A synthetic lease is a financing structure by which a company structures the ownership of an asset so that –
* for financial accounting purposes (under pre-2003 U.S. financial accounting rules), the asset is owned by a special-purpose entity and leased to the operating company under an operating lease. The
special-purpose entity
A special-purpose entity (SPE; or, in Europe and India, special-purpose vehicle/SPV; or, in some cases in each EU jurisdiction, FVC, financial vehicle corporation) is a legal entity (usually a limited company of some type or, sometimes, a limited ...
is usually owned by the lessee / operating company, and is given just enough independence so that it can be taken off the operating company's balance sheet. The asset is thus recorded as an asset on the
balance sheet
In financial accounting, a balance sheet (also known as statement of financial position or statement of financial condition) is a summary of the financial balances of an individual or organization, whether it be a sole proprietorship, a business ...
of the special purpose entity, not of the lessee / operating company. Thus, depreciation of the asset need not be charged against income of the operating company. Instead, the lease payments are recorded as an
expense
An expense is an item requiring an outflow of money, or any form of fortune in general, to another person or group as payment for an item, service, or other category of costs. For a tenant, rent is an expense. For students or parents, tuition is a ...
on the income statement.
* for tax purposes, the asset is owned by the operating company (or the special-purpose entity is consolidated with the operating company, so that the two are treated as a single entity for tax accounting purposes). Thus, the operating company can deduct depreciation of the asset for tax purposes, generally on an accelerated depreciation schedule.
Effectively, the asset is owned indirectly by the lessee / operating company, and the company leases the asset to itself. The post-Enron rules of the Financial Accounting Standards Board, which require some measure of independence of a special purpose entity from the operating company, and genuine economic substance to the transaction in which the SPE is a party, made it difficult or impossible to structure a synthetic lease SPE, so synthetic leases have essentially passed out of existence.
Synthetic leases are considered vulnerable in some jurisdictions to
recharacterisation Recharacterisation in law (and sometimes in accountancy) means the treatment of a certain course of conduct in a different manner to which the participants describe it.
The term is most important in the penal law of Continental legal systems. In so ...
.
Generally, the money to finance the asset is borrowed, and the lender takes a security interest against the asset, but has no further
recourse
A legal recourse is an action that can be taken by an individual or a corporation to attempt to remedy a legal difficulty.
* A lawsuit if the issue is a matter of civil law
* Contracts that require mediation or arbitration before a dispute can go ...
against the borrower / operating company.
References
Nancy Little, "What You Need to Know About Financing with Synthetic Leases", ''The Practical Real Estate Lawyer'', March 1999
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Leasing