Under the threat of sanctions from the European Union, the U.S. Senate approved legislation on May 11 to repeal the Foreign Sales Corporation/Extraterritorial Income Exclusion (ETI) Act, which the World Trade Organization has deemed an unfair subsidy to domestic corporations.
Because the legislation would replace the ETI Act with a new set of tax benefits for domestic manufacturers at a higher cost to the federal government, the legislation contains numerous "pay fors," including a crackdown on abusive tax-avoidance schemes.
One of the largest is a $39 billion set of restrictions on the tax benefits that leasing companies can claim on property leased to overseas entities and to nonprofit organizations, and state and local governments.
Under fire are so-called "SILOs" or "sale-in, lease-out" transactions in which a county - or other entity that does not pay federal income taxes - sells an asset to a private entity and then leases it back. The private entity claims a federal tax deduction from depreciation on the asset, and these savings are reflected in a reduced cost of the lease to the tax-exempt entity.
Senate Finance Committee Chairman Charles Grassley (R-Iowa) has derided these transactions as "old-fashioned tax fraud" in which "roads and bridges built with tax dollars are leased out to shelter promoters so major corporations can get a phony tax deduction." However, these transactions have been encouraged in the past by the Department of Transportation (DOT) and many counties and municipalities have used the mechanism to finance infrastructure investment.
Over the last five years, $848 million in transit vehicles have been financed through sale-leaseback agreements and the DOT has frozen another $250 million in transit leasing agreements pending the outcome of the legislation.
The legislation would also affect traditional leasing. Rather than defining an abusive transaction, it prevents leasing companies from claiming depreciation on all property leased to a tax-exempt entity that does not meet specific criteria. For example, leasing companies would have to maintain an equity investment in the leased property that is higher than the leasing-industry norm, and counties would be unable to prepay or otherwise set aside funds to pay a large percentage of future payments on the lease.
The legislation would also lengthen the depreciation period for computer and high-technology telephone and medical equipment, increasing the cost of all long-term leases on this equipment.
NACo adopted a policy at the Legislative Conference in February opposing the provision and urging a careful study of the effects on traditional leases, particularly for technological equipment and transportation vehicles, and of the costs that states and local governments would incur.
The policy insists that any restrictions be narrowly tailored to recognized abuses rather than a broad swath of financing arrangements, be "prospective" rather than retroactive, and be offset with appropriate fiscal relief to affected counties and cities.
NACo and other organizations representing local officials are working with staff of the House Ways and Means Committee to minimize the effects on traditional leasing and to identify an appropriate means of providing offsetting fiscal relief.
Prospects for halting the restrictions on sale-leaseback transactions altogether, however, appear dim, as Treasury officials and key members of the House of Representatives have joined Grassley in his effort to shut them down.
However, House Ways and Means Chairman Bill Thomas (R-Calif.) and Ranking Member Charles Rangel (D-N.M.) have expressed concern that a crackdown could diminish investment in transportation and water infrastructure projects. Subsequently, they have offered competing plans to finance the projects through tax-exempt or tax-credit bonds. NACo and other organizations representing local officials are also working with staff of the House Ways and Means Committee to minimize the effect on traditional tax-exempt leasing.
House action on the legislation is not expected until after the Memorial Day recess. An earlier version of the House legislation offered much broader tax benefits to manufacturers, and it is unclear how quickly the House and Senate will be able to agree on a final package to send to the president’s desk.