Lease & Finance Accountants Conference. September The Westin Charlotte Charlotte, NC

Transcription

1 Lease & Finance Accountants Conference September The Westin Charlotte Charlotte, NC H A N D O U T S

2 Comprehensive Tax Reform Impact on Equipment Finance ELFA Tax and Accounting Conference Charlotte, N.C. September 2017 Presented by: Glenn Johnson, Principal, Ernst & Young Joe Sebik, Director Tax Reporting, Siemens Financial Services 0

3 Agenda Expiring tax incentives Tax Reform Effect of Tax Reform on Leasing Industry Summary Observations 1

4 Expiring Tax Incentives Protecting Americans from Tax Hikes (PATH) Act passed December 2015 Phases out Bonus tax depreciation Except for Long Period Production Assets (LPPS ) started on or before December 31, 2014 Investment Tax Credit Renewable energy (largely Wind) Production Tax Credits (first enacted in 1992!) Section 179 deductions immediate expensing of certain capital expenditures for small businesses Although over 50 incentives expired, most of the others are very specific and don t generally affect equipment leasing and financing; many are largely alternative energy related In total temporarily extending these incentives costs about $95 billion in lost tax revenue over 10-years 2

5 Bonus Depreciation Phase Out EQUIPMENT LEASING AND FINANCE ASSOCIATION Bonus depreciation Based on placed in service date 50% bonus depreciation retroactive from 1/1/15 to 12/31/17 40% bonus depreciation from 1/1/18-12/31/18 30% bonus depreciation from 1/1/19-12/31/19 Special rules for long production period assets (over 1 year to build & costing over $1 million) Calculated as follows: Bonus percentage x Asset Basis Plus standard MACRS x (Asset Basis bonus depreciation claimed) i.e. 5 yr MACRS asset using ½ convention and 40% bonus Bonus depreciation = 40.00% Plus 32% x (100% - 40%) = 19.20% First year depreciation = 59.20% Second year 19.2% x 60% = 11.52% 3

6 Alternative Energy Investment Tax Credit Phase Out Energy Investment Tax Credit Converting to a start of qualified construction test from the placed in-service date test; generally claimed when placed in service 30% extended for projects starting construction by 12/31/19 26% for projects starting construction from 1/1/20 12/31/20 22% for projects starting construction from 1/1/21 12/31/21 with a required placed in service deadline of 12/31/23, or else the percentage will drop to 10% 10% for projects starting after 12/31/21 Investment Tax Credit claim in lieu of PTC Based on qualified start of construction date and continuous construction rules; generally claimed when placed in service Retroactive to 1/1/15 and extended through 2019 subject to a phase-down as follows: Rate remains 30% for start of construction from 1/1/15-12/31/16 Rate drops to 24% for start of construction from 1/1/17 12/31/17 Rate drops to 18% for start of construction from 1/1/18 12/31/18 Rate drops to 12% for start of construction from 1/1/19 12/31/19 4

7 Production Tax Credits Based on qualified start of construction date and continuous construction rules; commences at commercial operation date Retroactive to 1/1/15 and extended through 2019 subject to a phase-down as follows: Rate drops to 80% of current rate for start of construction from 1/1/17 12/31/17 Rate drops to 60% of current rate for start of construction from 1/1/18 12/31/18 Rate drops to 40% of current rate for start of construction from 1/1/19 12/31/19 5

8 Tax Extenders Alternative Energy PTC/ITC Renewable Energy Production and Investment Tax Credits The Production Tax Credit or PTC ) for electricity produced from wind, closed loop biomass and geothermal energy provides a 2.3 per KWh tax credit with a 1.1 per KWh credit for open loop biomass, sober and certain other projects. PTC is available each year for 10-years of production to the producer of the power Taxpayers could elect to receive a 30% investment tax credit ( ITC ) in lieu of the PTC. PTC was generally found in larger, more efficient installations; ITC in somewhat smaller or less cost effective facilities The Wind Industry is financed through a variety of complex structures such as the Partnership Flip Structure, often wherein one entity (a passive investor partner) is allocated the majority of tax benefits (PTC or ITC and accelerated tax depreciation) to provide them yield for their investment The Wind Industry in the US is very reliant on PTC/ITC because other forms of energy production are often less costly This provision expired with respect to projects with construction commencing after December 31, Start of construction rules grandfather the benefits even if the in-service date is after the expiration of the credit Each time PTC/ITC is scheduled to expire, often the US Wind Industry sees no new wind farms developed 6

9 Fundamental Tax Reform EQUIPMENT LEASING AND FINANCE ASSOCIATION Fundamental Tax Reform The movement for fundamental tax reform has again reached a more likely than not state Several analyses have concluded that a lower corporate tax rate can make the US economy more competitive Corporate inversions continue to gain momentum and Congress is seeking to act; JCT estimates it will cost taxpayers $20 billion over 10-years; since Jan 2013, [19] companies announced plans Many plans have been proposed and share the goal of greater fairness by broadening the tax base (some one has got to pay for this!) and reducing the corporate tax rate, the personal tax rate and repealing the alternative minimum tax The cost of a corporate rate reduction is expected to be over $1 trillion over the 10- year scoring period The cost of such rate reduction and the elimination of the AMT could approach $2.5 trillion over 10 years In the spirit of no additional debt to finance the rate reduction, the Joint Committee on Taxation, a bipartisan committee commissioned an analysis to determine how to pay for the $1 trillion cost 7

