United States: Requirements For A "Trust Lease" For Exclusion From Treatment As A Capital Expenditure

As a general rule, any capital expenditure which is properly chargeable to the capital account of any person and which is made with respect to the financed facility must be included for purposes of the $10,000,000 capital expenditure limitation under I.R.C. § 144(a)(4). Treasury regulations provide, however, that certain capital expenditures may be excluded from the computation. One such excluded expenditure is an expenditure made by a person, other than the bond user, a related person, or a State or local governmental unit, if the expenditure is made with respect to tangible personal property, or intangible personal property, leased to the bond user (or a related person) of the facility.

In accordance with Treasury Regulation § 1.103-10(b)(2)(iv)(b), the following requirements must be met for lease payments to be excluded as capital expenditures under I.R.C. § 144(a)(4):

(a) The property must be either tangible personal property or intangible personal property. In other words, the leased property cannot be real estate, buildings, or real estate improvements.

(b) The property must be leased to the user of the facility or a related person.

(c) The lessor of the property must not be a user or a related person to the user or a State or local governmental unit.

(d) The lessor must be either the manufacturer of the property, or a person in the trade or business of leasing property the same as the property being leased.

(e) The property being leased must be such type that it is ordinarily leased pursuant to general business practices.

(f) The "lease" must be a "true lease" and respected as such for Federal income tax purposes.

In addition, a leasing arrangement must be entered into before the bond user purchases, acquires, or takes delivery of the equipment. Compare Rev. Rul. 80-162 (purchase order cancelled and down payment returned prior to delivery) with Rev. Rul. 79-248 (equipment purchased and immediately sold to leasing company and leased back).

This memorandum sets forth the basic guidelines utilized by the Internal Revenue Service ("IRS") to determine whether a lease is to be considered a "true" lease and respected as such for Federal income tax purposes. It, however, is not exhaustive and does not cover many judicial decisions in which courts have found "true" leases in particular fact situations. See, e.g., Frank Lyon Company v. United States, 435 U.S. 561, 98 S. Ct. 1291 (1978) (sale and leaseback of building under construction for bank's long-term use was not a sham transaction); The LTV Corporation v. Commissioner, 63 T.C. 39 (1974) (computer lease was in substance, as well as in form, a lease so that lessee was entitled to rental deductions).

The leading IRS pronouncement on what constitutes a "true" lease in the equipment leasing context is Rev. Rul. 55 540, 1955-2 C.B. 39, which, although issued in 1955, still represents the position of the IRS. In this ruling, the IRS states that whether an agreement, which in form is a lease, is in substance a conditional sales contract depends upon the intent of the parties as evidenced by the provisions of the agreement, read in light of the facts and circumstances existing at the time the agreement was executed. In ascertaining such intent no single test, or any special combination of texts, is absolutely determinative.

Section 3.02 of the ruling provides that in making the determination of the intent of the parties under the facts and circumstances "it is necessary to determine whether by virtue of the agreement, the lessee has acquired, or will acquire, title to any equity in the property."

Section 4.01 lists a number of conditions that tend to show the existence of a sale rather than lease. The ruling states that a lease will be treated as a conditional sale for Federal income tax purposes if one or more of the following conditions are present:

(i) Portions of the periodic payments are made specifically applicable to an equity to be acquired by the lessee. See Truman Bowen v. Commissioner, 12 T.C. 466, acquiescence, C.B. 1951-2, 1.

(ii) The lessee will acquire title upon the payment of a stated amount of "rentals" which under the contract he is required to make. See Hervey v. Rhode Island Locomotive Works, 93 U.S. 644 (1876); Robert A. Taft v. Commissioner, 27 B.T.A. 808; Truman Bowen v. Commissioner, supra.

(iii) The total amount which the lessee is required to pay for a relatively short period of use constitutes an inordinately large proportion of the total sum required to be paid to secure the transfer of the title. See Truman Bowen v. Commissioner, supra.

(iv) The agreed "rental" payments materially exceed the current fair rental value. This may be indicative that the payment includes an element other than compensation for the use of property. See William A. McWaters, et al. v. Commissioner, Tax Court Memorandum Opinion, entered June 15, 1950; Truman Bowen v. Commissioner, supra.

(v) The property may be acquired under a purchase option at a price which is nominal in relation to the value of the property at the time when the option may be exercised, as determined at the time of entering into the original agreement, or which is a relatively small amount when compared with the total payments which are required to be made. See Burroughs Adding Machine Co. v. Bogdon, 9 F.2d 54; Holeproof Hosiery Co. v. Commissioner, 11 B.T.A. 547.

(vi) Some portion of the periodic payments is specifically designated as interest or is otherwise readily recognizable as the equivalent of interest. See Judson Mills v. Commissioner, 11 T.C. 25, acquiescence, C.B. 1949-1, 2.

