On-Site Magazine

Generating (extra) income from your equipment

By Frank McGillicuddy   

Construction Equipment Financing

A few simple steps could add double-digit returns from your construction machinery.

(PHOTO: EYECRAVE / E+ / GETTY IMAGES)

Most business owners understand that they should not own the land and buildings where their business operates, meaning inside your operating business corporation (OpCo), but did you know that once you also separate the ownership of equipment from your OpCo, you reduce risk of loss from legal action against the OpCo while also adding improved wealth creation? Owning the equipment inside your OpCo may be costing you money and creating unnecessary legal risk.

There are some simple steps necessary to create the structures that allow you to take financial advantage of this arrangement, and as long as your company is financially sustainable, it opens the door to an extra stream of income that you may not realize is available. Keeping in mind that this approach will only rarely be relevant for a start-up, let’s look at how a company can arrange their business to take advantage of this net-positive structure.

This first step is to establish a Limited Liability Partnership (LLP). The group of Limited Partners (LPs) could include yourself, your family members, your Holding Company (HoldCo) or other individuals that you trust to be in business with you. There also has to be an arm’s-length person who fills the role of General Partner (GP). They have the exclusive duty to run the LLP. The LPs may not involve themselves in running the LLP, so the choice of GP will be key.

Your equipment — that heavy machinery that makes you money — will be purchased by this LLP. Of course, if you’re going to put the equipment to be leased into an LLP, the LPs collectively have to be able to invest (or borrow to invest) enough money for the LLP to purchase the equipment. Any interest paid on such borrowing is tax-deductible.

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The GP will purchase the equipment and arrange a lease with OpCo on ordinary commercial terms. A primary goal of the lease will be to allow the LLP to maximize depreciation over as short a period as is allowed. This will likely make the lease shorter in term (and the lease payments higher) than you would see in a lease from a leasing company.

The lease payments for the equipment will be tax deductible to your OpCo, but they will be tax-free income to the LPs as long as the depreciation expense offsets the lease cash income. There is no statutory limit to how large the LLP can be regarding asset value. Once the equipment is fully depreciated, and assuming it still has value, then you can convert the LLP to a private corporation (NewCo), where NewCo is fully, 100 per cent owned by the LPs. NewCo can then be sold to, or merged with, your OpCo, another party, or even donated to charity. The choice need not disrupt the use of the equipment by the OpCo. All of these options create different tax and wealth generation benefits.

In the worst-case scenario, where the equipment is worthless at the end of its depreciation schedule, you and your fellow LPs would still receive double-digit after-tax returns. The ultimate value of this whole arrangement depends on the value of the equipment after depreciation is exhausted and the tax-rate gap between the owner of the OpCo and any family members who are LPs.

No investment in business is risk-free, however the inherent risk in this structure is the same business risk that you run every day, only it’s structured to drive more benefits to you. Since you own and operate OpCo, the biggest risk to the LLP is if your OpCo goes bankrupt and cannot pay the lease. If that happens, the reality is that you will already have a host of more important problems to deal with first.

You can begin this process at any time, but the sooner you act, the sooner you and your company can start receiving the benefits, which leaves us with how to start. These steps should be familiar to your accountant or lawyer, but if they have not mentioned these types of opportunities to you before, it might be best to seek out professionals who have experience structuring the necessary agreements and partnerships.

Frank McGillicuddy is a general partner at Thermocline Advisory Incorporated, a business consulting services firm in the Greater Toronto Area.

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