Legal Definitions - synthetic lease

A synthetic lease is a specialized financial arrangement that allows a company to use an asset, such as a building or equipment, while structuring the transaction in a particular way for accounting and tax purposes. The goal is to achieve the best of both worlds:

• For accounting purposes, it's treated as an operating lease. This means the asset and its associated debt do not appear on the company's balance sheet, which can make the company's financial statements appear stronger by improving key financial ratios (like debt-to-equity).
• For tax purposes, the arrangement is treated as if the company owns the asset. This allows the company to claim tax benefits typically associated with ownership, such as depreciation deductions.

Essentially, a synthetic lease "synthesizes" the benefits of off-balance-sheet financing (like a lease) with the tax advantages of ownership.

Examples of Synthetic Leases:

• Corporate Headquarters: Imagine a growing technology company that needs a new, state-of-the-art headquarters building. Instead of purchasing the building outright or taking out a traditional mortgage, which would add a significant asset and corresponding debt to its balance sheet, the company enters into a synthetic lease agreement. For accounting, the building is treated as a rental, keeping the large asset and its financing off the company's books. However, for tax purposes, the company is considered the owner, allowing it to claim valuable depreciation deductions on the building's value, reducing its taxable income.

• Manufacturing Equipment Upgrade: A large automotive parts manufacturer needs to invest in a multi-million dollar robotic assembly line to modernize its production. To avoid significantly increasing its reported debt and potentially impacting its credit rating, the manufacturer uses a synthetic lease. This allows the company to operate and benefit from the new machinery immediately. On its financial statements, the equipment doesn't appear as a owned asset or a long-term liability, which helps maintain favorable financial ratios. Simultaneously, the manufacturer can claim tax deductions for the depreciation of the expensive equipment, just as if it had purchased it directly.

• Airline Fleet Expansion: An airline decides to add several new, expensive passenger jets to its fleet to expand its routes. Given the high cost of aircraft and the airline industry's often high leverage, the airline opts for a synthetic lease arrangement for these new planes. This structure allows the airline to operate the new aircraft, and the associated financing does not appear as debt on its balance sheet, which is beneficial for its credit ratings and investor perception. Despite this off-balance-sheet accounting, the airline can still take advantage of tax deductions related to the aircraft's ownership, such as depreciation, which can significantly reduce its tax burden.