standpoint of the lessor, the lease will have the following earnings pattern: Year ended December 31 Tax Books Total Rental Income $166,500 $222,000 $222,000 $222,000 $222,000 $55,500 $1,110,000 Sale Proceeds 200, ,000 Depreciation Expense 200, , , , ,200 57,600 1,000,000 Tax Income (Loss) (33,500) (98,000) 30, , , , ,000 Tax Rate 40% (Combined Federal & State Rate) 40% 40% 40% 40% 40% 40% 40% Tax Liability (Savings) ($13,400) ($39,200) $12,000 $42,720 $42,720 $79,160 $124,000 GAAP Books Rental Income $166,500 $222,000 $222,000 $222,000 $222,000 $55,500 $1,110,000 Sale Proceeds 200, ,000 Depreciation Expense 120, , , , , ,000 1,000,000 Income before Tax 46,500 62,000 62,000 62,000 62,000 15, ,000 Tax 40% 18,600 24,800 24,800 24,800 24,800 6, ,000 Net Income $27,900 $37,200 $37,200 $37,200 $37,200 $9,300 $186,000 Current Tax Liability 13,400 39,200 (12,000) (42,720) (42,720) (79,160) (124,000) Deferred Tax Balance (32,000) (96,000) (108,000) (90,880) (72,960)

28 GAAP Tax Benefits - Operating Lease Example The deferred tax provision is calculated by identifying the temporary differences and carryforwards. Operating Lease Tax Provision Calculation Equipment Tax Basis 800, , , ,800 57,600 - Equipment Book Basis 880, , , , ,000 - Taxable Temporary Difference (80,000) (240,000) (272,000) (227,200) (182,400) - Applicable tax rate 40% 40% 40% 40% 40% 40% Deferred tax liability (32,000) (96,000) (108,800) (90,880) (72,960) - Current tax receivable/(payable) 13,400 39,200 (12,000) (42,720) (42,720) (79,160) Change in the Deferred Tax Liability (32,000) (64,000) (12,800) 17,921 17,920 72,960 (Deferred Tax Expense) Total Income Tax Provision (18,600) (24,800) (24,800) (24,800) (24,800) (6,200) 27

29 GAAP Tax Benefits - Operating Lease Example A simple GAAP balance sheet presentation of the lease: Year ended December 31 GAAP Books Cash $179,900 $441,100 $651,100 $830,380 $1,009,660 $1,186,000 Equipment under lease 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 0 Accumulated depreciation (120,000) (280,000) (440,000) (600,000) (760,000) 0 Equipment under lease, net 880, , , , ,000 0 Total Assets $1,059,900 $1,161,100 $1,211,100 $1,230,380 $1,249,660 $1,186,000 Deferred Taxes 32,000 96, ,800 90,880 72,960 0 Stockholder s Equity 1,027,900 1,065,100 1,102,300 1,139,500 1,176,700 1,186,000 Total Liabilities & Equity $1,059,900 $1,161,100 $1,211,100 $1,230,380 $1,249,660 $1,186,000 28

30 GAAP Tax Benefits - Direct Finance Lease Example An example comparing book income to taxable income for direct finance lease: 1. Assume an direct finance lease for GAAP purposes and a true lease for income purposes. - Lessor enters into a 60 month FMV lease of material handling equipment, having a cost of $1 million, monthly rent of $20,087, a residual of $100,000, and an implicit interest rate of 10.25%. The first basic rent date is April 1, There is no automatic transfer of ownership. - There is no bargain purchase option. - The equipment has an economic life of 10 years, therefore the lease term of 5 years is less than 75% of the economic life. The PV of the rents at the implicit rate of 10% is $939,970, which is more than 90% of the cost of the equipment. Therefore, the lease is a direct finance lease for financial reporting purposes. 2. Material handling equipment (generally) is five-year class property. MACRS depreciation rates (from the IRS table) are: Year MACRS % % % % % % % 29

