Tax vs. Non-Tax Yields – A Primer

by Scott Thacker

Scott Thacker serves as CEO of Ivory Consulting and on the Board of Directors of the Equipment Leasing and Finance Association as well as its Financial Accounting Committee. He also serves as the co-director of the Research Committee of the Equipment Leasing and Finance Foundation. Prior to joining Ivory Consulting, Thacker was a partner at Accenture responsible for creating and delivering management consulting and software solutions to the North American equipment leasing and asset finance industry. Previously, he held leadership positions with Oracle where he was instrumental in creating the company’s now widely used Oracle Lease and Finance Management application, and with American Airlines, where he was involved in executing aircraft, equipment, real estate leases and other financial transactions.

Ivory Consulting’s CEO Scott Thacker provides advice and counsel to equipment lessors and lenders on the best ways to improve customer satisfaction and profitability using modeling and pricing techniques, this time focusing on tax benefits from tax vs. non-tax yields. His colleague Ray James contributed to this article.

There are significant differences between an equipment lease transaction that is structured to take into account tax benefits, known as a tax lease, and one that does not take into account tax benefits, known as a non-tax lease. Calculating the yield on a given lease transaction is fairly straightforward for a non-tax lease, but much more complicated for a tax lease. Comparing these two yields as “apples to apples” requires complicated analysis.

Tax Benefits

Tax benefits primarily result from accelerated depreciation, ITC and renewable energy tax credits. The use of accelerated depreciation produces a deferred tax liability — the difference between the book depreciation (typically straight-line depreciation) and the tax depreciation (typically accelerated depreciation). Essentially, deferred taxes are the combined federal and state tax amount owed that has been recognized on the accounting books, but not remitted to the taxing authorities. To properly account for deferred taxes, think of the amount as being “borrowed” from the government at an effective interest rate of 0%.

Tax leases are often funded with both debt and equity. There is a cost of funds associated with the debt component, for example, it could be 6%. If the transaction includes deferred taxes, then the cost of funds for the debt component has two components: the cost of the debt actually borrowed and the deferred taxes which is hypothetically “borrowed” from the government at 0%.
Now, this is clear as mud so an example is needed to illustrate. If the average debt component is 15 parts borrowed money at 6% and one part deferred taxes at 0%, then the funding cost would drop from 6% to 5.63% ((15 x 6%)/16), and conversely, the spread on the tax lease would increase by 0.37%, all from the tax benefits.


Since non-tax leases and loans do not generate deferred taxes, a question arises as to how to compare the yield on these two instruments with the yield on a tax lease which generates deferred taxes. In this situation, it is common to measure the tax benefit of a tax lease as a hypothetical improvement of the tax lease yield rather than as a reduction in the cost of funds. In the equipment finance industry, various yields are often used when comparing a tax lease yield to a non-tax lease or loan yield.

  • Internal Rate of Return (IRR): This yield is most frequently used for non-tax leases and secured equipment loans. Thus, a non-tax lease or secured equipment loan would be measured using only the IRR of the transaction. Since no tax benefits were created, the funding cost would remain at 6%. For the sake of discussion, assume that the IRR is 8%. The spread in this case would be 2% (8%-6%.)
  • Internal Rate of Return (IRR) + Value of Deferred Tax Yield: This yield can be used for tax leases. In this case, the 0.37% deferred tax value recognized as a reduction in the cost of borrowing is simply added to the IRR of the lease. Thus, the 8% tax lease would be shown to yield 8.37%, hypothetically. The cost of funds would not be adjusted downward to reflect the free deferred tax liability (borrowed at 0%) because it has been added to the lease yield. The spread would be the same, 2.37%. (8.37%-6%.)
  • Multiple Investment Sinking Fund (MISF) Yield: Here the tax benefit from tax leasing is moved from the liability side of the balance sheet to the asset side to reduce the investment balance in the asset. This assumes that the tax benefits are earning hypothetical interest at the rate of the lease rather than at the reduced borrowing rate. MISF is the most frequently used metric in the industry for pricing a tax lease, but it usually overstates the accounting spread over the debt cost. It does, however, express the value of ITC in an investment which is not done with the “IRR + Value of Deferred Tax Yield.”
  • ROE (book and economic): Both of these ROE yields include tax benefits, if applicable, and have become well accepted in the equipment finance industry for comparing tax and non-tax lease financing as well as secured lending transactions. Unlike the above yield metrics, ROE introduces cost of funds, leverage, expected loss provisions, SG&A and other remaining benefits and costs associated with a transaction. It is beyond this scope of this article to discuss these items.

To be competitive in the equipment finance industry with tax lease products, it is essential to measure the value of the related tax benefits and also receive the benefit. Not recognizing tax benefits at the time of booking makes it difficult to structure competitive lease bids.

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