the food institute - equipment finance webinar - sept 2019 v5
TRANSCRIPT
AVOIDING PITFALLSI N F O O D M A N U F A C T U R I N GL E A S I N G & F I N A N C I N G
Equipment Finance & Leasing Webinar
September 24, 2019Presented by Bob Lehr of BMO Harris Equipment Finance
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Executive Summary
Food Equipment Finance and Leasing Discussion:
I. Trends in food manufacturing and production equipment
II. Financing considerations
III. Lease vs purchase pros and cons
IV. Specific considerations for food manufacturing and productions assets
V. Key accounting changes
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Trends in food manufacturing and production equipment in 2019
• Expected five‐year compounded growth rate of 5.8%.
• Continued prosperity buoyed by low unemployment and high consumer confidence.
• Category ‐ neutral/average
• Food safety and efficiency improvements driver plant improvements and capital spend.
• Strong demand• New: Packaging and labeling equipment, fillers, cappers, extruders, grinders, formers, SS bins, etc. • Used: Dishwasher, mixers, ovens, rotisserie ovens, slicers and stoves.
• Weaker demand: deep fat fryers, large walk‐ins and some display cases.
*Sources: BMO Harris Equipment Finance and Alta Asset Management
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Financing considerations
• Opportunity cost of capital: Can you reinvest the capital allocated for equipment purchases into other parts of the business to generate a higher rate of return
• Tax efficiency: Determine which is a more cost‐effective, long term approach—deducting lease payments, deducting total purchase cost, or deducting equipment depreciation.
• Interest rate policy: Weigh the benefits of adding fixed‐rate debt versus using a revolving line of credit with a variable interest rate.
• Equipment replacement cycle: How long do you plan to use the equipment, as this can affect the purchase‐or‐lease decision?
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Leasing vs. purchasing pros and cons
Advantages DisadvantagesPURCHASING • Tax benefits
• Rights of ownership
• No maintenance requirements• More streamlinedprocurementprocess
• Higher initial expense
• Less available liquidity
• Obsolete equipment
LEASING • Tax benefits
• Lower, fixed interest rate
• No upfront costs
• More available liquidity
• Flexible payment options
• Easier to upgrade equipment
• Payment obligationfor entire term
• Higher overall costs
• Maintenance requirements
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Advantages and Disadvantages of Purchasing
Advantages:• Tax advantages: Under the current Tax Cuts & Jobs Act of 2017 companies can take advantage of accelerated depreciation
to deduct up to 100% of the purchase cost to offset its taxes, but this then causes depreciation to decrease in later years. A company considering the purchase option should evaluate its projections for current and future profits to determine the best time for using this tax benefit, as they might not be as profitable now as they expect to be in the future.
• Ownership: Companies own the equipment and can do with it what they please, including selling and replacing it with newer equipment.
• No maintenance requirements: When purchasing equipment, companies can maintain it according to their own guidelines.
Disadvantages:• Higher initial expense: In the long run, purchasing equipment with cash may be less expensive than leasing, but companies
will have to spend more upfront. When purchasing through a loan, companies typically have to make a down payment and will be responsible for interest payments.
• Less available liquidity: Because of higher upfront costs, companies that purchase equipment might have less cash available to reinvest in other parts of the business.
• Obsolete equipment: Equipment becomes obsolete, with some types—such as computer technology—aging faster than others, so companies might need to replace equipment earlier than expected, even if they are still paying against the loan. In addition, companies might find it difficult to sell outdated equipment once they pay off the loan.
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Advantages and Disadvantages of Leasing
Advantages• Tax advantages: When a company leases equipment it can deduct the entire lease payment over the term of the lease. • Lower rate: Borrowers can trade the depreciation benefits to the lender in return for a lower interest rate, which lowers the
total cost of the lease.• Fixed rate: Because the interest rate is fixed, companies can easily calculate lease costs for the lease term, making budgeting
easier and effectively hedging some portion of their interest rate risk. This is especially important in a rising rate or inflationary environment.
• No upfront costs: Companies can finance up to 100% of the purchase price instead of making a down payment.• More available liquidity: Companies that lease equipment won’t tie up cash and can instead reinvest this cash into other
parts of the business to generate a higher rate of return.• More flexible payment options: Companies can customize lease terms to match equipment use and life expectancy, as well
as the company’s unique needs.• Easier to upgrade equipment: Companies that lease equipment for a short period can pass the burden of unloading
obsolete equipment to the lessor.• Lower rate: Borrowers can trade the depreciation benefits to the lender in return for a lower interest rate, which lowers the
total cost of the lease.
Disadvantages• Payment obligation for the entire term: Companies must pay the lease for the entire term, even if they stop using the
equipment before the lease expires. Some leases allow companies to cancel the lease or pay it off early, but these options often come with expensive termination fees. (Some loans also contain fees for paying off the loan early.)
• Can have higher overall costs: While there are tax benefits to leasing equipment, companies can have higher overall costs when leasing compared to purchasing outright. The variance depends on interest rates, the rate of inflation, and opportunity costs of the borrower.