31 GAAP Tax Benefits - Direct Finance Lease Example From the standpoint of the lessor, the direct finance lease will have the following earnings pattern: Year ended December 31 Tax Books Total Rental Income $180,786 $241,049 $241,049 $241,049 $241,049 $60,263 $1,205,245 Sale Proceeds 100, ,000 Depreciation Expense 200, , , , ,200 57,600 1,000,000 Tax Income (Loss) (19,214) (78,951) 49, , , , ,245 Tax Rate 40% (Combined Federal & State Rate) 40% 40% 40% 40% 40% 40% 40% Tax Liability (Savings) ($7,686) ($31,580) $19,620 $50,340 $50,340 $41,065 $122,098 GAAP Books Rental Income $73,253 $84,247 $67,398 $48,738 $28,074 $3,534 $305,244 Sale Proceeds Depreciation Expense Income before Tax 73,253 84,247 67,398 48,738 28,074 3, ,244 Tax 40% 29,301 33,699 26,959 19,495 11,230 1, ,098 Net Income $43,952 $50,548 $40,439 $29,243 $16,844 $2,120 $183,146 Current Tax Receivable (Liabili 7,686 31,580 (19,620) (50,340) (50,340) (41,065) (122,098) Deferred Tax (liability) balance (36,987) (102,266) (109,065) (78,760) (39,650)

32 GAAP Tax Benefits - Direct Finance Lease Example The deferred tax provision is calculated by identifying the temporary differences and carryforwards. Direct Finance Lease Tax Provision Calculation Equipment Tax Basis 800, , , ,800 57,600 - Lease Book Basis 892, , , , ,728 - Taxable Temporary Difference (92,467) (255,665) (274,014) (196,903) (99,128) - Applicable tax rate 40% 40% 40% 40% 40% 40% Deferred tax liability (36,987) (102,266) (109,605) (78,760) (39,650) - Current tax receivable/(payable) 7,686 31,580 (19,620) (50,340) (50,340) (41,065) Change in the Deferred Tax Liability (36,987) (65,279) (7,339) 30,845 39,110 39,650 (Deferred Tax Expense) Total Income Tax Provision (29,301) (33,699) (26,959) (19,495) (11,230) (1,414) 31

33 GAAP Tax Benefits - Direct Finance Lease Example A simple GAAP balance sheet presentation of the lease: Year ended December 31 GAAP Books Cash $196,508 $469,136 $690,566 $881,275 $1,071,984 $1,183,147 Gross Receivable 1,024, , , ,311 60,262 0 Unearned Income (231,991) (147,744) (80,346) (31,608) (3,534) 0 Residual 100, , , , ,000 0 Net Investment, Leases 892, , , , ,728 0 Total Assets $1,088,974 $1,204,801 $1,252,580 $1,250,978 $1,228,712 $1,183,147 Deferred Taxes 45, , ,641 86,796 47,686 0 Stockholder s Equity 1,043,952 1,094,500 1,134,939 1,164,182 1,181,026 1,183,147 Total Liabilities & Equity $1,088,974 $1,204,801 $1,252,580 $1,250,978 $1,228,712 $1,183,147 32

34 Pricing for True Leases Many lessors price to an MISF (Multiple Investor Sinking Fund) yield target. The MISF yield is the rate of return of after-tax cash flows on the amount of net cash invested, in periods where it is positive. It s purpose is to amortize accounting earnings for leveraged leases where the net cash invested can be zero or even negative. It has incorrectly evolved into a measurement of profitability but does not correlate to GAAP returns. 33

35 Pricing for True Leases: ROA The solution to the MISF dilemma is to target ROA (Return on Assets). The denominator is Net Asset (or Net GAAP Investment) usually discounted using the ROE return target rate to levelize uneven returns. The numerator is after-tax profits, also discounted at the ROE discount rate. Deferred taxes generate a free source of funds, which reduces interest cost to carry. 34

36 MISF Profile 100% Net Cash Invested (Net Investment Deferred Taxes) Net Investment (GAAP) Residual Inception Expiry MISF yield is the internal rate of return of the net cash flows versus the net cash invested. Net Cash Invested is reduced by: Cash received from rents Cash received from taxes (and then increased by cash paid for taxes) (in effect the deferred tax balance is deducted from the investment) 35

