Valuation of Safe Harbor Tax Benefit Transfer Leases

The Economic Recovery Tax Act of 1981 (ERTA) was designed to stimulate capital investment through liberalization of depreciation allowances and investment tax credit for property acquired and placed in service after December 31, 1980. To offer equal incentives to companies that could not benefit from these changes, the ERTA made it easier to sell those tax benefits. The vehicle created by Congress for selling the unused portion of tax benefits is known as the safe harbor lease. At the extreme, an unprofitable company can purchase and own an asset, while selling outright for cash the tax benefits typically associated with ownership. Under this arrangement, referred to as Tax-Benefit Transfer (TBT) lease, the firm buying the tax benefits is recognized as lessor and owner of the assets for tax purpose only. Although the Tax Equity and Fiscal Responsibility Act (TEFRA) of 1982 repealed safe harbor leases after December 31, 1983, the conferees included special transitional rules to allow safe harbor leasing beyond that date for certain troubled industries. This paper derives a valuation formula for pricing the TBT lease as viewed by the lessor. Further analysis examines the partial and joint effects on price of two decision variables - the interest rate charged on the attached phantom loan and the term of the lease - and contrasts the pricing model of the new type of lease with that of a conventional financial lease