10 Fundamental Tax Reform EQUIPMENT LEASING AND FINANCE ASSOCIATION Tax Benefit JCT 10 yr Revenue Estimate Scoring $B MACRS $506.8 Expensing R&E expenditures $152.2 Sec 199 Domestic Production Activities deduction $127.0 LIFO and LCM Inventory methods $ 65.6 Credits for affordable/ low income housing investments $ 33.0 Sec 1031 Like Kind Exchanges $ 16.0 Completed contract rules $ 13.9 Energy related expenditures $ 12.3 Total savings possible $926.8 Lost revenues from tax rate change $964.3 Pay for coverage 96.1% * Source Deloitte Tax LLP

11 Easier said than done! 9

12 Done by September? EQUIPMENT LEASING AND FINANCE ASSOCIATION 10

13 The Big Six Players Statement on Tax Reform Trump Administration US House of Representatives US Senate Treasury Secretary Nat l Economic Council Speaker Ways & Means Chair Majority Leader Finance Chairman Mnuchin Cohn Ryan Brady McConnell Hatch The goal is a plan that reduces tax rates as much as possible, allows unprecedented capital expensing, places a priority on permanence, and creates a system that encourages American companies to bring back jobs and profits trapped overseas. And we are now confident that, without transitioning to a new domestic consumption-based tax system, there is a viable approach for ensuring a level playing field between American and foreign companies and workers, while protecting American jobs and the U.S. tax base. 11

14 The Big Six Statement on Tax Reform Big Six House Speaker Paul Ryan ( R) House Ways & Means Chairman Kevin Brady ( R) Senate Majority Leader Mitch McConnell ( R) Senate Finance Chairman Orrin Hatch ( R) National Economic Council Chairman Gary Cohn Treasury Secretary Steve Mnuchin Summary of Statement Issued July 27, 2017 Lower personal tax rates Lower rates for pass-through entities (partnerships) Lower C corporation rates Some form of capital expensing Some permanent provisions Repatriation of existing foreign earnings No border adjustability! No statement on deductibility of interest expenses No statement on limiting of personal S&L taxes deductibility The Objective A comprehensive tax reform bill during 2017 or at least by the 2018 elections The Challenge Who pays the bill? 12

15 ELFA Federal Tax Committee Effect of Tax Reform GOP Blueprint for Tax Reform Modeled Reduction in federal tax rate from 35% to 20% 100% expensing of asset acquisitions (equivalent to 100% bonus depreciation for ALL assets) Limitation on deductibility of interest expense to that of interest income Limitation of lessee s deductibility of rent expense equal to the excess of imputed interest expense embedded within rents (apply ASC 842 model to all leases to identify embedded interest component) 13

16 ELFA Federal Tax Committee Basis of Analyses 1. Ran multiple loan and lease pricing models comparing prices and ownership costs 2. Ran lease-versus-own analyses using typical assets, residuals and lease terms; all analyses are in present value terms 3. Compared 2017 pro forma rents (no bonus depreciation & 35% tax rate) with GOP Blueprint V1 & V2 pro forma rents V 1 = 100% depreciation, 20% tax rate & full rent deductibility V 2 = V 1 except limiting rent deducibility for embedded interest (applying ASC 842 approach) 4. For lessee lease-versus-own analyses, compared 2017 results with GOP Blueprint results V1 & V2 5. Analyzed pro forma lessee free-cash created by taxing pro forma revenue at 35% & 20% tax rates; kept gross revenues the same Base case AT revenues = 110% of AT PV 2017 lease costs; 10% PV margin Normalize revenues by calculating gross revenues (AT revenues / 35% tax rate) 6. Examined effect on tax-exempt borrowing costs 7. Analyzed effect of lessor interest deduction limitation 14

17 Lessee View Comparison of Rents EQUIPMENT LEASING AND FINANCE ASSOCIATION $100 million of equipment 3 yr tractors 5 yr tractors 5 yr trucks / med equip 7 yr med equip 7 yr machine tools 10 yr rail cars 15 yr rail cars 2017 BASE 35% Tax Rate PV AT Cost 1,927,742 1,394,16 5 1,420,029 1,144,802 1,113, , ,356 GOP BASE 20% Tax Rate, 100% dep, no interest deductibility PV AT Cost 1,913,732 1,396,17 3 1,396,173 1,127,367 1,085, , ,795 Cost Decrease/ Increase (14,010) 2,008 (23,856) (17,435) (27,551) (542) 17,439 % Cost Change (0.727%) 0.144% (1.680%) (1.523%) (2.475%) (0.075%) 2.526% 15