Rev. Rul. 55-541, 1955-2 C.B. 19, a companion ruling to Rev. Rul. 55-540, discusses a situation where an asset was leased for substantially its entire useful life. The ruling states that the absence of an agreement to pass title is not indicative that the agreement was a lease and, in that situation, equitable ownership had passed. Therefore, it is essential that the lease is for a period which is not substantially the entire useful life of the asset. Accord, Rev. Rul. 60 122, 1960 1 C.B. 56.

In Rev. Rul. 68-590, 1968-2 C.B. 66, the IRS set forth the terms of a financing lease between a political subdivision and a user for a project constructed through the issuance of industrial development bonds. Under this lease, the political subdivision agreed to "lease" the project to the corporation for an initial term of twenty years, which was substantially shorter than the useful life of the project. The corporation assumed an unconditional obligation to make periodic payments, called "basic rental", during the initial term in amounts sufficient to cover the payment of the interest on and principal of the bonds. The basic rental was adjustable to take into consideration any excess of net proceeds from the sale of the bonds over the cost of the project and certain other contingencies. The corporation was given options to renew for terms which, when added to the initial term, aggregated ninety-nine years. The basic rent during the renewal periods was nominal. The corporation was also given an option to purchase the project for a nominal amount at the end of the lease term, or earlier upon prepayment of basic rental. The corporation also agreed to pay, as additional rent, all fees and expenses of a trustee incurred under a "Trust Indenture" all utility charges, taxes, assessments, casualty and liability insurance premiums, and any other expenses or charges related to the use, operation, maintenance, occupancy and upkeep of the project. The IRS held that the corporation had all the burdens and benefits of ownership under this arrangement and, in effect, the corporation was treated as the owner of the project for Federal income tax purposes.

In Rev. Procs. 75-21, 1975-1 C.B. 715, 75-28, 1975-1 C.B. 752, 76-30, 1976-2 C.B. 647 and 79-48, 1979-2 C.B. 529, the IRS has published guidelines which must be satisfied in order to receive an advanced private ruling on the determination of whether a "leveraged lease" is a "true lease" for Federal income tax purposes. Generally, a leveraged lease occurs where the lessor-owner has borrowed the funds to purchase the equipment. Presumably, if the contemplated leasing company will not be borrowing the funds in order to purchase the property it will lease, these requirements need not be met. Nevertheless, if such requirements can be met, strong evidence would exist that the "lease" is a "true lease." The revenue procedures above require the lessor to have, incur and maintain a minimum investment of 20% of the cost of the property. In addition, the revenue procedures provide for a further requirement that at least 20% of the original price of the property be equal to the fair market value of the property at the end of the lease term. In effect, the revenue procedures quantify, in an analogous situation, the requirement of the minimum residual value at the end of the lease term that is required in Rev. Rul. 55-540.

Also, these revenue procedures require (i) that any renewal options should be at fair rental value and that any purchase options should be at fair market value; (ii) that the equipment be capable of removal from the lessee's premises, and (iii) that any maintenance and repairs performed by the lessee not be such that they constitute an improvement or addition to the property. Furthermore, no part of the cost of the property should be furnished by the lessee. If the lessor-leasing company borrows the funds to acquire the property, the lessee may not guarantee any such indebtedness. Also, the lessor should be able to demonstrate, through a formula set forth in the revenue procedures, that it expects to receive a profit, apart from the value of the tax benefits obtained from the transaction.

In summary, Rev. Rul 55-540 contains the IRS's most complete statement on whether a lease of equipment will be treated as a "true" lease or conditional sales agreement. In the ruling it was stated that the IRS will look at the intent of the parties at the time the agreement was executed to determine the proper characterization of the transaction. Generally, an intent to enter into a conditional sale agreement will be found to be present if (a) portions of the rental payments are made specifically applicable to an equity acquired by the lessee, (b) the lessee will acquire a title automatically after certain payments have been made, (c) the rental payments are a disproportionately large amount in relation to the sum necessary to complete the sale, (d) the rental payments are above fair rental value, (e) title can be acquired at a nominal option price, or (f) some portion of the rental payments are identifiable as interest. See also Rev. Rul. 60 122, 1960 1 C.B. 56; Rev. Rul. 72-543, 1972-2 C.B. 87.

In addition to Rev. Rul. 55-540, the IRS has announced, in a series of revenue procedures starting with Rev. Proc. 75-21, more specific guidelines under which it would answer ruling requests in an analogous context, leverage leasing transactions. In general "[u]nless other facts and circumstances indicate a contrary intent," the IRS will not rule that a lessor in a leveraged lease transaction is to be treated as the owner of the property in question unless (a) the lessor has incurred and maintains a minimal investment equal to 20% of the cost of the property, (b) the lessee has no right to purchase except at fair market value, (c) no part of the cost of the property is furnished by the lessee, (d) the lessee has not lent to the lessor or guaranteed any indebtedness of the lessor, and (e) the lessor must demonstrate that it expects to receive a profit on the transaction other than the benefits received solely from the tax treatment.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.