Philip West, the US international tax counsel, said at an American Bar Association meeting in August that the government has new regulations in the works that will prevent trafficking in tax benefits through cross-border leasing. West said the government is not concerned about cross-border leasing per se, but “the more egregious uses of leasing.” He gave so-called lease-in-lease-out, or LILO transactions, as an example.

In a LILO, the owner of equipment – for example, a European utility – leases the equipment to a US lessee who then subleases it back to the utility. The rents under the head lease are largely prepaid. Head lease rents are allocated to different periods under the lease in a pattern that is front loaded. The utility receives the rent and then pays back sublease rents, but the sublease rents have a reverse pattern that starts low and goes high. The lease gives the US lessee net deductions for rent that are equivalent to a depreciation allowance on the equipment, except that the deductions are more accelerated.

LILOs were already hit by proposed regulations the IRS issued in June 1996 under section 467. These regulations limit the extent to which rents can fluctuate in leases. The market had already assumed LILOs would be impossible using the existing form once the section 467 regulations take effect. West said the new action is in addition to anything the government might do under section 467.

The latest action may be good news? The leasing market has a history of building a better mousetrap each time the government moves to shut down one of its products.