Wells Fargo & Co. claimed $115,174,203 in depreciation, interest, and transaction cost deductions for 2002. These deductions stemmed from the financial-services company’s participation in 26 “leveraged lease” transactions — specifically “sale-in lease-out” or SILO transactions.
SILOs are set up to suggest that a “sale” of property has taken place, that the property has been “leased back” to the original owner, and that a “loan” has been created to finance the transaction. With one exception, several courts have considered the tax treatment of SILOs, and their close relative LILOs (lease-in, lease-out), and have concluded that the taxpayer is not entitled to any of the claimed tax benefits.
Indeed, with regard to the Wells Fargo case that concluded on January 8, the court found that the company is not entitled to claim tax deductions. That’s because the SILO transactions did not afford Wells Fargo the “burdens and benefits” of property ownership, the transactions lacked “economic substance,” and the deals intended only to reduce the company’s federal taxes. (See Wells Fargo & Company and Subsidiaries v. United States, _F.3d_ (Fed. Cl. 2010).)
In a typical SILO, the taxpayer purports to lease capital assets from a tax-exempt entity under an agreement called a “head lease.” The length of the head lease is longer than the remaining economic useful life of the assets so the taxpayer can assert that the head lease should be treated as a sale for tax purposes. The tax-exempt entity concurrently enters into an agreement, called a “sublease,” in which it claims to lease the assets back from the taxpayer for a shorter period than the head lease.
As payment or “rent,” the taxpayer makes a single payment to the tax-exempt entity at closing that pays for the head lease. The funds for the head lease rent come from two sources: the proceeds of a nonrecourse loan, called the “debt funds,” and a cash payment from the taxpayer, called the “equity funds.”
“Wells Fargo did not have any funds at risk…. The debt will be completely paid without Wells Fargo having to supply any funds.” — Robert Willens
The tax-exempt entity does not retain the head-lease payment; rather, the debt funds are paid to an affiliate of the lender (the “debt-payment undertaker”) as part of a debt-defeasance arrangement. The debt-payment undertaker is obligated to make the tax-exempt entity’s rental payments. The rental payments, in turn, are made to the lender to satisfy the taxpayer’s debt-service obligations on the nonrecourse loan. These obligations are set to match, in both timing and amount, the tax-exempt entity’s rental payments. As a result, the debt funds flow in a circle, beginning and ending with the lender.
The equity funds are paid to the “equity-payment undertaker” as part of an equity-defeasance arrangement. Then the remaining portion of the equity funds is retained by the tax-exempt entity as its “incentive fee” for its participation in the transaction.