Like businesses of all sizes and types, manufacturers also are searching for options to address the challenges of acquiring new equipment without large outlays of cash or losses in operational flexibility.
Faced with a fresh need for new equipment, many manufacturers are considering equipment loans and leases, as well as the exclusive tax-exempt options, as a way to reach the next level in production, sales, and profitability.
In the broader market, equipment financiers are seeing a healthy pick-up in demand as confidence in the manufacturing sector grows and expansion begins. This swelling of demand calls for a return to the fundamentals of equipment financing, which can apply to just about any type of equipment, including the traditional drills, grinders, molds, presses and rollers, as well as the new technology or technological upgrades that increase output and can be bundled into a financing agreement along with the costs of installation and training.
Equipment Financing Fundamentals
How should manufacturers get started? By first considering these 12 benefits of equipment financing:
- Tax treatment: The IRS does not consider certain equipment leases to be a purchase, but rather a tax-deductible overhead expense. Therefore, manufacturers can deduct the lease payments from income, thus reducing the net cost of financing.
- 100% financing: Since leasing often does not require a down payment, it is equivalent to 100% financing. Manufacturers can conserve the capital that would have been used for a down payment and reinvest it in the business.
- Immediate write-off of the dollars spent: With certain equipment leases, payments are treated as expenses on the income statement, so the equipment solution does not have to be depreciated over an extended term.
- Flexibility: As facilities grow and needs change, the manufacturer may be able to add or upgrade technology at any point during the financing term.
- Asset management: Equipment leasing can provide for the use of a technology solution for specific periods of time at fixed payments. The financing company assumes and manages the risk of technology ownership. At the end of the financing term, if the manufacturer elects to return the technology, the financing company is responsible for the disposition of the asset.
- Upgraded technology: Technology solutions that could depreciate quickly should be leased to limit a manufacturer’s risk of getting caught with obsolete equipment. Plus, leasing makes it easier to upgrade or add technology solutions to meet ever-changing needs.
- Streamlined processes: Leasing can allow you to respond quickly to new opportunities with minimal documentation and red tape.
- Improved cash forecasting: When manufacturers lease equipment, they can accurately forecast the cash requirements for the equipment since they know the amount and number of lease payments required, and with leasing, there are no floating fees.
- Flexible end-of-term options: There are typically three flexible options at the end of a term. The lessee can return the equipment, purchase the equipment from the financing company or extend the lease for an additional period of time.
- Tax benefits: For companies who do not need MACRS depreciation resulting from owning equipment, tax leases can be utilized to pass along the tax benefits in the form of lower payments. For companies who want the depreciation benefits a non-tax lease or loan can provided.
- Easier financing than loans: With equipment leasing, manufacturing facilities can avoid requirements like compensating balances, large down payments, client list reviews and cash-flow projections, making the finance process faster and easier.
- Finance services: Training, support and other services are some of the most important components of a new equipment acquisition, particularly when obtaining new manufacturing technology. Yet these “soft costs” are some of the most overlooked during the decision-making phase. Often, everything involved in a technology purchase, from servers and scanners to software and services can be bundled into one predictable monthly lease payment, making it easy to budget for all costs associated with a technology acquisition.
The tax-exempt lease – an alternative to the Industrial Revenue Bond - is a lesser-known option for manufacturers but one that provides many benefits, including a tax-exempt rate lower than taxable rates.
Better known in the nonprofit sector, the tax-exempt lease also is an option for manufacturers, typically those with $20 million to $200 million in revenue. Local governments like these transactions for economic development reasons, while manufacturers like them because they make it possible to acquire new equipment at a lower cost. In addition, the structure often has a longer repayment timeframe than a typical lease or loan and may go as long as 10 years instead of 5-7, which makes payments lower.
While typical equipment leases involve two parties – manufacturer and leasing company - tax-exempt lease structures are a three-party agreement between manufacturer, governmental agency and leasing company. Basically, the leasing company leases the equipment to the municipal entity (city, county or other issuing authority), which then subleases the equipment to the manufacturer on a tax-exempt basis. For tax purposes, the manufacturer owns the equipment and at the end of the lease has clear title to it.
To determine if you qualify for a tax-exempt manufacturing lease, consider these criteria:
- The manufacturer needs to acquire new equipment versus used.
- The project needs to provide economic benefit such as job creation or retention and be approved by the local industrial development authority.
- The IRS limits tax-exempt financing to $10 million per site, with a $40 million nationwide limit per company, including affiliates.
- A manufacturer’s capital expenditures must not exceed $10 million, including the tax-exempt financing, for a period of three years prior to the tax-exempt financing’s closing and three years forward from that date.
- The IRS restricts tax-exempt financing for non-core production costs, land and building retrofit/refurbishment costs.
If you’ve decided to finance new or used manufacturing equipment, your next step is to seek guidance on the equipment financing process, which doesn’t need to be complicated or intimidating, especially with the right partner.
When making this choice, consider whether the finance company:
- understands your company’s needs.
- has a streamlined credit application approval process, among other factors.
- is stable and able to offer expert guidance through economic ups and downs.
- has experience in manufacturing equipment financing and tax-exempt financing structures.
The goal is to gain an understanding that will make the financing package as attractive as possible for your company, because after all, the value of equipment comes from using it, not owning it.
Always consult with a tax advisor before making equipment-purchasing decisions.
Peter K. Bullen is senior vice president and national sales manager for the Bank Channel of Key Equipment Finance, an affiliate of KeyCorp (NYSE: KEY) that provides business-to-business equipment financing solutions to businesses of many types and sizes. The company focuses on four distinct markets: businesses of all sizes in the U.S. (from small business to large corporate); equipment manufacturers, distributors and value-added resellers worldwide; federal, provincial, state and local governments as well as other public sector organizations; and lease advisory and syndications support for corporations looking to optimize risk and revenue. For more information, contact Peter at firstname.lastname@example.org or 216-689-8579.
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