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Selected Issues in Domestic Tax-Exempt Leasing Transactions

By Daniel Lavin
August 01, 2003

Lease investors have been participating in cross-border transactions for a wide variety of municipal facilities for several years. Assets have included water and sewer systems, electric and gas distribution systems, rail rolling stock and infrastructure, and convention centers. Investors have also been participating in transactions involving U.S. state and local government entities for several years. However, the preponderance of the U.S. transactions closed to date have involved rolling stock or transit facilities.

Although the tax law governing both cross-border transactions and U.S. state and local government transactions is the same and the structures used (most commonly sale leaseback followed by a service contract with most rent payment obligations economically defeased, and potential purchase option exercise provided for) are similar, the U.S. market has not yet grown to encompass the breadth of asset types seen in the foreign market. Many considerations interact to make U.S. state and local transactions difficult to do despite their clear economic attractions. While some of these factors are common to all transactions with governments and government-controlled entities, many of them are particular to U.S. state and local government entities. The purpose of this article is to explore some of the issues surrounding U.S. state and local transactions.

The nature of U.S. state and local government in the context of a federal system creates issues which a leasing transaction must address. In contrast with jurisdictions outside of the United States, where local processes tend to be relatively uniform within a given country, there is a substantial variation in governmental processes which may apply to U.S. state and local transactions. State laws governing fundamental aspects of leasing transactions vary from state to state. Moreover, assets are often in the hands of special authorities that have unique rules. This variety of applicable law adds substantial complexity and uncertainty to the transaction process. In addition, tax exempt state and local financing provides competition for leasing and an additional layer of complication.

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