3 Tax Position Risk Adversity and Financial Goals and Strategies

Financing strategies have different tax and accounting consequences. Because balance sheet analysis is used when obtaining credit, the tax and accounting consequences of any financial obligation may become an important part of the choice of financing vehicles.

In formulating a financing strategy, a primary determination is usually whether the project cost is treated as a capital budget item or an expense budget item in internal accounting. If it is to be treated as a capital budget item, various types of loan and lease/purchase options are considered. If it is to be treated as an expense budget item, rental or true lease agreements or various types of energy services agreements are considered. Consider the following examples:

• A rental agreement implies no ownership on behalf of the renter. The renter wishes to use equipment for a period of time, after which the owner may rent the equipment to someone else. The payment of an equipment rental becomes an expense item that is deducted from a company's profits before taxable income is determined.

• As opposed to a rental agreement, a loan agreement used to finance a project implies ownership transferring to the user or borrower. The asset must be depreciated over its useful economic life, and the interest incurred in the transaction is an expense item. In this case, a loan has common tax and accounting treatment.

In the previous two examples, ownership is fairly straightforward. There are, however, many financing agreements in which ownership determination is not so

Term

Energy Savings

+

Net OM&R Savings -

Financing Costs

Cash = Flow

36 months (negative]

$12,000

+

$1,500 -

$16,847 (@13%)

= ($3,347)

48 months (negative]

$12,000

+

$1,500 -

$13,663 (@14%)

= ($163)

60 months (positive]

$12,000

+

$1,500 -

$13,663 (@15%)

= $1,605

Table 43-3 Monthly Cash Flow Analysis at Various Financing Terms and Interest Rates.

Table 43-3 Monthly Cash Flow Analysis at Various Financing Terms and Interest Rates.

straightforward and may be subject to interpretation. For example, an operating lease, which is a long-term (up to 80% of the useful life of the asset) rental agreement with a fair market value purchase option may, in certain cases, be treated as an operating expense item to the lessee for book purposes, but as ownership for tax purposes.

These considerations also become important to institutions and corporations, which for organizational reasons, charter restrictions, or other internal reasons cannot or choose not to include the project in the capital budget. For example, a school board may be able to execute a lease agreement, but not increase the commitment to physical plant without voter approval. In such cases, the lease option or some variation becomes the choice financing format. Should a company have loan covenants with preexisting lenders, leaving an asset on or off the balance sheet often becomes a threshold decision whether or not to undertake a project. In all cases, accountants or tax counsel should be consulted to determine appropriate tax and accounting treatment for financing vehicles.

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