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Equipment Leasing: Substance and Form (Portfolio 544)

Product Code: TPOR40
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Equipment Leasing: Substance and Form, Portfolio No. 544, and Equipment Leasing: Benefits and Burdens, Portfolio No. 545, discuss the factors that must be considered in structuring an equipment leasing arrangement so that it will be treated as a lease for U.S. federal income tax purposes. They also examine other business arrangements that involve rights to use tangible personal property, including conditional sales, partnerships and service contracts. 

Equipment Leasing: Substance and Form, written by Toby Cozart, Esq., summarizes basic lease transactions, the reasons for leasing, various factors that have affected lease structures and the sources of legal principles governing tax lease characterization. This portfolio focuses on business purpose and economic substance and other doctrines relating to the form and substance of a transaction involving the use of tangible personal property. It presents the case law as it has crystallized around the landmark cases of Frank Lyon Co., Rice's Toyota World, ACM Partnership and BB&T Corp. In discussing BB&T Corp., this portfolio addresses the IRS's attack on defeased lease transactions.

This portfolio also addresses the doctrine that prevents taxpayers from disavowing the form of a transaction, which is particularly relevant to cross border leasing transactions. It covers principles determining when a transaction party is treated as an agent or conduit, which have been applied to rent stripping transactions.

Equipment Leasing: Substance and Form allows you to benefit from:

  • Hundreds of hours of original research on specific tax planning topics from leading practitioners in this area
  • Invaluable practice documents including tables, charts and lists
  • Plain-English guidance from world-class experts
  • Real-world and in-depth analysis that lets you explore various options
  • Time-saving access to relevant sections of tax laws, regulations, court cases, IRS documents and more
  • Alternative approaches to both common and unique tax scenarios

This Portfolio is part of the U.S. Income Portfolios Library, a comprehensive series that includes more than 200 Portfolios, which covers every federal tax topic with expert, in-depth analysis, and offer commentary on a wide range of federal taxation topics, including Compensation Planning, Deductions and Credits, Partnerships and Corporations, Special Pass-Through Entities, Corporate Reorganizations, Real Estate, Procedure and Administration, and more.

 

Detailed Analysis

I. Introduction

A. In General

B. Description of a Lease Transaction

C. Reasons for Leasing

D. Financial Analysis of Lease Transactions

E. Factors Affecting Lease Structures

1. Lease Accounting

2. Debt Optimization

3. Limitations on Lessor's Upside

4. Deferred Rent

5. Floating Rate Debt; Refinancings

6. Qualified Nonrecourse Indebtedness

7. Change in Tax Law Risks

8. Alternative Minimum Tax

9. Secondary Market Transactions

10. Cross-Border Leases

11. Lease Stripping Transactions

12. LILOs and Other Defeased Leases

13. The Flip Partnership Alternative

F. Sources of Law

1. Tax Shelter Limitations

2. The IRS's Advance Ruling Guidelines

a. Historical Importance

b. Relevance of the Guidelines for Current Transactions

c. Rev. Proc. 2001-28 Guidelines

3. Case Law Directions

a. Simple Precepts Founder: Financing Leases

b. Importance of Form

c. Tax Court's Sham Transaction Doctrine

d. Coleman's Effect on Cross-Border Lease Transactions

4. Treaty Provisions Affecting Cross-Border Leases

5. Legislative Efforts to Define Lease Concept

6. Retroactive Changes in Law

G. Relevance of Financial Accounting Treatment

H. Tax Consequences of Alternative Characterizations

1. Timing Effects Compared

2. Cost Recovery Differences

3. Interest on Third-Party Loans

4. Possible Permanent Losses

5. Shared Ownership

II. Substance and Form

A. Frank Lyon

1. Primacy of Form; Lessor Need Only Possess Significant Attributes of Ownership

2. Digression: Net Lease versus Estate for Years

3. Sham Transactions

B. Sham Transaction Doctrine

1. Foundation: Rice's Toyota World

a. Business Purpose

b. Economic Substance

c. Sham Consequences

d. Tax Subsidies (ETCs)

2. Rise of the Unitary Sham Test

3. Implications of Unitary Test

a. Minimal Profit Potential Not Sufficient

(1) Generic Tax Shelters

(2) Straddle (and Similar) Cases

(3) ACM Partnership

(4) Implications for Leasing

b. Reasonable Profit Potential Not Required

4. Sham by Association; Defeasance Transactions

a. Defeasance Arrangements

b. Relevance of Lessee Motives

c. Defeasance Rulings Raise Other Issues

d. SILO Legislation (§ 470)

e. BB& T Corp.: LILO Transactions

(1) Transactional Background

(2) Economic Substance Argument Abandoned

(3) Lease Collapse Argument Advances

(4) Fourth Circuit's Decision

(5) Reconciling the Opinion

5. Time Value of Money

a. Non-egregious Leases

b. ACM Partnership's Emergent Principle

6. IRS Profit Guidelines

a. Overall Profit and Cash Flow

b. Inflation

c. Back Leverage

7. Sham Transaction Doctrine Justification

a. Four Competing Justifications

(1) Bad Motive Rationale

(2) Abuse Rationale

(3) Economic Utility Rationale

(4) Legitimacy Rationale

b. Controversial Issues Affecting Leasing

(1) Minimal Profit and Risk; Codification Proposals

(2) Lease Stripping Transactions Evidencing Collusion

(3) Integrated Acquisitions of Unprofitable Leased Property

(4) Germaneness of Lease Transactions and Portfolios to Ordinary Business

(5) Reliance Upon Unsettled Interpretations of Substantive Tax Law

C. Related-Party Leases

1. Business Purpose Requirement

2. Independence of Lessor; Gift-Leaseback Transactions

3. Lessee Has Reversionary Interest

D. Holding the Taxpayer to the Form of the Transaction

1. Purposes Behind Doctrine

2. What Is the Form of a Transaction?

3. Strong Proof Rule: Coleman

4. Danielson's Stricter Rule

E. Disregarding Intermediaries

1. Agents and Conduits

a. Aiken Industries

b. Fictitious Transactions

c. Lease Stripping

d. Anti-Conduit Regulations

e. Disavowing Steps

2. Separate Entity Doctrine

Working Papers

Table of Worksheets

Worksheet 1 Model Tax Indemnity Agreement

Worksheet 2 Model General Tax Indemnity

Worksheet 3 Lease Checklist

Worksheet 4 Form of Basic Equipment Lease

Worksheet 5 Rev. Proc. 2001-28, 2001-19 I.R.B. 1156

Worksheet 6 Rev. Proc. 2001-29, 2001-19 I.R.B. 1160

Bibliography

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Statutes:

Legislative History:

Treasury Rulings:

Cases:

UNOFFICIAL

Treatises:

Periodicals:

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Toby Cozart
Toby Cozart, B.A., University of North Carolina (1974); J.D., Duke University (1978); M.S. in Philosophy, University of North Carolina (1979); LL.M. in Taxation, New York University School of Law (1981). Law office, Piedmont, California. Previously: Tax Counsel, GATX Capital Corporation, San Francisco, California; Partner, Lillick, McHose & Charles, San Francisco, California; Associate, Morgan, Lewis & Bockius, New York, New York; Staff Counsel, Subcommittee on Oversight, Committee on Ways and Means, U.S. House of Representatives, Washington, D.C.; Member of the Bars of the District of Columbia, New York, California, and the United States Tax Court.