How do tax laws affect leasing?

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How do tax laws affect leasing?


How do tax laws affect leasing?

Explanation & AnswerSolution by a verified expert


Tax laws do affect the leasing transaction as decrease or increase in tax rate, changes the ability of lessees to apply for leasing and capacity of lessors to present lease arrangements in the market. Moreover, this particular change in corporate tax rate requires the companies to alter their lease conditions as per the new tax reforms.
Further, in case of a financial lease, depreciation on the equipment is recorded in the books of the lessee, so the lessee will be benefited from the rapid depreciation through reduction in taxable income and enhanced tax savings whereas, in case of an operating lease, depreciation on the equipment is recorded in the books of the lessor, so the lessor will be benefited from rapid depreciation through the tax savings.
Also, the provision regarding a fixed limit on the interest expenses during a particular year deleverages the company. This change promotes the leasing transaction as by leasing the asset instead of financing it, the company incurs rent or lease expense rather than the interest expense.

Verified Answer

The tax laws affect the treatment of lease transactions in the financial statement of lessor and lessee which in turn affects the leasing transaction. As per the tax laws,

The reduction in corporate tax rate reduces the demand for leases due to smaller tax savings and lower tax rates and asks the companies to alter the lease transaction by assuming new tax reforms.
The introduction of bonus depreciation requires the companies to charge additional depreciation in most of the assets. This may create net advantage to leasing as more depreciation can be charged in the initial years of the lease transactions. However, in case of owning the asset , the company has to forego the bonus depreciation. This makes leasing transactions more favourable.
Depreciation of the equipment is charged in the books of the lessee in case of financial lease and reduces the taxable income of the lessee, enhancing tax savings.
The tax reforms regarding interest limits the interest expense that can be claimed in a particular year and any excess expense is deferred for the future years.This in turn, deleverages the companies with promotion of leasing transactions.

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