37 ROA Profile 100% Net Risk Asset (= Investment rent + income) Residual Deferred Tax Balance Inception Expiry Under the ROA calculation the net risk asset is not reduced by the deferred tax balance as the risk is the unamortized balance of the your investment. The deferred tax balance is utilized under the ROA calculation as a reduction of the amount to be funded (reduction in cost of funds). 36

38 Pricing for True Leases: ROA vs. MISF Aligned with GAAP Books/Mgmt Acctg Numerator (Income) ROA Yes Book Income MISF No After-tax cash Denominator (Asset) Income Pattern GAAP Asset Varies by lease classification Net Cash Invested No adjustment Best Suited for Pricing all True Leases incl. Leveraged Leases Accounting for Leveraged Leases 37

39 ROA vs. MISF: What is the Impact? The greater the tax benefits and the more back-ended the accounting earnings, the greater the difference. Example parameters: - 5 year term, level rents in arrears - 5 year MACRS, December delivery - 15% residual 40% tax rate, 5% COF rate, 3% PT spread on MISF basis - Operating lease for lessor Results = PT ROA < PT MISF Spread by 67bps! 38

40 The Future of Lease Taxation Like Kind Exchange Programs for Equipment Leasing October 24, 2006 Jeff Nelson PricewaterhouseCoopers LLP

41 Today s Agenda Background What is Like Kind Exchange (LKE) and why should you consider an LKE Program for your business? IRS Safe Harbor Rules for Leasing LKE Programs Valuing LKE for your business? Direct Benefits cash flow, pricing, profitability and competitiveness. Indirect Benefits - proper state/fed reporting, vendor programs. Questions 40

42 What is Like Kind Exchange ( LKE )? IRC Section 1031 provides: No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business if such property is exchanged solely for property of like-kind which is also to be held for productive use in a trade or business. Bottom line: No tax is paid on the disposition of tax leased property where sales proceeds are reinvested in new leases of like kind property. 41

43 Exchange v. Sale and Repurchase Exchange Sale & Repurchase Taxpayer Taxpayer Old Asset New Asset Old Asset $ $ New Asset Buyer & Seller Buyer Seller 42

44 Exchange v. Sale and Repurchase QI Safe Harbor A Fictional Exchange Exchange of old and new assets Taxpayer Old Asset New Asset Qualified Intermediary (QI) Old Asset $ $ New Asset Buyer Seller 43

45 Nature of LKE benefit Trade-off between current gain recognition and future depreciation deductions Single Asset LKE results in a disappearing net deferral over the replacement assets tax depreciable life, however LKE program results in a permanent deferral to the extent taxpayers continue their trade or business, and maintain the level of their $investment in Like Kind property 44

46 Nature of LKE benefits Where does LKE make sense? Significant tax lease portfolio High rate of asset turnover - Recurring originations and dispositions High residual value relative to tax bases (however, Bonus Op ) High unit volume Asset replacements occur as part of a continuous process Utilized bonus depreciation in 2001 thru

47 Nature of LKE benefits Where does LKE make sense? Equipment Leasing where LKE makes sense - vehicles (automobiles, trucks, trailers) - construction equipment - industrial machinery - aircraft - motor coaches / buses - railcars - tractors and trailers - barges & ships 46

48 Nature of LKE benefits Where does LKE make sense? Assets subject to 50 & 30% Bonus Depreciation Commodity intensive industries Oil and Gas Industry - pipelines, drilling, production and refining equipment Electrical Generation and Transmission - cable, poles and insulators Rail Transportation - ties, ballast and rail Telecommunications cable, switching and microwave communications equipment 47

49 Nature of LKE benefit Why adopt an LKE Program Now? IRS and Regulatory Acceptance of LKE Programs Safe Harbor Guidance under Rev. Proc The Impact of expiring Bonus depreciation on your decision. Benefits of Step in the Shoes depreciation Ongoing Improvements in LKE Best Practices & Technology Direct benefits to lessors Indirect benefits to vendors and customers 48

50 Revenue Procedure LKE Program Safe Harbors Applicable only to LKE Programs Issued May 7, 2003 Applicable to tax leases only 49

