Academic journal article Revue Canadienne des Sciences de l'Administration

Tax Effects and the Leasing Decisions of Canadian Corporations

Academic journal article Revue Canadienne des Sciences de l'Administration

Tax Effects and the Leasing Decisions of Canadian Corporations

Article excerpt


Previous empirical research has failed to detect tax effects in the leasing decisions of U. S. corporations. This paper extends previous theoretical research to analyse the effect of the tax as well as nontax incentives to lease by Canadian corporations. The empirical research demonstrates that the higher the marginal tax rate of the firm, the lower its degree of leasing. Further, the results show that the tax reform of 1989 affected lease financing in predicted directions.

Previous theoretical research (Miller & Upton, 1976; Myers, Dill, & Bautista, 1976) analysed the effect of taxes on the leasing decision of the lessor and lessee, but came to no consensus on the relationship between the lessee's tax rate and the decision to lease. Previous empirical research on U. S. corporations was unable to detect a tax effect. Ang and Peterson (1984) and Krishnan and Moyer (1994) found that the average tax rates of firms that used capital leases did not differ significantly from the average tax rates of firms that did not use capital leases. Finucane (1988) found that lessee firms' federal tax rates and investment tax credit levels did not influence firms' lease usage.

Ang and Peterson, Finucane, and Krishnan and Moyer examined average tax rate levels. However, it is the marginal tax rate (the applicable tax rate on an additional dollar of income) that should influence the firm's various investment and financing decisions. In contrast to previous research, this paper investigates the relationship between the firm's degree of leasing and its marginal tax rate for Canadian corporations.

The marginal tax rates used in this paper are estimated by extending the research of Graham (1996a, 1996b) and Shevlin (1990). Shevlin simulated marginal tax rates for U. S. firms that captured the firms' ability to carry tax losses back and forward and that therefore depended on the firms' future taxable income. Graham (1996a) included the effect of investment tax credits and the alternative minimum tax. Calculation of the simulated marginal tax rates involves the difficult process of forecasting 18 years of taxable income. Therefore, Graham (1996b) investigated several proxies for the marginal tax rate that had been suggested by previous researchers. He showed that while the simulated rate proved to be the best proxy for the "true" marginal tax rate, the second best proxy was a trichotomous variable suggested by Shevlin and modified by Graham (1996b). In this paper, an extension of this trichotomous variable that is applicable to Canadian corporations is used to capture the effect of marginal tax rates.

In contrast to previous research on the effect of taxes on the firm's leasing decision, this paper focuses on incremental changes in the firm's use of leasing each year by modifying a variable suggested by Marston and Harris (1988). This variable should be more responsive to the factors hypothesized to affect the leasing decision than cumulative lease ratios, which represent the results of decisions on leasing made over several different years. This approach is similar to that of Mackie-Mason (1990).

The overall conclusion of this paper is that the higher the lessee's marginal tax rate, the lower the degree of leasing. The tax reform of 1989 in Canada limited the amount of capital cost allowance (CCA) that the lessor can claim (Athanassakos & Klatt, 1993; Jog, 1991) and reduced the ability of lessees to trade accelerated CCAs to lessors in return for reduced lease payments. However, lessees could continue to deduct lease payments from taxable income and could also elect to deduct the CCA on the asset from taxable income rather than the lease payment itself. Thus, profitable firms with a high ability to use tax shields should have a greater incentive to lease following the tax reform of 1989. The empirical results confirm this effect. The new tax rules governing leasing are only applicable to high-cost and heavy equipment and not to equipment that is generally leased for operational purposes. …

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