Summary of Decisions

The board made decisions on EITF-13B on September 13, 2013. The good news is that they allowed for inclusion of tax credits in revenue recognition on a probable basis but the bad news is they did not allow the effective yield method to be used for an LIHTC investment — rather the “proportionate amortization” method was adopted. The basis for the decision to allow only the proportionate amortization method appears to be due to many comment letters supported that this method over the effective yield method due to “complexities associated with the effective yield method.”

Under the proportionate amortization method, “the cost of the investment is amortized each reporting period in proportion to the tax credits and other tax benefits received.” Under the tentative decision, LIHTC investors would no longer be permitted to apply the effective yield method. The resulting investment amortization will essentially match the allocable credits (i.e., generally straight-line). In my opinion they have a double standard when it comes to complexity. Investors can very easily calculate the effective yield amortization, as that is how they price their complex tax-driven investments so there is no additional complexity imposed on them. Compare that to the complexity they plan to impose on all lessees of all operating leases in their proposed capitalization and subsequent accounting in their Leases Project.

Included in the decisions reached are changes in the conditions that must be met for both LIHTC and other tax credit investments for an investor to apply the proportionate amortization method include the following:

1. It is probable that the tax credits allocable to the investor will be available.
2. The investor retains no significant ability to influence the operating and financial policies of the limited liability entity and substantially all of the projected benefits are from tax credits and other tax benefits.

The FASB staff clarified that the term “probable,” as used in this context, is consistent with ASC 450-20, which defines “probable” as “the future event or events are likely to occur.”

Background

Generally, investors in qualified affordable housing project investments earn a majority of their return through the receipt of tax credits and other tax benefits (such as operating losses/timing differences). Accordingly, a significant risk associated with qualified affordable housing investments is potential noncompliance with Federal Income Tax rules resulting in loss of tax benefits. US GAAP, prior to this change, derives from EITF issue No. 94-1, “Accounting for Tax Benefits Resulting from Investments in Affordable Housing Projects.” EITF 94-1 (codified in ASC 323-740) provides that an investor in a qualified affordable housing project may elect to account for that investment using the effective yield method if all the following conditions are met:

1. The availability (but not necessarily the realization) of the tax credits allocable to the investor is guaranteed by a creditworthy entity through a letter of credit, a tax indemnity agreement or another similar arrangement.
2. The investor’s projected yield based solely on the cash-flows from the guaranteed tax credits is positive.
3. The investor is a limited partner in the affordable housing project for both legal and tax purposes, and the investor’s liability is limited to its capital investment.

Under the effective yield method (per ASC 323-740-35-21), the investor recognizes tax credits as they are allocated and amortizes the initial cost of the investment to provide a constant effective yield over the period that tax credits are allocated to the investor. In addition, investors present the amortization of their investments net within their provision for income taxes along with tax credits and other tax benefits. The effective yield is the internal rate of return on the investment, based on the cost of the investment and the guaranteed tax credits allocated to the investor. Any expected residual value of the investment should be excluded from the effective yield calculation. Cash received from operations of the limited partnership or sale of the property, if any, should be included in earnings when realized or realizable. An investor often cannot apply the accounting policy election in ASC 323-740 to use the effective yield method to account for its LIHTC investments because many such investments do not meet the required conditions. Specifically, many such investments do not include a guarantee that the tax credits allocable to the investor will be available. In addition, many LIHTC investments do not provide a positive yield on the basis of the tax credits alone. These issues prompted the request to the EITF to issue EITF 13B for comment.

For those investments not accounted for using the effective yield method, GAAP, prior to this new decision, requires that those investments be accounted for in accordance with Subtopic 970-323, Real Estate—General—Investments—Equity Method and Joint Ventures, which results in the investments being accounted for under either the equity method or the cost method.

Commentary

The ELFA wrote a comment letter in support of expanding the scope to have LIHTC investments eligible for effective yield method and to change the tax credit recognition threshold to probable from guaranteed. The ELFA comment letter recommended further expanding the scope to include investments with similar characteristics to LIHTC programs (e.g., solar credits in leases where the pre-tax income is negative due to the aggregate effect of federal and state incentives). We also supported adding a project on the accounting for tax credits generally.

The ELFA continues to provide what I consider sound advice in the area of accounting for tax credits and tax benefits in investments like leveraged leases, true leases as well as the LIHTC investments. Users of financial statements are best served if the pattern of earnings reflects the effects of timing differences and tax credits, but we fight an uphill battle as the matching concept is out of style (why, I do not know, as investors seem to care about EPS, earnings growth and predictability of earnings). Additionally, the revenue should be reported on the revenue line for leases or for other tax-oriented investments, at a minimum. Amortization of the investment should be netted with the tax credit amortization on the tax expense line of the P&L as finance company analysts measure efficiency ratios, so it is important to get the right display in the income statement to reflect the economics of the investment. Sadly, boards often do not listen to the practical business and accounting feedback but prefer a top-down approach.

I must give credit to Rod Hurd, chair of the ELFA Financial Accounting committee for writing the ELFA comment letter and sharing ideas. Also I sourced much of the information in this article from iasplus.com, a Deloitte website that provides current information on FASB and IASB activities.

Bill Bosco is the principal of Leasing 101, a lease consulting company. Bosco has over 37 years’ experience in the leasing industry. Bosco has been on the ELFA Accounting Committee since 1988 and served as its chair for ten years. He has been selected to the FASB/IASB Lease Project working group. He can be reached at [email protected], www.leasing-101.com or 914-522-3233.