Energy Project Financing : Resources and Strategies for Success

72 Energy Project Financing: Resources and Strategies for Success

eration project might. Operating leases are considered “off balance sheet”

financing, and payments are treated as an operating expense.

A common capital lease is a “finance lease,” which is similar to a con-

ditional sales agreement because the asset must be reflected on the les-

see’s (borrower’s) balance sheet. A finance lease is easily recognized be-

cause the customer can buy the equipment at the end of the lease term at

a stated price that is less than its fair market value (“a bargain purchase

option”). For example, a lease with a one dollar purchase option is clearly

a capital lease. Other conditions that define a capital lease deal with the

term of the lease, transfer of ownership, and lessor’s equity in the asset.*

Not everyone realizes that the tax treatment of a lease may be differ-

ent from the financial reporting treatment of a lease. A tax lease or guideline

lease is one in which the lessor keeps the tax incentives provided by the

tax laws for investment and ownership of equipment (typically deprecia-

tion and tax credits). Generally, the lease rate on tax or guideline leases is

reduced to reflect the lessor’s recognition of this tax incentive. A true lease,

similar to a long-term rental agreement, gives the lessee the option to buy

the equipment at its true fair market value at the end of the lease term and

may allow the lessee to deduct the monthly lease payments as an oper-

ating expense for income tax purposes. After all, you can’t depreciate an

asset that you do not own. However, a true lease will be picked up on the

balance sheet.

Public sector organizations frequently lease equipment. However,

because most public sector organizations are tax-exempt, tax strategies

are not usually a consideration when deciding which type of lease to en-

ter into.

FUNDING SOURCES

Once you have determined that internal sources of funds are not

available or are insufficient for your energy efficiency project, your op-

tions become (a) using third party lenders, (b) postponing the project, or

(c) installing part of the upgrades by breaking the project into smaller

pieces. Earlier in this chapter, we explained why postponing or delaying

*See Financial Accounting Standards Board Statement of Financial Accounting Standards

No. 13 for more information. Note that the financial treatment of operating leases is currently

under review and may change.