51 Revenue Procedure What is an LKE Program Multiple exchanges of 100 or more properties with all the following characteristics. - Regular & routine purchase and sale of personal property - Qualified Intermediary - Utilizes a Master Exchange Agreement - Process for collecting, holding & disbursing funds ensuring QI control - Process that matches relinquished wt. replacement property 50

52 Revenue Procedure Receipt of non-lke property - TP can process checks or instruments made payable to person other than TP (or disqualified person) - Joint QI-TP account OK as long as in third party or QI name & QI must OK funds transfer - Funds netting OK Amounts owed by TP to buyer against buyer purchase Amounts owed to TP by seller against TP purchase 51

53 Revenue Procedure Receipt of non-lke property Continued - TP can loan purchase funds to Buyer (Conversion of lease to loan) TP makes similar loans in ordinary course of its business Buyer has option to obtain other financing Loans must be arm s-length - Security Deposits can be applied to Purchase Price 52

54 The Bonus Depreciation Bubble Can Recapture be avoided? - Bonus Depreciation expired as of Tax Lessors can expect a significant increase in taxes and gains on dispositions of assets acquired under the Bonus rules - What can lessors do to avoid paying tax on Bonus Depreciation recapture? - Like Kind Exchange Programs under IRC Sec and Rev Proc

55 The Bonus Depreciation Bubble The future cost of depreciation recapture Bonus Depreciation Tax Bases, Gain and Increased Tax Assuming $1mil Asset Cost Year Year Year Year Year Year Tax Basis under Reg. MACRS $ 800,000 $ 480,000 $ 288,000 $ 172,800 $ 57,600 $ - Tax Basis under Bonus MACRS $ 400,000 $ 240,000 $ 144,000 $ 86,400 $ 28,800 $ - Addt'l Gain due to Bonus Recapture $ 400,000 $ 240,000 $ 144,000 $ 86,400 $ 28,800 $ - Increased Tax on 40% $ 160,000 $ 96,000 $ 57,600 $ 34,560 $ 11,520 $ - 54

56 Valuing LKE for Your Business LKE Opportunities For Leasing Companies - Direct or Captive Leasing Companies - Vendor or Dealer Leasing Companies - Funding Other Leasing Companies 55

57 Valuing LKE for Your Business LKE Opportunities For Leasing Companies - Direct or Captive Leasing Companies Source business directly Can use the LKE benefit to reduce its funding costs, increasing its profits Can use the LKE benefit to reduce pricing on replacement business 56

58 Valuing LKE for Your Business LKE Opportunities For Leasing Companies - Vendor or Dealer Leasing Companies Source business through vendor or dealer relationships Can use the LKE benefits to reduce costs or reduce pricing Vendor or dealer may want a cut or may force LKE process on the lessor to offer competitive pricing to vendor/dealer customers 57

59 Valuing LKE for Your Business LKE Opportunities For Leasing Companies - Funding Other Leasing Companies Leasing companies with NOL or AMT problems can t get the full LKE benefit on tax lease business they do for their account Other leasing companies with big tax base target those leasing companies with sale-leasebacks and ongoing portfolio financings using LKE techniques to make the pricing attractive The lessor prices in the LKE on replacement leases so the NOL/AMT lessor gets a lower financing cost and possibly offbalance sheet financing 58

60 Nature of LKE Program Benefits Single asset sale in year 1- Disappearing deferral Year of Sale Year 1 Year 2 Year 3 Year 4 Total Without LKE Gain recognized on Relinquished Asset $ 10,000 $ 10,000 Depreciation on Replacement Asset $ (3,333) $ (4,445) $ (1,481) $ (741) $ (10,000) Net effect on taxable income $ 6,667 $ (4,445) $ (1,481) $ (741) $ - With LKE Gain recognized on Relinquished Asset $ - $ - Depreciation on Replacement Asset $ - $ - $ - $ - $ - Net effect on taxable income $ - $ - $ - $ - $ - Net Taxable Income Deferral

