Sales Make it Happen
Depends on which corner your view is coming from...
by Terry Winders, CLP
When making a presentation to a prospective lessee, you may be asked the differences in the various leases.
It may appear your potential client only wants only one answer to every set of lease questions, when, in fact, there are multiple answers depending on the nature of the question and the difference between legal, tax, and accounting.
While it is not the smartest sales ploy to pretend to be a professional accountant, I recommend using the metaphor of a four-corner intersection ----with a person standing on each corner when three cars have an accident in the center of the intersection. Each person observed the accident, but from a different corner thus from a different point of view.
Each point of view is correct from the angle of the observer ---but will be different from each other. The words and phrases from both accounting rules and income tax requirements appear to look the same; however, they have a different perspective for the outcome.
You can treat a lease different on your financial statement than on your tax return. Each has an advantage on how the rules are applied.
The old adage that it is the "use" of the equipment that makes the profit, not the ownership is the key. In situations where the lessee can take advantage of the depreciation allowance, the "capital lease" may be the best approach. If alternate minimum tax issues or the company has already utilized its allowance with loss carry forwards, start-up costs, then an operating lease may be the way to go.
Or a flexible arrangement that at the end of the year the accountant can make that decision, may be another alternative.
By definition, equipment leasing is a financial product that deals with asset ownership in many different ways. When you say that you own something, what does that really mean? We purchase many things during our lives but the way we approach each purchase varies with the purchase. A car, truck, or transportation equipment requires a certificate of ownership; a title. This is also true for airplanes, boats, railcars and mobile homes. These assets are called titled personal property . However if we purchase a sofa, desk, computer, or office equipment there is no certificate of ownership. This type of asset is called untitled personal property or tangible property .
Tangible property is not supported by any title so the owner obtains control and ownership with a "bill of sale" and "possession". Many professionals define ownership in personal property, as having "title" even though there is no actual title instrument. Therefore, as we start we can see that the rules we are asked to follow are going to be different depending on what type of asset is going to be leased.
The Federal government and most State governments are interested in taxing the profits that come from the "use" of the equipment. Therefore the Internal Revenue Service has established rulings to determine who is the true user and will allow capital recovery benefits (depreciation) to anyone using the equipment for 80% or more of its "useful life," regardless of legal ownership .
These rules are defined by "useful equipment life" (the term of time the equipment can be used by some business, some where, to help create a profit) and proving who will gain from the equipments "use" and how much of that "use" has been controlled by the user.
The legal system (UCC) on the other hand has to define who has the rights to the equipment (ownership or title). This legal approach includes rules on how an asset is pledged to a lender, or owned by a Lessor. The legal system is therefore said to be interested in the "title" aspects of the equipment, to determine who has ownership rights.
For accounting purposes a different problem emerges. Who has the right to place the asset on their balance sheet as an owned asset? It is difficult to place an asset on the Lessee's balance sheet if it appears that the Lessor owns it, so the accountants have decided to value the "possession" of the asset and make it equal to the present value of the payments the Lessor requires of the customer. How the rent payments impact the income statement will also be viewed in relation to what type of lease transaction the lease "is" (classification) according to an accounting approach.
You see, after all, it depends on which corner of the intersection your view is coming from.
Terry Winders, CLP
Lease training and Consulting