Synthetic leases are a method for adjusting accounts and tax books. But what are synthetic leases and what benefits do they offer businesses?
In 2001, businesses were looking for new ways to refine their accounts and tax books. This was especially hard for those with large stakes in real estate developments. Tax books needed to be as streamlined as possible to allow for larger write-offs. And accounts books needed to be as enticing as possible to potential investors.
Many companies turned to the then-novel method of synthetic leases. Synthetic leases were used to fuel large construction projects and draw in investors. It was a popular method for streamlining the books and project an image of strength and profitability.
However, the Enron Crisis in the earlier part of the century revealed the problems associated with such practices. New laws were passed to better control such effective methods and synthetic leases largely fell out of vogue.
Recently, developments and better legislation have resurrected corporate interest in synthetic leases. But what are synthetic leases and how can they benefit your business?
What is a Synthetic Lease?
A synthetic lease works as a two-man operation. A parent company wants to make their account books look more promising by removing assets that may devalue it. At the same time, they want to improve their tax records by keeping these assets for use. A synthetic lease is off-balance-sheet financing that is classified as a lease for financial purposes and as a loan for tax purposes.
The parent company sets up a special purpose entity, typically another company, that purchases assets.
This special purpose entity, which is still owned by the parent company yet operates as a separate organization, will lease the asset to the parent company.
The asset and its subsequent effect on accounts and income will fall on the special purpose entity. Meanwhile, the parent company that owns the special purpose entity can use the assets on their tax books.
But how is this arrangement different from a traditional lease?
Differences Between Synthetic & Traditional Leases
A synthetic lease is used by companies that are seeking off-balance sheet reporting of their asset-based financing as well as the tax benefits of owning the financed asset. The asset is owned by the lessor for accounting purposes but is owned by the lessee for tax purposes. For the parent company/lessee, the depreciation of the asset does not affect net income. The lessee can, however, claim depreciation deductions for tax purposes.
In a traditional lease, a completely separate entity owns the asset in question. All benefits, expenses, and responsibilities (i.e., taxes) associated with asset ownership are assumed by the lessor. The lessor is the owner for tax and accounting purposes.
But why would companies want to use this process? What’s in it for you if you use synthetic leases?
Why Consider a Synthetic Lease?
Synthetic leases became popular because they allowed companies to tidy up their books and decrease financial obligations associated with certain assets.
The following are a few of the benefits your business may enjoy when you use synthetic leases.
- Because the property was bought and owned by a separate special purpose entity, that entity will have the property in their accounts books. Depreciated properties or properties tied up with legal or financial constraints can be set aside from the parent company’s books.
- By putting ownership of certain assets under a special purpose entity, the parent company’s accounts book will appear more profitable. This can be used to attract new investors and secure future contracts.
- Because the parent company still technically owns the special purpose entity, and thus its subsequent properties, they can put the asset they’re leasing into their tax books. This will allow the company to ask for write-offs when the asset devalues over time.
Synthetic leases offer companies a novel solution to owning property while preventing damage to their projected profitability.
So, when you need your business to attain new assets without major drawbacks, consider setting the groundwork for a synthetic lease today!