Bob, can you tell us what a synthetic lease is?
Assuming that's not a rhetorical question...
I think that term is used to describe a number of different transaction structures and I don't know about IDPH, but what I've heard about KKD's leases sounds like what I used to know as a "lease intended as security" or "off-balance sheet loan."
The latter term is more descriptive and the former a more technical/tax-based name for something that's been around since the mid-1980s at least and is really not that complicated (or deceptive).
To understand the purpose of these transactions (yes, they WERE in fact designed for a valid business purpose - maximizing cash flow by minimizing - legally - current taxes), you first need to understand that tax and book treatments of a given lease/financing transaction are not necessarily the same for a given lessee (or lessor for that matter). In addition, there is no requirement that the lessee and lessor give the transaction the same book treatment - only that they use the same tax treatment (you can't have two taxpayer depreciating the same asset).
So, an "LIS" is designed to allow the lessee to finance assets such that, for tax purposes, they get the full benefits of ownership (depreciation and interest deductions, and tax credits, if any) while, for book purposes, they have an operating lease, which is an "off-balance sheet" obligation.
The "business purpose" comes in when the depreciation and interest deductions exceed the lease payments and, therefore, the lessee gets a bigger current tax deduction than with a true lease. Legally minimizing or deferring taxes IS a valid business purpose.
For book or GAAP purposes, neither the asset nor the payment obligation would show up on the balance sheet. But, if the lease term was greater than one year, the payment obligations WOULD be disclosed as any other long-term lease in the footnotes.
BTW, as we all now know, it's important to read the footnotes. You might be interested in knowing also that lenders, in evaluating credit, would factor these and all other lease payments into coverage ratio calculations by adding them back to cash flow numbers to get "EBIRTDA" or "EBIRT".
And you thought EBIRT was a movie critic. ;-)
Anyway, where it got really tricky (and, one might argue, potentially deceptive) is when an LIS is structured with a minimum term of less than one year, even though the intent is for the full term to be much longer. This could be done in situations where the asset is so critical to the lessee's operations and the consequences of an early (voluntary) termination are so severe that the lessor can reasonably assume the lessee would never voluntarily terminate. These deals would not even get disclosed in the footnotes - the legal term of the deal and minimum payment term was under a year. I don't know for sure whether these can still get done, though.
Now, if you're really into this kind of stuff, I can tell you how you can have a capital lease (financed purchase or assrt and loan) for tax purposes, a GAAP operating lease for the lessee, and a GAAP capital lease for the lessor, all while keeping the asset and associated debt off the lessor's balance sheet. Pretty cool, eh?
Bob |
