Q:  What are the implications of the new ETI regime on companies in the cross-border leasing industry?

A:  The ETI legislation contains significant benefits for FSC leasing companies and opens up new opportunities for leasing businesses using the ETI exclusion.  The legislation provides special benefits for foreign sales and lease income (FSLI) and contains transitional relief rules that apply to existing and new FSCs in 2000.  See Sec. 5 – Effective Date.

Most leasing companies involved in cross-border leases can obtain the same after-tax and cash flow benefits under the ETI regime as they received under the FSC regime.  Under Sec. 941(a)(1)(A), 30% of the FSLI derived by a leasing company can be excluded from U.S. taxable income.  FSLI is defined under Sec. 941(c) to include the net lease or rental income attributable to activities performed by the taxpayer (leasing entity) outside the United States in connection with the lease or rental.  In addition, FSLI includes income derived from the sale of leased property. Structuring a cross-border lease under the ETI regime may require maintaining a separate legal entity offshore, which is deemed to be or elects to be subject to U.S. tax, in order to be eligible to claim the ETI exclusion.  In addition, leasing companies are required to meet the annual foreign economic process (FEP) requirements.

The FSC transition rules also contain special relief provisions for leasing FSCs in existence on September 30, 2000.  These rules allow existing FSCs to retain their exemption benefits over the life of binding contracts entered prior to September 30, 2000. For purposes of applying this rule, a binding contract includes an enforceable purchase option, renewal option or replacement option, if it is in the original contract.

For illustration, assume a leasing FSC was formed on June 1, 1998, for leasing an aircraft and entered a 10-year (binding) lease with an unrelated airline on July 1, 1998.  In this situation, the FSC tax exemption benefits will continue over the life of the contract, which is beyond September 30, 2000, or December 31, 2001, when most existing, commercial FSCs will be terminated.

This transition relief also would apply to existing FSCs that have entered a binding contract prior to September 30, 2000, even though delivery of the aircraft occurs after September 30.

The transition rules also contain an election to have the ETI exclusion apply to sales after September 30, 2000.  Presumably, this election only applies to new sales contracts and would not apply to existing leasing FSCs, since they are under an existing long-term contract.

Finally, special grandfather relief is provided to leasing FSCs that dispose of leased assets under Sec. 5(d) of the legislation, which contains the effective date and transition rules.  These rules treat the sale of FSC lease assets as qualified foreign trading gross receipts for purposes of applying the FSC exemption.  This situation can arise where a leasing FSC is terminated or sold.