Tax Shelter

This feature is designed to enable companies with limited tax shelter or accumulated losses to price leasing transactions.

Leases sometimes create taxation losses in early years, effectively postponing payment of taxation when compared to conventional lending (see Example). For a lessor to gain full benefit from the deferral of tax payment, there must be taxable income generated by other activities sufficient to absorb the deductions arising from leases written.

If there is no or inadequate tax shelter available, a higher rental must be charged to attain the same yield, or a lower yield must be accepted.

If the lessor had existing taxation losses or no other source of income, the deduction could not be realised in the current year, but would have to be carried forward and used to offset income arising in later years.

AFQS models three tax shelter methods:

1. No Limits
   
   The lessor has unlimited tax shelter, and will never have to carry forward tax losses. This is the most commonly employed assumption.
    
2. Specify Shelter
   
   Some losses generated by leasing can be absorbed, while the remainder will have to be carried forward. This is the appropriate option to choose if leasing will have a significant impact upon the lessor's overall taxable income in each future year. The calculations performed in this case are explained in detail below.
    
3. Delay Payment
   
   No matter how much or how little leasing the lessor does, tax will not be paid for a known amount of time. Both deductions and tax payable are carried forward until the year specified with the effect that:
    
   • If (overall) deductions are carried forward, the extra cost is borne by the lessee, and
      
   • If (overall) tax payable is carried forward, the extra benefit is passed on to the lessee.

As noted in the description of the Specify Shelter option above, this option is appropriate if leasing will have a significant impact upon the lessor's overall taxable income in each future year.

The following example illustrates a situation in which the Specify Shelter option should be used:

Suppose that you plan to write $20 million of leases over a one year period, but can only absorb $750,000 of tax losses in the first year.

There is $37.50 = 1,000 × ($750,000 / $20 million) tax shelter available in the first year of income per $1,000 of assets financed; this is the amount required by the program.

Using the Tax Loss Example, each $100,000 lease generates an average of $10,800 / 2 = $5,400 in tax losses in the first year. Two hundred such leases would generate combined losses of $1,080,000 of which only $750,000 can be used to offset other taxable income while $330,000 must be carried forward into the next financial year.