Faced with the pressing need for new equipment so they can reach the next level in production, sales, and profitability, many manufacturers turn to equipment loans and leases. They may not be aware, however, of the lesser-known tax-exempt equipment leasing option, which can provide a lower cost of financing, among other benefits.
The tax-exempt lease—an alternative to the Industrial Revenue Bond—is a better known structure in the nonprofit sector, but it is also an option for manufacturers, generally those with $20 million to $200 million in revenue.
Fundamentally, a tax-exempt manufacturing equipment lease is a structure that allows the lessee—in this case, a manufacturer in need of new equipment—to receive a tax-exempt rate on its financing terms. For example, a manufacturer who is offered a $5 million traditional lease to buy equipment might find the rate for the tax-exempt lease to be as much as 2 percent lower.
Welcome the Benefactor to the Party
While a traditional manufacturing equipment lease is typically a two-party arrangement between a bank and a manufacturer, a tax-exempt lease brings in a third party: a government issuer. The government issuer—whether a municipality, county, port authority or state—is empowered to issue tax-exempt debt. This gives the tax-exempt structure its benefit in the form of a lower effective interest rate compared to traditional equipment financing.
In a three-way tax-exempt manufacturing equipment lease arrangement, the leasing company leases the equipment to the government entity, which then subleases the equipment to the manufacturer on a tax-exempt basis. For tax purposes, the manufacturer owns the equipment and at the end of the lease has clear title to it.
Local governments like these transactions for economic development reasons. Manufacturers like them because they make it possible to acquire new equipment at a lower cost. However, there are other benefits to the manufacturer in addition to cost savings. For example, because a government issuer is involved, the manufacturer’s repayment period is typically longer, often 10 years instead of 5-7 years, which makes payments lower.
Do You Qualify?
To determine if you qualify for a tax-exempt manufacturing lease, consider these criteria:
- The manufacturer needs to acquire new equipment versus used;
- The project needs to provide economic benefit such as job creation or retention and be approved by the local industrial development authority;
- The IRS limits tax-exempt financing to $10 million per site, with a $40 million nationwide limit per company, including affiliates;
- A manufacturer’s capital expenditures must not exceed $20 million, including the tax-exempt financing, for a period of three years prior to the tax-exempt financing’s closing and three years forward from that date; and
- The IRS restricts tax-exempt financing for non-core production costs, land and building retrofit/refurbishment costs.
Navigating a Tax-exempt Lease: Choose the Right Partner
Manufacturers interested in tax-exempt equipment financing should seek guidance from a trusted equipment finance provider. With the right partner, it doesn’t need to be complicated or intimidating.
First, make sure the finance company understands your company’s needs. Then determine that it has a streamlined credit application approval process, is stable and able to offer expert guidance through economic ups and downs, and has experience in manufacturing equipment financing and tax-exempt financing structures.
Next, make sure the financing partner will take the time to ask questions and listen as you work through the process. It’s important that manufacturers consider all available tools for optimal acquisition of equipment. After all, the value of equipment comes from using it, not from owning it.
Caveat! – Always consult with a tax advisor before making equipment-purchasing decisions.
Peter K. Bullen is senior vice president and national sales manager, Key Equipment Finance, an affiliate of KeyCorp, which provides B-2-B equipment financing solutions to businesses of many types and sizes. The company focuses on four distinct markets: businesses of all sizes in the US (from small business to large corporate); equipment manufacturers, distributors and value-added resellers worldwide; federal, provincial, state and local governments as well as other public sector organizations; and lease advisory and syndications support for corporations looking to optimize risk and revenue. For more information, contact Peter at email@example.com or at 216-689-8579.