61 Nature of LKE Program Benefits Recurring asset sales yr. 1 & after - Permanent deferral Year of Sale Year 1 Year 2 Year 3 Year 4 Total Without LKE Gain recognized on Relinquished Assets $ 10,000 $ 10,000 $ 10,000 $ 10,000 $ 40,000 Depreciation on Replacement Assets $ (3,333) $ (7,778) $ (9,259) $ (10,000) $ (30,370) Net effect on taxable income $ 6,667 $ 2,222 $ 741 $ - $ 9,630 With LKE Gain recognized on Relinquished Assets $ - $ - Depreciation on Replacement Assets $ - $ - $ - $ - $ - Net effect on taxable income $ - $ - $ - $ - $ - Net Taxable Income Deferral $ 6,667 $ 2,222 $ 741 $ - $ 9,630 Cumulative Deferral $ 6,667 $ 8,889 $ 9,630 $ 9,630 60

62 Nature of LKE benefit Cumulative Tax Savings Equipment Lessor Equipment Lessor Like Kind Exchange Estimated Tax Savings In 000's Facts & Assumptions: Tax Rate 38.0% Inflation Rate 3.0% Annual Sales Proceeds $200 million Fleet Growth 2.0% Annual Intial Tax Cost of Sales $300 million Average Lease Term 3.00 MACRS Life 3,5 & & years 2006 Yr. Yr. Yr. Yr. Yr. Yr Total Taxable Income Effect Without like kind exchange $73,324 -$47,075 -$171,674 -$213,776 -$235,688 -$272,838 -$1,803,105 With like kind exchange -$52,444 -$142,145 -$208,374 -$239,989 -$252,492 -$292,290 -$2,211,609 Tax Inc. Impact -$125,768 -$95,069 -$36,699 -$26,213 -$16,804 -$19,453 -$408,504 Annual Tax Savings $47,792 $36,126 $13,946 $9,961 $6,385 $7,392 $155,231 Cumulative Tax Savings $47,792 $83,918 $97,864 $121,628 $134,095 $155,231 61

63 Nature of LKE benefit Sample Benefits Representative Equip Lease Portfolio Assumptions: Tax Rate 38.0% Fleet Growth 2.0% Inflation Rate 2.0% Avg Lease disp 3.61 yrs Earnings Rate 6.5% MACRS Life (3,5, or 7) Various Annual Sales $200 mil Annual COS $344 mil Portfolio Size 7 Year In 000's Net Deferral Tax Deferral Earnings Cash Flow PV $ 1,241,304 $ 351,789 $ 133,680 $ 43,349 $ 177,028 $ 35,231 $ 500,000 $ 141,701 $ 53,846 $ 17,461 $ 71,307 $ 14,191 $ 1,000,000 $ 283,402 $ 107,693 $ 34,922 $ 57,445 $ 28,382 $ 1,500,000 $ 425,104 $ 161,539 $ 52,383 $ 69,418 $ 42,573 $ 2,000,000 $ 566,805 $ 215,386 $ 69,844 $ 111,846 $ 56,765 $ 2,500,000 $ 708,506 $ 269,232 $ 87,304 $ 225,259 $ 70,956 $ 3,000,000 $ 850,207 $ 323,079 $ 104,765 $ 544,409 $ 85,147 62

64 Valuing LKE for Your Business Case Study Analysis Basis Point & Rental Rate Benefits Most business managers want to know both the portfolio benefits of an LKE and the transactional benefits Assumptions: - Equipment: Construction Equipment - 50% bonus MACRS - Same 5 year lease replaced with a new deal using regular MACRS Calculation method - Target a yield of 6.50% and solve for rent. - Freeze rent, adjust depreciable basis solve for new IRR 63

65 Valuing LKE for Your Business Case Study Analysis IRR and Rental Rate Impact Effect of LKE process benefits in the replacement lease Increased Profits and Margins Case Study - LKE produces an 84 bps after tax increase in IRR Reduction of customer lease rates Case Study - Lease rate reduced by 4.1% at the same IRR 64

66 Valuing LKE for Your Business Case Study Analysis Facts Example: Cash Savings Utilizing a Like-Kind Exchange Sale of Old Equipment Current Situation Like-Kind Exchange Program Proceeds 168, ,500 Tax Basis - - Gain 168, ,500 Less Federal & State Taxes Due 67,400 - Cash available to acquire new equip 101, ,500 Assumptions: Combined tax rate 40% 65