• Maintenance records: Leased equipment often must be maintained to certain standards and companies must keep accurate maintenance records to ensure they comply with these requirements.
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Considerations for Food and Production Equipment
• Items that impact financing term length and projected values– Is there a contract that supports this equipment or is being acquired
for growth to follow?– What is the projected useful life of the equipment (5‐years, 10‐years,
15‐years or more)?– What is the anticipated “hard cost” of the project vs. “soft cost”
(installation, electrical, etc.)? – How much will the annual usage be on the equipment (one shift, two
or around the clock)?– Do you desire to return the equipment, upgrade it or retain?
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Key accounting changes on the horizon
• The FASB (U.S. Accounting Standards Board) and the IASB (International Accounting Standards Board) have discussed converging their standards since the mid‐90s– The groups proposed a shared standard for both balance sheet and P&L
treatment for leases globally.
• The new FASB standard was finalized in February 2016 and shares similar characteristics, but is not fully converged, with the IASB
• The standard has gone into effect for Public companies and will start for privately held ones 1/1/20 for entities reporting on a calendar year.
• As of July 2019 FASB has proposed a one‐year delay for privately held companies.
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Changes to FASB lease accounting rules
• Leases will now be classified as operating or finance– Tests to determine operating/finance leases will remain the same as
current lease classifications.
• All leases will be recorded on the balance sheet – Finance Leases (previously known as Capital Leases): Assets and
liabilities are recognized on‐balance sheet, with interest and amortization flowing through P&L.
– Operating Leases: Now considered an ROU asset recognized on‐balance sheet; remains a straight‐line expense on P&L.
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What changes and what doesn’t?
• Operating Leases:Will be on‐balance sheet but at less than the full cost of the asset – Depending on the residual position taken by lessor, this will still result
in a benefit when determining leverage and financial ratios.
• Finance Leases: No changes– Still contain benefits of 100% financing with terms tailored to useful
life of equipment, transactional financing instrument.
• NO IMPACT TO THE TAX & STRUCTURAL BENEFITS OF LEASING
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These materials are confidential and proprietary to, and may not be reproduced, disseminated or referred to, in whole or in part without the prior consent of BMO Harris Equipment Finance (“BMO”). These materials have been prepared exclusively for the BMO client or potential client to which such materials are delivered and may not be used for any purpose other than as authorized in writing by BMO. BMO assumes no responsibility for verification of the information in these materials, and no representation or warranty is made as to the accuracy or completeness of such information. BMO assumes no obligation to correct or update these materials. These materials do not contain all information that may be required to evaluate, and do not constitute a recommendation with respect to, any transaction or matter. Any recipient of these materials should conduct its own independent analysis of the matters referred to herein.
United States Department of Treasury Regulation Circular 230 requires that we notify you that, with respect to any statements regarding tax matters made herein, including any attachments, (1) nothing herein was intended or written to be used, and cannot be used by you, to avoid tax penalties; and (2) nothing contained herein was intended or written to be used, and cannot be used, or referred to in any marketing or promotional materials. Further, to the extent any tax statement or tax advice is made herein, BMO Financial Group does not and will not impose any limitation on disclosure of the tax treatment or tax structure of any transactions to which such tax statement or tax advice relates. BMO Financial Group does not provide legal advice to clients. You should review your particular circumstances with your independent legal and tax advisors.
Contact Information & Disclaimer
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Bob LehrSVP/Director ‐ BMO Harris Equipment Finance
(414) 765‐[email protected]
www.bmoharris.com/equipmentfinance
marcumllp.com
Presented by James Aspromonti
(631) [email protected]
SUMMARY OFTAX IMPACT OF NEW TAX LAW &ACCOUNTING LEASE STANDARD
Depreciation Rules Under TCJA that May Affect Leasing V. Buying of Assets
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New Bonus Depreciation
Immediate expensing of 100% of the cost of new investments in depreciable assets acquired after September 27, 2017, and before January 1, 2023. (The placed‐in‐service date will be extended for one year for property with a longer production period).
Asset does not have to be new property; however, it must be the business taxpayer's first use of such property.
Qualified property does not include any property used in a real property trade or business.
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New Bonus Depreciation
Cost recovery periods of residential and non‐residential remain at 27.5 and 39 years, respectively.
Recovery period for qualified improvement property is set at 39 years. The separate definitions of qualified leasehold improvement, qualified restaurant and qualified retail improvement property are eliminated.
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Vehicles
Caps are placed on write offs of business use vehicles. The new caps will be $10,000 for the first year a vehicle is placed into service.
The new law changed depreciation limits for passenger vehicles placed in service after Dec. 31, 2017. If the taxpayer doesn’t claim bonus depreciation, the greatest allowable depreciation deduction is: $10,000 for the first year, $16,000 for the second year, $9,600 for the third year, and $5,760 for each later taxable year in the recovery period.
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Vehicles
If a taxpayer claims 100 percent bonus depreciation, the greatest allowable depreciation deduction is: $18,000 for the first year, $16,000 for the second year, $9,600 for the third year, and $5,760 for each later taxable year in the recovery period.
