Rev. Proc. 79-48

Section 1. Purpose

This Revenue Procedure concerns requests for advance rulings on leveraged lease transactions as described in Rev. Proc. 75-21, 1975-1 C.B. 715, and Rev. Proc. 75-28, 1975-1 C.B. 752. The purpose of this Revenue Procedure is to modify section 4(4) of Rev. Proc. 75-21 and section 4.05 of Rev. Proc. 75-28 (entitled "No Investment by Lessee").

Sec. 2. Background

Rev. Proc. 75-21 sets forth guidelines relating to advance rulings on leveraged lease transactions. Section 4(4) of those guidelines sets forth a general rule that no part of the cost of the leased property may be furnished by any member of the Lessee Group and that no member of such group may furnish any part of the cost of improvements or additions to the property, except for improvements or additions that are owned by a member of the Lessee Group and are readily removable without causing material damage to the property. Rev. Proc. 75-28 sets forth the information and representations required to be furnished by the taxpayers in a request for an advance ruling on a leveraged lease transaction. Section 4.05 of Rev. Proc. 75-28 describes information required to be furnished relating to investments by members of the Lessee Group in the leased property.

The Internal Revenue Service has reconsidered section 4(4) of Rev. Proc. 75-21 and has concluded that, for advance ruling purposes, the circumstances in which a member of the Lessee Group may furnish the cost of improvements, modifications, and additions to leased property after it has been placed in service should be modified.

Sec. 3. Modification of Sec. 4(4) of Rev. Proc. 75-21

Sec. 4(4) of Rev. Proc. 75-21 is amended to read in its entirety as follows:

"(4) Investment by Lessee.

.01 Permitted Investments. Except as otherwise specifically provided in paragraphs .02 and .03 of this subsection, no part of the cost of the property or the cost of improvements, modifications, or additions to the property (Improvements), may be furnished by any member of the Lessee Group.

Property which could itself be separately leased in a transaction eligible for an advance ruling under Rev. Proc. 75-21 and Rev. Proc. 76-30, 1976-2 C.B. 647, does not constitute an Improvement. For example, assume X leases a chemical plant from Y. Assume further, that after the plant is placed in service X wishes to erect and own additional tanks that will be used to store the output of the plant. Although the tanks will be used in conjunction with X's plant, they constitute separate items of property that could be used in conjunction with other facilities and therefore do not constitute limited use property. Thus, if a third party owned the tanks it could lease them to X in a transaction eligible for an advance ruling. The tanks do not constitute an improvement.

.02 Severable Improvements. A member of the Lessee Group may furnish amounts to pay for the cost of an Improvement that is owned by a member of the Lessee Group, and is readily removable without causing material damage to the leased property (Severable Improvement), provided that such Improvement is not subject to a contract or option for purchase or sale between the lessor and any member of the Lessee Group at a price other than fair market value at the time of such purchase or sale. At the commencement of the term of the lease a Severable Improvement to the leased property must not be required in order to render the leased property complete for its intended use by the lessee. However, property will be considered to be complete even though the lessee may add as Severable Improvements ancillary items of equipment of a kind that customarily are selected and furnished by purchasers or lessees of property of the kind subject to the lease.

Thus, for example, to the extent an item of equipment such as the boiler for a leased, steam powered vessel otherwise constituted a Severable Improvement, the vessel would not, for purposes of this section, be considered complete without the boiler. On the other hand, a leased airplane would be considered complete without items of equipment such as aviation electronics and a leased vessel would be considered complete without such ancillary items such as radar, lines, or readily removable fittings, and will be eligible for an advance ruling even though such items of equipment are to be added by the lessee.

.03 Nonseverable Improvements.

(A) A member of the Lessee Group may furnish amounts to pay for the cost of an Improvement that is not readily removable without causing material damage to the property (Nonseverable Improvement) if the conditions of section 4(4).03(B) are satisfied and the Nonseverable Improvement is described in at least one of the subparagraphs of section 4(4).03(C).

(B) The following conditions must be satisfied:

(i) At the commencement of the term of the lease a Nonseverable Improvement must not be required in order to complete the property for its intended use by the lessee.

(ii) The furnishing of the cost of the Nonseverable Improvement must not constitute an equity investment by a member of the Lessee Group in the property. (The lessee's rights to use the Improvement during the lease term in which such Improvement is made does not constitute an equity investment in the property.) The furnishing of such cost will be considered an equity investment in the property if a member of the Lessee Group may receive compensation, directly or indirectly, for its interest in such Nonseverable Improvement. A member of the Lessee Group will be regarded as having made an equity investment in the property if, for example:

--the lessor is obligated to purchase the Nonseverable Improvement or reimburse a member of the Lessee Group for the cost or the fair market value of the Nonseverable Improvement; or

--any option price or renewal rental rate to a member of the Lessee Group is adjusted downward to reflect any portion of the cost or fair market value of the Nonseverable Improvement; or

--the lessor is obligated to share with a member of the Lessee Group a portion of the proceeds of any sale or lease of the property to a third party.

(iii) The Nonseverable Improvement must not cause the leased property to become limited use property within the meaning of Rev. Proc. 76-30.

