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"Double-dip" tax benefit leases.

ISSUE NO. 89-20

Here's an interesting situation. Imagine: Two entities on opposite sides of the Atlantic Ocean can each claim ownership of the same asset and reap the tax benefits from owning that asset in their respective countries.

Sound absurd?

Well, this is precisely the scenario the EITF recently considered.

Here's how it works: U.S. Co, a domestic company, purchases equipment from a manufacturer for $100. The domestic company then arranges for ForeignCo, an overseas enterprise, to obtain an ownership right in the asset that will enalbe ForeignCo to claim certain tax benefits overseas. ForeignCo pays U.S.Co $100, the appraised value of the equipment ($94) plus consideration for the foreign tax benefits ($6).

U.S.Co then leases the equipment from ForeignCo with an option to purchase at the end of the lease term. The present value of the future lease payments, with the purchase option, is $94. U.S.Co gives $94 to a third party to make the lease payments.

Both U.S.Co and ForeignCo reap tax benefits in their respective tax jurisdictions for owning the equipment. U.S.C.'s tax basis in the equipment is $100, its original purchase price.

U.S.Co agress to indemnity ForeignCo for any future events that might adversely affect ForeignCo's ability to reap the tax benefits, such as destruction of the equipment, sale of the equipment by U.S.Co or the bankruptcy of U.S.Co.



The issue is how U.S.Co should account for the $6 fee received from ForeignCo for the tax benefits ForeignCo will reap overseas -- as income or as a reduction in the cost of the equipment (deferred)?

Those who believe the $6 fee should be accounted for as a reduction in equipment cost argue that the tax benefits in the foreign jurisdiction have no value to the U.S. company apart from the transaction. U.S.Co gave up assets of only $94, not $100, in exchange for the equipment.

Others disagree. They believe the $6 fee should be taken into income immediately because, in their view, the asset sold--the ownership right that enables ForeignCo to reap the tax benefits--costs U.S.Co nothing and therefore the company has an immediate gain on the sale of $6.

Consensus: The task force decided the timing of income recognition should be determined based on individual facts and circumstances, but immediate income recognition is not appropriate if more than a remote possibility exists of losing the cash received due to indemnification or other contingencies.

The task force acknowledged practice is diverse--in some cases incoome was recognized immediately and in other cases it was deferred.




The FASB staff responded to a technical inquiry on the accounting by a rate-regulated enterprise.

A utility constructs two generating plans that share certain facilities, such as coal-handling equipment, transmission facilities and an administrative building. Plant 1 is completed January 31, 19X1, and Plant 2 on December 31, 19X1. The common facilities also are completed by January 31, 19X1, and used by Plant 1 during the year.

New rates effective February 1, 19X1, include the effect on revenue requirements of Plant 1 and one-half of the common facilities. Additional new rates effective January 1, 19X2, include the effect on revenue requirements of Plant 2 and the other half of the common facilities.

The utility meets the criteria for application of FASB Statement no. 71, Accounting for the Effects of Certain Types of Regulation. Consistent with the above rate treatment, the utility capitalizes interest on and doesn't depreciate one-half of the common facilities from January 31 to December 31, 19X1.

The question is whether that accounting is a phase-in plan under FASB Statement no. 92, Regulated Enterprises--Accounting for Phase-in Plans. Because of the increased costs of constructing electric utility plants, regulators adopted phase-in plans to moderate the initial rate increase by increasing rates more gradually than under conventional rate making. If certain criteria are met, allowable costs deferred for future recovery under a phase-in plan would be capitalized.

The FASB staff concluded the depreciation deferral and continued interest capitalization on one-half of the common facilities represent a phase-in plan unless the rate treatment routinely was used before 1982 for similar costs. The interest capitalization period should end and depreciation for the common facilities should begin on February 1, 19X1. If the depreciation pattern for those facilities is not a "rational and systematic" method acceptable for the entity in general, the deferral of depreciation and interest constitute a phase-in plan. Otherwise, only the deferral of interest is a phase-in plan.

Edited by JOHN GRAVES, CPA, director-technical services, and MOSHE S. LEVITIN, CPA, technical manager, of the American Institute of CPA's technical information division.
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Article Details
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Author:Levitin, Moshe S.
Publication:Journal of Accountancy
Date:Oct 1, 1990
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