67 Valuing LKE for Your Business Case Study Analysis Basis Points Benefits WITHOUT LKE CASH FLOW Pre-taxCash Flow Taxes Paid After-Tax Cash Flow IRR - = Origination (235,000) - (235,000) 12/30/ ,500 (12,560) 55,060 12/30/ ,000 (19,800) 74,800 12/30/ ,000 8,080 46,920 12/30/ ,500 2,280 25,220 Termination 91,000 36,400 54,600 36,000 14,400 21, % 66

68 Valuing LKE for Your Business Case Study Analysis Basis Point Benefits WITH LKE BENEFIT INCREASING IRR CASH FLOW Pre-taxCash Flow Taxes Paid After-Tax Cash Flow IRR - = Origination (235,000) - (167,600) 12/30/ ,500 8,400 34,100 12/30/ ,000 11,200 43,800 12/30/ ,000 18,400 36,600 12/30/ ,500 7,400 20,100 Termination 91,000 36,400 54,600 36,000 81,800 21, % Without LKE 3.22% IRR BPS Advantage 0.83% 67

69 Valuing LKE for Your Business Case Study Analysis Rental Rate Benefits WITH LKE BENEFIT REDUCING RENTAL RATE CASH FLOW Pre-taxCash Flow Taxes Paid After-Tax Cash Flow IRR - = Origination (235,000) - (167,600) 12/30/ ,736 7,620 33,116 12/30/ ,718 10,287 42,431 12/30/ ,718 17,487 35,231 12/30/ ,359 7,018 19,341 Termination 91,000 36,400 54,600 28,530 78,812 17, % 68

70 Valuing LKE for Your Business Internal Challenges to Implement LKE Program - Overview The internal approval and implementation process is challenging Economics may not work Low tax gains on sale Small ticket assets Low interest rates Business heads and tax staff are usually supportive Need a project manager/champion to run the implementation LKE software offers a solution for lack of detailed asset level systems and record keeping for tax depreciation Business people may have concerns about customer notifications Treasury will have to change processes and add new ones Treasury has to give allocate internal credit for the tax deferral benefits 69

71 The Future of Lease Taxation Communicating & allocating value to business units October 24, 2006 Laurie Humann U.S. Bank Jeff Nelson PricewaterhouseCoopers LLP

72 Topics for Discussion ID the tax incentive or benefit ( TIB ) Quantify the value for the business unit Present the value to leadership Implement your plan Allocating impacts to business lines 71

73 Tax Incentives and Benefits ID and quantify the value of the TIB for the business unit Understand the value of the TIB - Permanent vs. deferral - Income vs. other - Jurisdictional & geographic differences Federal State & Local International 72

74 Tax Incentives and Benefits For example: Like Kind Exchange Interest free loan from the IRS - Tax ownership creates a deferred tax liability LKE creates an additional deferred tax liability - Free cash flow/roe/irr Strategic advantages - Pricing - Lower funding costs 73

75 Tax Incentives and Benefits Presentation of Benefits to Leadership Quantify the value - Benefits Enhanced cash flow Strategic advantages - Costs Implementation and software costs Ongoing costs such as Qualified Intermediary and processing Headcount Tailor message according to time constraints and audience - Pricing advantages - Payback period - Adoption hurdles 74

76 Tax Incentives and Benefits Implementing Your Plan - Adopting a LKE program Recommendations for a smooth implementation - Need a point person from business line and tax - Optimal time for any data clean-up - Reconciliation efforts - Operational burdens Benefits - Improved compliance efforts 75

77 Tax Incentives and Benefits Making it happen in the business Example: USBEF Like Kind Exchange Program Success factors and process - Who? Who do you need to get buy-in? - What? What do they need to know? - When? Priorities and resources? - Where? Who benefits? - How? Logistics, scheduling and follow-up? 76

78 Tax Incentives and Benefits Allocating Impacts to Biz Lines Attributing the value of LKE to business line - Improved cash flows - Lower funding costs Interest free loan from the IRS Enhanced understanding of data Increased interaction with tax and finance Increasing market competitiveness - Pricing impacts - Advantages for vendors & customers 77

79 Questions and Panel Discussion 78