why firms with lower effective tax rates had a higher propotion of lease debt to total assets than did firms with higher effective tax rates?
i am totally confused…
Do you mean -> Lower effective tax rate would result in higher D/A Higher effective tax rate would result in Lower D/A
Oddly enough, I was confused by the same section this evening. He’s referring to page 519 of Reading 40 which discusses the incentives for leasing. Under the heading marked “Tax Incentives” is says the “tax benefits of owning assets are exploited best by transferring them to the party in the higher marginal tax bracket. Firms with low effective tax rates more readily engage in leasing than firms in high tax brackets as the tax benefits can be passed on to the lessor”. After re-reading the passage, it sounds like there are cases where there’s common ownership of multiple incorporations. For tax purposes, they would have the leased assets in the corporation with a low tax rate and then pass the tax benefits to the company with the higher tax rate. I guess I’m confused because I don’t see the benefit of having leased equipment in a company with a lower tax rate (i haven’t read all the readings, i just jumped to this reading out of interest, so not suprising i don’t understand that well). If someone could explain how the tax savings are generated by having the leases in a company that pays a lower tax rate and then passes it to the company with a higher tax rate that would be fantastic. I think I may be confused about the last sentence from the quote above which involves the lessor as well… it is talking about common ownership of multiple incorporations lease equipment to each other? Definitely a little lost here… Are we allowed to quote from the CFAI text? I know it’s only a couple sentences but I just don’t want to get into hot water, so if it is I apologize… i have no clue on copyright violations for quoting short passages for the sake of education/discussion etc.
Benifits can be few of the following - 1.) The Lessor might not want to sell the asset bcos he might be a dealer who is more specialized in repairing/refurbishing/bringing to a better shape at a later stage and can get a higher value after lease if there is any salvage value. 2.) Lessee would not want to take the risk of owning bcos the value of asset might go down at any time - usually happens for eqipments with technology changes. 3.) Lessee might require the asset for a small period and assets life might be greater. Talking in terms of tax benifits - There are 2 types of leases - 1.) If it is an operating lease, the lessor has the title of ownership and takes the tax benifit because of Depr of the asset. 2.) If it is a capital lease, the lessee shows the asset on his bal. sheet and the depr exp. and should get the tax benifit. So firms with high tax brackets would want to lease the asset rather than sell and that too would be an operating lease. The benifit that lessee would get here is on financial stmts - higher Netincome (bcos of low depr. expense), higher ROA, higher ROE etc. I might be confused abt the concept above but this is what i thought. Experts may put feedback.