18 $100 million of equipment 3 yr tractors Lessee View PV of Cost to Own 2017 Base Case vs GOP Base Case 5 yr tractors 5 yr trucks / med equip 7 yr med equip 2017 BASE 35% Tax Rate EQUIPMENT LEASING AND FINANCE ASSOCIATION 7 yr machine tools 10 yr rail cars 15 yr rail cars PV AT Cost GOP BASE 20% Tax Rate, 100% dep, no interest deductibility PV AT Cost Cost Increase % Cost Increase 26.4% 30.2% 26.9% 31.2% 28.1% 38.2% 50.6% 16

19 Lessee View PV of Cost to Lease 2017 Base Case vs GOP Base Case EQUIPMENT LEASING AND FINANCE ASSOCIATION 3 yr tractors 5 yr tractors 5 yr trucks/ med equip 7 yr med equip 7 yr machine tools 10 yr rail cars 15 yr rail cars 2017 BASE 35% Tax Rate PV AT Cost GOP BASE 20% Tax Rate (full rent deductibility) PV AT Cost Cost Increase % Cost Increase 22.0% 23.1% 20.9% 22.0% 19.9% 22.8% 26.0% 17

20 Lessee View PV of Cost to Lease 2017 Base Case vs GOP Base Case with Interest/Rent Deduction Limitations 3 yr tractors 5 yr tractors 5 yr trucks/ med equip 7 yr med equip 7 yr machine tool 10 yr rail cars 15 yr rail cars 2017 BASE 35% Tax Rate PV AT Cost GOP BASE 20% Tax Rate (limited rent deductibility) PV AT Cost PV Cost Increase % Cost Increase 24.3% 26.9% 24.5% 26.6% 25.3% 31.7% 40.4% 18

21 Lessee View Free Cash 2017 Base Case vs GOP Base Case 3yr tractors 5yr tractors 5yr trucks /med 7yr med equip EQUIPMENT LEASING AND FINANCE ASSOCIATION 7yr mach tools 10yr rail cars 15yr rail cars Gross Rev BASE 35% Tax Rate PV AT Revenues PV AT Cost PV AT Free Cash GOP BASE 20% Tax Rate (full rent deductibility) PV AT Revenues PV AT Cost PV AT Free Cash vsGOP (0.310) 19

22 Lessee View Free Cash 2017 Base Case vs GOP Base Case with Rent Deduction Limitations 3yr tractors 5yr tractors 5yr trucks/ med 7yr med equip 7yr mach tool 10yr rail cars 15yr rail cars Gross Rev BASE 35% PV AT Revenues PV AT Cost PV AT Free Cash GOP BASE 20% Tax Rate (limited rent deductibility) PV AT Revenues PV AT Cost PV AT Free Cash (2.446) 2017vsGOP (0.706) (0.605) (2.644) (7.297) 20

23 Effect of Tax Reform on Tax Exempt Financing Rates Many tax exempt transactions (loans) are priced with an assumption of tax deductible internal debt; often because they are considered bank-qualifying transactions (originate less than $10 million from obligor per year) If tax rates decrease, the value of the interest deduction also decreases and the rates must increase 5yr Muni 10 yr Muni 15 yr Muni Lender rate 3.0% 4.5% 5.5% 35% 1,775,925 1,004, ,649 20% 1,794,727 1,034, ,424 Change in payment 18,802 29,750 38,775 % change in payments 1.06% 2.96% 4.92% Interest Rate (@35%) 2.527% 3.833% 4.959% Interest Rate (@20%) 2.952% 4.456% 5.694% % change in rates 16.81% 16.27% 14.83% 21

24 Observations of the Effect of Tax Reform Generally rental rates are about the same under 2017 & GOP Blueprint tax cases However, PV of AT cost of owning or leasing (to taxable lessees) increases substantially because lower tax rate makes tax deductions worth less Relationship of lease-vs-own analysis remains comparable when both rents & interest expense is deductible by obligors Analysis of PV AT free cash assumes tax reform objective should be to create incremental free cash for reinvestment When rents are fully deductible but interest is not under the GOP Blueprint: Tax-oriented (true) leasing is much more favorable than financing with debt Pro forma PV free cash under lease increases substantially in most cases compared to the 2017 lease status quo, as accomplishing its objective of increasing overall profitability and free cash for reinvestment For leasing, outlier may be the longer term transaction(s) where the PV of AT cost rises more than the revenues; uncertain of rationale but it may be the nature of present value calculations 22

25 Observations of the Effect of Tax Reform When rents are NOT fully deductible to the extent of the pro forma embedded interest expense within rents: Incremental benefit from tax reform is virtually eliminated and possibly creates some negative effects, largely because the longer term transactions have a much high interest expense composition (principal remains outstanding for a much longer period) Although this (as well as ASC 842) may drive lessees to seek shorter term leases with higher residual risks, many lessors may be wary of such deals; especially banks which are restricted under Reg Y as to the amount of residual risk they can assume Solar & wind transactions may be affected because the will be construed to be leases under the new lease accounting standards Limiting interest expense deductions when in excess of interest/finance income should not affect lessors; Interest income exceeds interest expense for match funded transactions Captive leasing may provide other benefits by sheltering parent s interest expense 23

26 Our Viewpoint? EQUIPMENT LEASING AND FINANCE ASSOCIATION 24