The New Tax Law
The Tax Cuts and Jobs Act (the ‘Act’) will be an investment game changer. It is expected to pass Congress and be signed by the President. It will lower the corporate tax rate to 21% and provide for 100% immediate expensing of capital investment (but only for five years).
Currently, the U.S. tax regime employs a ‘worldwide’ system, meaning U.S. taxpayers owe U.S. tax on all their profits regardless of where those profits were earned. The new act will employ a ‘territorial’ system, meaning U.S. companies would owe U.S. tax only on what they earn here. Offshore profits would be subject to whatever tax is imposed by the country where the money is made, meaning you would just pay the local rate and be free to move your funds back to the U.S. Existing offshore profits will be ‘deemed’ to be repatriated and immediately taxed at 15.5%.
There will be a global ‘minimum’ tax of 10% (if you pay a lower rate in a foreign country you will have to remit the difference to the U.S. Treasury). Interest deductions will be limited to the sum of business interest income plus 30% of EBIT (no depreciation). And, since the Act taxes interest earned but limits the deduction for interest paid it has an ‘implicit’ tax on leverage. For those equipment lessors who are taxed as pass-through entities, a ‘deduction’ of 20% of ‘qualified business income’ subject to limitations and phaseouts is allowed.
How The Tax Act Will Impact Equipment Financing and Leasing
Lower tax rates, 100% write-offs, and limitations on the deductibility of interest all impact the economics of the equipment financing decision. If your firm is ‘EBIT’ taxable and has access to equipment investment funding, whether from internal cash flow, bank lines or from the capital markets the lease versus buy decision may change. But, lease financing will remain an attractive alternative in both the air and rail markets. It retains its risk transfer characteristics, term flexibility, and allows those air and rail carriers, who are not otherwise able, to fully utilize the tax benefits of ownership through lease pricing.
Investment managers now have the task of analyzing the Act and acting to improve competitive position. Tax planning and profit shifting is used to exploit gaps and mismatches in tax rules. Since investment platforms seek to maximize after tax returns the goal is to move profits to low-tax entities or jurisdictions where profits will be taxed at lower rates, and move expenses to where they will be relieved at higher rates. The Act’s switch to a ‘territorial’ system will require both air and rail operators and investors to review sourcing rules to determine where income is earned.
Aviation and Rail Investments
Aviation investment has delivered returns better than competing asset classes. Both domestic and international Aviation markets continue to show demand growth with historically high load factors and aircraft utilization rates. Rail carload and intermodal traffic for 2018 is expected to improve. Investors who understand equipment values and the business dynamics of their lessees will continue to support fleet growth in this new environment.
America is successful because of its geography, resources, political system, and decentralization of power. America is a magnet because of our freedoms and business environment. Strong businesses drive growth and create jobs. This legislation introduces the most pro-growth tax policy in decades. With passage investors will be faced with a new competitive landscape. Lease pricing and existing portfolio values will change.
Long term value decisions are best made based on the most probable compounding of after-tax net worth. Risks comes from not knowing what you are doing. Interested in discussing what actions you should take? Contact RESIDCO.
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