WASHINGTON -- Some careless but common practices associated with small lease transactions can jeopardize the financings' tax-exempt status and put them in violation of state and local laws, the California Debt Advisory Commission warns in its draft leasing guidelines.

The draft report's half dozen or so guidelines for curbing problems with small lease deals resulted from the commission's first comprehensive review of leasing industry practices in California.

Legal problems especially can occur, the report says, when issuers and lease dealers rely solely on "boilerplate" language and forms in their lease documents to address complex issues such as the private use restrictions and arbitrage earnings limits of the federal tax laws.

Similarly, some small lease deals appear to ignore altogether such important state requirements as the need for capitalized interest on abatement-style leases for assets that are not immediately available for use. The omission could jeopardize both the tax status and the validity of the lease in California, the report says.

"The documentation may have been prepared by persons outside California or without the unique nature of California law and practice in mind. Capitalized interest may not be taken into account when required. Federal income tax law requirements and restrictions, such as filings with the Internal Revenue Service and prohibitions on arbitrage or financing private activity, may be violated," the report says.

"The purpose of these admonitions is not to raise alarm, but to advise appropriate caution," the report says. "Issuers should avoid blindly accepting 'boilerplate' types of lease documents which may or may not address the specific needs of the issuers and the facility or item being financed."

Another danger, according to the report, is improper authorization of small lease financings, which also can threaten both the validity and the tax-exemption of the lease. Some issuers and dealers apparently handle authorization "casually" and do not comply with all statutory requirements for entering into leases, the report says.

To ensure compliance with all laws affecting the tax status and validity of the lease, the report recommends that even small financings be reviewed by bond counsel and, if necessary, special tax counsel.

To deal with another common problem with vendor or small lease financings -- exorbitantly high interest rates -- the report recommends agencies consider using master leasing and pooling, paying for small purchases up-front, and competitively bidding lease financings separately from equipment purchases.

"Government agencies should not simply accept the financing terms extended by equipment vendors, which often carry high interest charges," the report says, enumerating several reasons why vendor rates can be as much as twice the market rates for comparable short-term offerings.

Many equipment vendors want to add high-rate leases to their lucrative portfolios, the report says. And "it is not uncommon for vendors to negotiate transactions with governmental lessees at taxable interest rates by claiming that they need to arrange private financing to underwrite the transaction."

Also, if the vendor sells the lease to another investor, the transaction produces broker's fees that add to the financing costs.

"The market for small tax-exempt leases is now sufficiently competitive so that no government agency should pay interest rates which are significantly above the norm for comparable tax-exempt debt," the report says.

As long as the leases are guaranteed to be tax-exempt, there is a growing market of institutional investors with an interest in competitively bidding for them, including lease brokers representing wealthy individuals, finance companies, banks, and insurance companies, the report says.

Some agencies apparently accept the lease financings extended by vendors "out of habit" and do not consider less expensive alternatives, the report adds. But if an agency has a large administrative overhead, paying for small equipment purchases up-front is probably the best option.

Also, an increasing number of master lease and pooling arrangements are now available to small issuers, offering market access and economies of scale which can reduce interest costs dramatically.

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