(C) The Nonseverable Improvement must be described in at least one of the following subparagraphs:

(i) The Nonseverable Improvement is furnished in order to comply with health, safety, or environmental standards of any government or governmental authority having relevant jurisdiction. An industrywide health, safety, or environmental standard recognized by a government or governmental authority shall be regarded as a standard or requirement of a government or governmental authority.

(ii) The Nonseverable Improvement does not:

(a) substantially increase the productivity of the leased property over its productivity when first placed in service;

(b) substantially increase the capacity of the leased property over its capacity when first placed in service; or

(c) modify the leased property for a materially different use. An increase in productivity or capacity is substantial only if the increase is more than 25 percent.

In any case, a Nonseverable Improvement will be regarded as described in subparagraph (ii) if the cost of the Nonseverable Improvement when added to the cost of Nonseverable Improvements which previously have been made to the property (other than Nonseverable Improvements described in subparagraph (i)) does not exceed 10 percent of the cost of the property. For purposes of this subparagraph, the cost of a Nonseverable Improvement will be considered to be the actual cost multiplied by a fraction. The numerator of the fraction is the Implicit Price Deflator for Fixed Nonresidential Investment (published by the Department of Commerce in the Survey of Current Business) for the year the property was placed in service. The denominator of the fraction is the Implicit Price Deflator for Fixed Nonresidential Investment for the year in which the Improvement is made. As indicated in Section 4(4).05 ordinary maintenance and repair does not constitute an Improvement.

If separate units of property are subject to one lease (e.g., 10 boxcars subject to one lease) each separate unit shall be considered "the property" for purposes of subparagraph (ii).

(D) Unless a Nonseverable Improvement constitutes rent, the lessee shall be allowed the deduction for amortization or depreciation and the investment credit with respect to such Nonseverable Improvement, if otherwise available under the Internal Revenue Code of 1954; see Regulation sections 1.162-11(b), 1.167(a)-4, and 1.48-1(b)(1). Generally, a Nonseverable Improvement will not be regarded as constituting rent. A Nonseverable Improvement that is not made pursuant to the terms of the lease (or any related document or other agreement) requiring a member of the Lessee Group either to make the specific Nonseverable Improvement, or to make Nonseverable Improvements of a specific value or minimum value will not be regarded as constituting rent. A general requirement that the lessee make improvements required to maintain compliance with standards or requirements of any government or governmental authority having relevant jurisdiction will not be regarded as constituting rent.

.04 Cost Overruns and Modifications. If the cost of property exceeds the estimate on which the lease was based, the lease may provide for adjustments of rent to compensate the lessor for such additional cost (but see section 5.01 concerning uneven rent payments).

.05 Maintenance and Repair. If the lease requires the lessee to maintain and keep the property in good repair during the term of the lease, ordinary maintenance and repairs performed by a member of the Lessee Group will not constitute an Improvement."

Sec. 4. Modification of Sec. 4.05 of Rev. Proc. 75-28

Sec. 4.05 of Rev. Proc. 75-28 is amended to read in its entirety as follows:

".05 No Investment by Lessee

1. Indicate whether any member of the Lessee Group may be required to furnish any part of the cost of the Property, and if so, when and under what conditions.

2. Submit a representation that at the commencement of the term of the lease neither a Nonseverable Improvement, nor a Severable Improvement (other than a Severable Improvement of a kind customarily furnished by purchasers or lessees of property of the kind subject to the lease) is required in order to complete the property for its intended use by the lessee.

3. If Severable Improvements may be made to the Property, indicate who will own the Severable Improvements and identify the parties who will provide the funds necessary to purchase them.

4. Indicate whether any Severable Improvement is to be the subject of a contract or option for purchase or sale, and if so, describe the contract or option terms.

5. If Nonseverable Improvements may be made to the Property, identify the parties who will provide the funds necessary to purchase them.

6. Indicate whether a member of the Lessee Group may receive compensation, directly or indirectly, for its interest in any Nonseverable Improvement.

7. Indicate whether the lease states that the addition of any Nonseverable Improvement may not cause the Property to become limited use property.

8. Indicate whether a member of the Lessee Group may provide the cost of a Nonseverable Improvement that is not described in one of the subparagraphs of section 4.03(c) of Rev. Proc. 75-21 as modified.

9. Indicate whether the lease (or any document or other agreement) requires a member of the Lessee Group either to make a specific Nonseverable Improvement, or to make Nonseverable Improvements of a specific value or minimum value.

10. Indicate whether the transaction contains any cost overrun provisions, who must pay the cost overrun, and whether the lease provides for an adjustment to rents to compensate the lessor for any additional cost incurred because of cost overruns."

Sec. 5. Effect on Other Documents

This Revenue Procedure modifies Rev. Proc. 75-21 and Rev. Proc. 75-28 with regard to the specific areas contained herein.

Sec. 6. Inquiries

Any inquiries concerning this Revenue Procedure should refer to its number and be addressed to the Commissioner of Internal Revenue, 1111 Constitution Avenue, N.W., Washington, D.C. 20224, Attention: T:C:C.