from Schweser study notes book 3 page 249: “if the lessor is in a higher marginal tax bracket than the lessee, the lease should be structured as an operating lease so that the lessor can take advantage of the depreciation of the leased equipment to reduce its taxable income, and thereby the taxes it pays.” how does this actually work? i don’t understand what the lessor’s tax position has to do with this. is there even really a choice here anyway? the rest of the section makes it seem like the capital vs. operating lease really is a function of other specific criteria that will determine the treatment.
companies get a depreciation shield on PP+E. if they capitalize it, it goes on balance sheet, hence depreciated annually. you cant depreciate an asset if you op lease it, bc there is only rent expense, hence not capitalized, hence not an asset.
Accounting Dictionary: Tax Shield Deductions that result in a reduction of income tax payments. The tax shield is computed by multiplying the deduction by the tax rate itself. For example, assume an annual depreciation deduction is $3000 and the tax rate is 40%; the tax shield, or tax savings on depreciation is $3000 x .4 = $1200. The company saves $1200 annually in taxes from the depreciation deduction. The higher the deduction, the larger the tax shield. Therefore, an accelerated depreciation method produces higher tax savings than the straight line method. Note that the term applies to other non-cash charges (e.g., amortization and depletion) as well. SOURCE: http://www.answers.com/topic/tax-shield
I do agree with the statement and it makes much sense to me. Under a capital lease, the income statement consists of two things, the rental revenue and interest payments, all received from the lessee. However, under the operating lease, only income and depreciation(Remember this equals to the rental revenue-a constant amount over the term of the operating lease). On taxation, the lessor will be taxed on a higher figure in a capital lease, while under a operating lease, income is less-and there is depreciation tax shield. Thus, less taxes.