Synthetic Lease

What Is a Synthetic Lease?

A synthetic lease is an off-the-balance sheet operating lease by which a special purpose entity, laid out by the operating or parent company, purchases an asset and afterward leases it back to the operating company. The synthetic lease is famous among publicly traded companies that try to further develop debt to equity ratios as the asset is displayed on the balance sheet of the special purpose entity and expensed on the parent/operating company's income statement.

How a Synthetic Lease Works

With a synthetic lease, the special purpose entity regards the lease as a capital lease for tax purposes and charges depreciation expense against its earnings. Basically, the synthetic lease allows a company to lease an asset to itself. Nonetheless, the asset doesn't appear on the balance sheet of the parent company. All things considered, the parent company regards it as a operating lease for the purpose of accounting, recording it as an expense on the income statement.

The structure of the synthetic lease allows a company to control real estate without being required to show the real estate as an asset on the financial statements. After the Enron crisis, laws fixed and the predominance of synthetic leases faded. In any case, they are getting back in the game for elements that have the resources to explore the new regulatory scene.

Benefits of Synthetic Leases

Synthetic leases give sophisticated financing options, as well as different benefits. The real property isn't recorded on the balance sheet of the operating company, yet depreciation benefits are recognized. For tax purposes, the lessee is recognized as the owner, which empowers it to claim deductions for interest (interest portion of lease payments) and depreciation. Nonetheless, in light of the fact that the property isn't an asset of the lessee/operating company, its depreciation won't reduce net income on their income statement, making a better position with shareholders and likely investors. Under a synthetic lease, the lessee has the freedom to choose the asset and settle on executive choices in regards to its construction and upgrades; likewise, lease payments are generally low compared to those of a conventional lease. Overall, the lessee benefits from worked on financial ratios, tax benefits, and full control over how the asset is utilized: a best of the two universes scenario.

Traditional Lease versus Synthetic Lease

Under a traditional lease, the lessor holds full control over how the property is utilized and is generally responsible for enhancements; in any case, some lease provisions permit lessees to make modifications to the property to suit business needs. All benefits, expenses, and obligations (e.g., taxes) associated with asset ownership are assumed by the lessor. Basically, the lessor is the owner for tax and accounting purposes. The lessee cares very little about the property other than whatever is given by the operating lease.

Features

• For the parent company/lessee, the depreciation of the asset doesn't influence net income, as displayed in the income statement.
• A synthetic lease is an operating lease wherein a special purpose entity, owned by a parent company, purchases an asset and leases it to the operating company.
• The asset is owned by the lessor for accounting yet is owned by the lessee for tax purposes.
• The lessee can, in any case, claim depreciation deductions for tax purposes.