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Section 179
Section 179 expensing is increased to $1 million for years 2018 to 2022.
A phase‐out of the Section 179 benefit will begin when the purchases exceed $2.5 million. Qualified energy efficient heating and air conditioning property will be included as Section 179 property.
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Interest Expense
Every business, regardless of form, is subject to disallowance of a deduction for net interest expense in excess of 30% of the business' adjusted taxable income. Net interest expense is determined at the tax filer level (e.g., the partnership versus the partner).
Adjusted taxable income is business taxable income without regard to business interest expense, business interest income, net operating losses, depreciation, amortization and depletion. Disallowed interest under this rule becomes an indefinite carryover. Businesses with average gross receipts of $25 million or less would be exempt from the interest limitation rules.
Financial Reporting Tax Impact of New Lease Standard
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What Tax Professionals Should Know
ASC 842 is the new lease accounting standard published by the Financial Accounting Standards Board (FASB).
Requires lessees to report assets and liabilities for leases of one year or more on the balance sheet.
The new lease accounting guidance will be effective for public companies for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Calendar year‐end public business entities adopted the new lease standard on January 1, 2019.
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What Tax Professionals Should Know
Calendar year entities that do not meet the FASB’s definition of public entities will first be required to adopt the standard in their December 31, 2020 financial statements. There is a tentative decision to postpone the adoption of this standard further.
Early Adoption is permitted.
There are finance (FKA capital) leases and operating leases.
There is different treatment for lessors and lessees
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Previous Rules
Prior to the adoption of ASC 842, lease classification determines not only how lease expense is recorded in the income statement, but also whether a lessee is required to record an asset and a liability associated with its obligations under the lease. Operating leases were not required to recognize the asset and associated liability. Rather rent expense was recognized on a straight‐line basis over the term of the lease Capital leases required the lessee to reflect an asset and corresponding liability equal to the present value of the future lease payments. Meanwhile the lessor always reflected lease‐related assets on its balance sheet.
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New Rules – Lessees
New guidance will significantly impact the U.S. GAAP financial statement accounting for leases by lessees, eliminating the traditional concept of an operating lease. Under the new guidance, virtually all leases will be included on the balance sheet for lessees. Under the new accounting model under ASC 842, lessees will need to recognize a right‐of‐use asset and a lease liability on the balance sheet for virtually all of their leases. This excludes leases that meet the definition of a short term lease. The liability will be equal to the present value of the future lease payments.
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New Rules – Lessees
The asset will be based on the liability, subject to adjustment, such as for initial direct costs. For income statement purposes the FASB retained a dual model, requiring leases to be classified as either operating or finance. Operating leases will result in straight‐line expense (similar to the current operating leases). Finance leases will result in a the treatment similar to current capital leases. The changes in accounting guidance will not impact how leases are treated for U.S. federal income tax purposes. New rules will affect financial statement covenants and ratios.
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New Rules – Lessors
The model for Lessor accounting will be similar to the current model
Lessors will classify leases as operating, direct financing, or sales‐type
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Tax Considerations
The changes in accounting guidance will not impact how leases are treated for federal income tax purposes. However, as companies transition to the new leasing standard, changes to lease accounting policies may impact several areas within the tax function, including U.S. tax accounting methods, deferred tax accounting, state taxes, and transfer pricing.
For lessees with leases classified as operating leases under the current accounting model, a right‐of‐use asset and lease liability will now be recorded under the new standard. However for tax purposes the basis amount may not change. Therefore, this creates a change to deferred taxes.
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Tax Considerations
It will be important to understand and assess any changes to the book basis of the lease assets and liabilities to ensure book and tax basis amounts are appropriately reconciled and deferred taxes are accurately recorded.
In addition if lease terms and conditions or policies change as a result of the adoption of the new standard, the tax basis and method may be impacted and deferred tax considerations must be considered.
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Tax Considerations
For income statement purposes, book expense may be reversed for tax purposes, and a deferred tax item may be created. For example to the extent any impairment is recorded for a right‐of‐use asset for book purposes, it will be reversed for tax purposes.
In addition the tax deduction for lease expense will be based on current tax methods (i.e. in accordance with IRC Sec. 467), and differences between book and tax accounting would impact deferred tax computations.
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State Taxes
Certain states levy franchise taxes for companies doing business within a particular jurisdiction. These taxes are usually based on net worth, with various adjustments to arrive at the taxable base.
Implementation of the new leasing standard may impact the computation of a company’s franchise tax base due to the requirement to record essentially all leasing transactions on the balance sheet. Moreover, this could also impact the property factor for state apportionment purposes
Companies should also consider the impact on non‐income taxes such as property tax liability if based on its financial accounting balance sheet, as well as sales and use tax impact.
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Summary
As companies prepare to adopt the new lease accounting standard, tax implications and opportunities should be considered at each step of the implementation process.
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Disclaimer
This presentation has been prepared for informational purposes only from sources believed accurate and reliable as of the date of preparation. It is intended to inform the reader about the subject matter addressed. This is not to be used or interpreted as tax or professional advice.
Those seeking such advice should contact a Marcum professional to establish a client relationship.
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