Content area
Full Text
At the end of May, the IRS broke its silence on much-anticipated proposed rules for tax accounting of rent in lease transactions. Philip Spector, partner at Watson, Farley & Williams in New York, explains what the proposals could mean for the booming US cross-border leasing industry.
During the last week of May, the US Internal Revenue Service (IRS) issued proposed regulations under section 467 of the Internal Revenue Code. These proposed regulations deal with the tax treatment of lease agreements with increasing or decreasing rent, or deferred or prepaid rent. The rules provide a new benchmark for deferred and prepaid rents and for uneven rent schedules in all US leases - both domestic and cross-border.
The regulations also reduce the benefits of leasehold - or lease-in lease-out structures that have been fueling the recent surge in cross-border leasing of rail equipment, power generation facilities, vessels and aircraft.
The rules are, however, still in proposed form, and may be modified before they are made final. However, regardless of when they are eventually finalized, for many tax-sensitive leasing transactions they will be effective for deals entered into after June 3, 1996. For other transactions, the rules will be effective only for leases entered into after the date final rules are adopted.
The proposed section 467 rules require a lessor and lessee to treat rents consistently, and to use an accrual method of tax accounting that takes into account time value of money principles. For leaseback transactions and long-term lease transactions with uneven rent schedules, rent generally will be accrued on a level basis, notwithstanding the contractual allocation of rents, unless the rent for each calendar year does not vary by more than 10% of the average annual rent for all years. For leases with increasing rents that do not meet the 10 % limitation, rent will accrue on a level basis, and the transaction will be treated as having an embedded loan from the lessor to the lessee. For leases with decreasing rents that do not meet the 10% limitation, rent will accrue on a level basis, and the transaction will also be treated as having an embedded loan from the lessee to the lessor. Leases that have level rent allocations but provide for deferred...