The Importance of a Corporate Tax Sharing Agreement

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 continues to provides advice and counsel to equipment lessors and lenders on the best ways to improve customer satisfaction and profitability using modeling and pricing techniques. His colleague Ray James contributed to this article.

In our industry, many equipment finance companies are subsidiaries of a larger organization, and their parent is usually a bank or a manufacturing company. Typically, the parent organization generates taxable income and files a consolidated tax return with the leasing subsidiary. Often the leasing subsidiary generates valuable tax deductions and credits in the form of accelerated depreciation, ITC and/or renewable energy tax credits. The question then is, how can the leasing subsidiary enjoy the tax benefits it generated but were consumed by the parent company in the consolidated tax filing? The value of the tax benefits generated in the equipment finance subsidiary needs to be recognized by the parent company so that this benefit is measurable at the parent company level and gives management an incentive to maximize profits for the entire organization.

Tax Sharing Agreement

Most successful consolidated equipment finance subsidiaries engaged in true tax lease products establish a Corporate Tax Sharing Agreement (CTSA) with their parent company. The CTSA is an agreement worked out by the senior management of both the parent company and the subsidiary, and it recognizes the full value of benefits generated by a true tax lease product. The people working on the detail of the CTSA sharing arrangement within each organization are usually tax accountants and other accountants who know how to measure and recognize these benefits.

In general, a CTSA contains the following

  • Methodology for computing the value of the deferred tax benefits (including ITC) that were generated by the equipment finance subsidiary which are enjoyed by the parent company.
  • The location in the subsidiary’s adjusted statements where the value will be realized. For example:
    o A special reduction in their borrowing cost, or
    o A direct computation added to the income of the subsidiary, but not both.
  • The frequency of the benefit being recognized: monthly, quarterly or annually.

Those responsible for crafting a CTSA should have an understanding of the different ways that tax benefits can be recognized – both economic and accounting. Companies may need to seek out industry assistance to fully understand the impact of various CTSA approaches.

Lease accounting for both capital leases and operating leases recognizes income only on a pre-tax basis – whether or not the lease is a true tax lease. Yet true tax leases generate tax benefits that are included in sophisticated tax pricing analysis – as they should be. These tax benefits are either based on deferred taxes and/or ITC-Green energy credits.

Equipment finance subsidiaries that do not have a CTSA with their parent company are likely operating at a significant economic disadvantage. Deferred tax generated from tax leases can easily raise the yield by 100 basis points, and when including ITC, can yield much more. From a competitive standpoint, an equipment finance subsidiary which is unable to recognize the yield benefit that deferred tax from a tax lease product provides will end up in a much less competitive position. The competitive disadvantage is worsened if unrecognized ITC is involved.

You might be wondering how the CTSA discussed here compares to a TSA that is filed with the IRS as part of a tax return. The IRS TSA is used in the situation where taxes are formally allocated between an owner/investor, other owners/investors and/or a partially owned entity commonly seen in LLC structures. A consolidated tax return does not normally use an IRS TSA since consolidated filing combines the numbers of two or more entities. It is beyond the scope of this article to discuss IRS Tax Sharing Agreements.

The next article will address tax effected and non–tax effected yields on equipment leases¬ which helps decide how to craft a Corporate TSA between an equipment finance subsidiary and its parent.

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