Synthetic Lease

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wuxicfa

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Anybody can share thoughts on Synthetic Lease? What's the benefits for companies doing that?
 
It says
"A transaction that appears as a lease from an accounting standpoint, but as a loan from a tax standpoint. The end results are an off-balance sheet account of the financing and the tax benefits that accompany the financed asset".

But I still could not get the big picture.
 
GAAP Perspective (reporting purposes) = you aren't the owner of the equipment/asset. Not the owner for GAAP purposes so you don't have to report it as an asset or report the required payments (debt) on your financials. While you can't hide things like Enron did (your auditors will "make" you put it in the footnotes) it can help with things like covenant restrictions (Debt/EBIT for example) because while everyone knows it's an obligation, chances are the definition of the covenant will only refer to things actually on the balance sheet.

IRS (tax purposes) = you are the owner so you can use the interest portion of the payments to reduce income in the form of 1) the interest portion is "mortgage interest" so it can be deducted from income and 2) you get to use the benefits of the depreciation.

Essentially there is disparity between the two codes and a synthetic is using "tax / reporting code arbitrage" to sneak your accounting into the cracks between the two.



Edited 1 time(s). Last edit at Monday, June 19, 2006 at 08:40PM by mkgref.
 
What if you are the owner of the asset, how does synethetic lease into play? It might not be allowed to do so. But just curious to know how it works before.

Say, Company A own $100k assets, A has to find a partner (B) to hide the asset. A pays B lease payment to pretend as a lessee. So A does not need to book the debt. My confusion is how A can deduct the interest portion of the payments to reduce income tax at the same time since A did not book the asset. I am lost...

Thanks anybody who can help me back on the track!
 
First off it's not "hiding" the asset. It's simply the fact that you have to conform to 2 different systems and you are dealing with some of the parts where those systems (GAAP and IRC) are different.

The debt is not "on the books" for GAAP purposes (specifically FASB-13). This is what the SEC says you need to use for reporting.

The debt is "on the books" for tax purposes. This is what Uncle Sam says you need to use for paying your taxes.



Take this as an example (this is not exactly how it works but hopefully you get the point...).

You work for a company that is owned by 2 men. You have to send a monthly report to both. Man A wants to see how many "good" sales you have and he considers a "good sale" to be one of $80 or more. Ban B wants the same thing but in his mind a "good sale" is a sale of $100 or more.

So what do you do with your sales of $90? Well you report them exactly as what they are - you don't "hide" them in your report. Since the two people are using different definitions you give them the information based on the guidelines they give you.
 
Mostly it applies to the real estates. When a company (A) owns big buildings, they do not want to see large depreciation to distort the profit. Meanwhile by depreciation, the value of building declines. In reality, the value of real estate most likely will go up. Thus, company do like to own the R.E. assets as well as for the advantage of tax. That's why they introduce another party (SPE). A pays a small amount of equity in and lease payment to SPE, to make it like lease. For GAAP, A does not need book the assets and no depreciation, which will make profit look bad. However, according to the tax rule (e.g. A associated all risks with the building), A owns the assets that has the tax benefits.

mkgref, I just rephrased what you explained by my own understanding. Does that sound right?

Thanks for your help!
 
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