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Top 10 of 2017: Tax reform could raise funding costs for lessors

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Editor's note: This is the eighth in a series of 10 articles revisiting some of our most-read stories of the past year.

The recently enacted tax reform legislation will make it uneconomical for auto and equipment rental companies to tap the securitization market for funding, according to the industry trade group.

In a Dec. 11 letter to the Senate and House tax reform conferees, the Structured Finance Industry Group said depriving auto and equipment leasing companies of an efficient cost of funds via securitizations would lead to more expensive leases for consumers and businesses.

At issue is the bill’s limit on the deductibility of interest to a percentage of the taxpayer's earnings. In a securitization, assets such as loans or leases are sold by the lender or aggregator to a bankruptcy remote, special purpose vehicle; this securitization trust issues bonds that are backed by the loans or leases. Interest and principal payments on the assets are used to pay interest and repay principal on the bonds.

This financing method allows some lenders and lessors to access financing more cheaply than they could be issuing general obligation bonds.

Here’s why limiting interest deductibility creates a problem for bonds backed by auto and equipment leases – and not bonds backed by many other kinds of assets such as consumer loans, according to SFIG,

“In most securitizations, the amount of interest income (from, for example, a pool of mortgage loans) is closely aligned with the amount of interest expense on the securitization debt,” the letter states. “In these cases, there would be little impact from the proposed limits on interest deductibility.

“In certain types of securitizations, however, the income is not treated as interest but instead is treated as lease payments. Securitizations of auto leases and equipment leases fall into this group. The inability in a lease securitization for the issuer to offset lease income with interest expense would make such securitizations uneconomical.”

The letter provided the following example:

Suppose an equipment manufacturing company securitized leases on construction equipment which produced $100,000 in equipment-leasing income in year one (and the company had no other net income) and the company issued a single class of debt (backed by these equipment leases) which paid $80,000 in interest in year. Under the (then current) proposal, the company's business interest deduction would be limited to the sum of (A) the business interest income of the company (here they have none), plus (B) 30% of the adjusted taxable income of the company (here, 30% of $100,000 = $30,000). As such, despite paying $80,000 in interest on the debt in year, the company would only be permitted to deduct only $30,000 of the interest. As a result, the company would owe tax on $70,000 of income ($100,000 minus $30,000) but only have $20,000 in net funds ($100,000 minus $80,000).

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