Tax Deductions Are Being Bought and Sold

With its generous subsidies for investment, the Reagan administration's tax bill will virtually eliminate the corporate income tax by 1986. But even firms that, already pay no taxes have been able to cash in on the benefits, thanks to a provision that allows them to trade tax breaks for cash.

When President Reagan proposed his generous depreciation write-offs and 10% credit for capital investments, ailing industries like autos and steel complained that the tax cuts would do them little good. Because they had no profits and thus no taxable income, these industries said, they couldn't use the tax credits and depreciation write-offs to reduce their tax payments.

To aid these firms and firms like them that might otherwise accumulate unused tax subsidies, the administration loosened the rules governing leasing transactions. The relaxed requirements allow firms to lease equipment solely for tax purposes. Thus, ailing companies can sell new equipment to more profitable firms, who in turn rent the equipment back to the ailing companies.

Under the new rules, Automan, a hypothetical car manufacturer, could buy $500 million worth of equipment and then, on paper, sell it to XYZ Co., a profitable chemical firm, for $100 million cash with the remaining $400 million to be paid off over a number of years. (The down payment must be at least 10% of the full price, and in fact, most deals to date have involved cash payments of between 15 and 25%.)

XYZ then leases the equipment-which has never left Automan's plant-back to Automan for the same monthly payments as XYZ is making to pay off the $400 million outstanding. In other words, the two companies pay each other exactly the same amounts. When the lease expires, Automan can repurchase the equipment from XYZ for a nominal fee, say $1.

The net result of all this is that XYZ receives depreciation deductions on $500 million worth of equipment it never uses -as well as investment tax credits which, under the law, means that in the first year they may deduct 10% of the full price (i.e. $50 million) from their taxable income.

Automan, for its part, receives a cash payment of $100 million in the first year of the deal-cash that it otherwise would not have received anytime in any form.

The new rules gave firms until November 13 to reach retroactive agreements on equipment purchased between January 1, 1981 and August 13, when Congress enacted the measure; after that time, the leasing provisions apply only to new equipment. The November deadline sent firms scurrying to find potential partners and lease brokers rushing to complete numerous deals.

Some observers estimate that the first round of leasing may have involved equipment worth nearly $20 billion. Precise estimates are difficult to obtain, however, because many companies prefer to keep their agreements private. One of the most aggressive buyers was IBM, which spent over $300 million on leasing deals that included the purchase of $500 million-$1 billion worth of equipment from the Ford Motor Company.

Many financially weak companies had trouble consummating deals, however, because of Treasury Department regulations that would have opened the possibility of significant penalties for the equipment buyer if the seller went bankrupt. But on October 20, after heavy lobbying from the financially troubled Chrysler Corporation, the Treasury modified its rules to eliminate that possibility. As a result, Chrysler was able to sell nearly $150 million worth of equipment to the General Electric Credit Corporation for $26 million, five hours before the deadline. Other weak firms and many smaller companies were less successful in arranging deals.

Allen Greenspan, Chairman of the Council of Economic Advisors under President Gerald Ford, has called the tax provisions "food stamps for undernourished corporations." But some companies selling the tax breaks and most of those buying them can hardly be classified as "truly needy." Occidental Petroleum, for example, one of the nation's fastest growing oil companies, sold equipment valued at $948 million to Marsh & McLennay, a New York investment and insurance company. Occidental, a Los Angeles-based firm with major oil holdings in the North Sea, Peru and Libya, earned nearly three-quarters of a billion dollars last year. But because it reported the profits from foreign sources, it has not only paid no U.S. federal income tax for the last three years, but has also accumulated unusable tax credits. Leasing brokers, who reportedly receive .25-1% of the equipment's cost, will also profit from the trades.

According to the Congressional Joint Committee on Taxation, the leasing provisions will cost the Treasury $2.6 billion in 1982 and $26.9 billion through 1986. These figures, however, only include the tax loss directly attributable to the new rules. They do not include the loss to the Treasury from the fact that some firms which were intending to lease equipment in the future will now buy that equipment instead, sell it to a second company with larger tax liabilities, and rent it back again.

In the long run, the leasing provisions will transfer to corporations funds that would have gone to the government, but this subsidy is likely to do little to aid distressed American firms. With tax breaks available for paper transactions, firms are likely to be diverted from spending time and capital on risky entrepreneurial ventures.

- by Ruth Simon, editor of People & Taxes, a monthly publication of the
Public Citizen Tax Reform Research Group, based in Washington D.C.