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•Concept
•Development of Leasing business
•Types of leasing business.
•Advantages to Lessor and lessee.
•Tax aspect
•Difference between Leasing & Hire Purchase
Concept
Lease is defined under :
–Transfer of Property Act
–Indian Accounting Standard (AS) 19
–International Accounting Standard – 17 (IAS)
–Sale of Goods Act, 1930; Indian Contract Act, 1872; Transfer of Property Act, 1882
Transfer of Property Act defines a lease as “a transaction in which a party owing an
asset provides the asset for use over a period of time to another for consideration either
in the form of periodic rent or in the form of down payment.”
At the end of the lease period the asset/ equipment reverts back to the lessor unless
there was provision for the renewal of the contract.
•Real function of lessor is not to rent the asset but lending funds and
lease financing is a contract of lending money.
•Lessee is free to choose the asset according to his requirements.
•Lessor does not take recourse to the asset as long as the rentals are
regularly paid to him.
Essential Elements
•Manufacturer/ Supplier
•Lessor: leasing company
•Lessee
Both lessor and lessee may be individuals, partnership, joint stock companies,
corporations or financial institutions.
•Lease brokers may act as intermediaries in arranging lease deals.
•Lease financiers : who refinance the lessor either by providing long
term loan or by subscribing to equity of lessor.
•Asset: are the subject matter of lease contract.
–Automobile, plant and machinery, equipment, land and building, factory,
running business, aircraft etc.
–Asset must be of lessee’s choice & suitable for his business.
•Term of lease
Lease should of definite period otherwise it will be legally inoperative. In
perpetual lease also there is an option to renew it further at the end of its
period.
Essential Elements
• Equipment Leasing Companies and Hire Purchase Companies are called Asset
Finance Companies (AFCs).
• Lease Rentals:
– Finance Lease- Interest + Principal
– Operating Lease- Interest+ Principal+ Repair & Maintenance, Depreciation, Insurance
etc.
– Equated OR Structured
• Stepped up/ Upfront lease, Stepped down/ Back-end lease
Development of Leasing Business
• Leasing is an age old concept.
• First leasing transaction in 1066: Conqueror
William rented ships for intrusion in Britain.
• World War II led to the evolution of equipment
leasing.
• Traditionally land, animals, agricultural tools
were involved in leasing.
• Now leasing involves high value items like ships,
aircrafts, cars, railroad equipments, computers,
office equipments etc.
Development of Leasing Business
• First Leasing Co. of India Ltd. (1973) was first leasing co. in India in organized form.
Software, windmill, telecom towers leasing etc. Assigned AA+ by FITCH.
• 20th Century Finance Corporation Ltd., Jayabharat Credit & Investment Ltd., Sundaram
Finance entered the industry in 1980s. Leasing business picked up in 1980’s. In 2011-
12 Indian leasing business volume touched an astonishing figure of USD 41 million.
• Railway Wagon Leasing Scheme 2008. IRFC funds were insufficient.
• ICICI bank pioneer.
• SBI and Canara Bank active players.
• The annual leasing business in India is estimated at USD 3.67 billion with an annual
average growth rate of more than 30%.
• Indian leasing Industry holds 12th to 13th position in the world and is the 3rd largest
player in Asia after Japan & Korea.
• Post liberalization foreign financial firms entered the leasing business starting with GE
Capital. Other leading international brands Siemens, Volkswagen, IBM, Hewlett-
Packard.
• Presently there are more than 400 leasing players in India.
Development of Leasing Business
• Number of lessors in India exceeds those in U.S. which
is the world’s leading market.
• Dahotre Committee’s recommendations mark a
significant phase in development of leasing business.
– RBI formed guidelines for allowing commercial banks to fund
leasing companies.
– Leasing companies have to get registered with RBI as NBFC
• Tax concessions and depreciation benefits are the
motivations behind leasing arrangement.
• Items like pollution control devices, renewable energy
devices, gas cylinders are eligible for 100 %
depreciation
CLASSIFICATION
Classification of lease as Finance or Operating
Lease is done on the basis of the:
Extent to which risk and reward incidental to
ownership of the asset is transferred.
Risk refers to the possibility of loss arising on
account of idle capacity or technological
obsolescence
Reward refers to the cash flows that are
generated from the usage of equipment & the
realization of appreciation of anticipated residual
value on the expiry of economic life.
Classification
Ownership Ownership of the asset remains with the lessor for the entire lease Ownership transfer option at the end of the lease
period. period is there with the lessee. Title might or might
not be transferred eventually.
Accounting Operating lease is treated generally like renting. That means, the Financial lease is treated like loan generally. Here,
Effect lease payments are treated as operating expenses and the asset the asset ownership is considered of the lessee and
does not show on the balance sheet. so asset appears on the balance sheet.
Purchase In operating lease, the lessee does not have any option to buy the Financial lease allows the lessee to have a purchase
Option asset during the lease period. option at less than the fair market value of the
asset.
Lease Term Lease term extends to less than 75% of the projected useful life of Lease term is generally more than or equal to
the leased asset. estimated economic life of the asset leased.
Expenses Lessee pays only the monthly lease payment in operating lease. In financial lease, lessee bears insurance,
Borne maintenance and taxes.
Tax Benefit Since operating lease is as good as renting, lease payment is Lessee can claim interest and depreciation both, as
considered as expense. No depreciation can be claimed. financial lease is treated like a loan.
Running Cost In operating lease, no running or administration costs are to be In a financial lease, running cost and administration
borne for example: registration, repairs etc. since it gives only right expenses are higher.
to use the asset.
Example Normally, A Projector, Computers, Laptops, Coffee Dispensers etc Normally, Plant and Machinery, Land, Office
Building etc
SALE & LEASE BACK
Indirect form of leasing.
Owner of the equipment sells it to leasing company (lessor).
Lessor further leases it back to the owner (lessee).
Therefore, the lessor buys the asset from lessee instead of
buying from vendor.
Lessee gets the funds (sale proceeds) of the asset immediately
and can utilize those funds for working capital or other
purposes.
Reduces the debt equity ratio and so enhances the borrowing
capacity of lessee.
– Eg. Sale & lease back of lockers by banks.
– Sale & lease back arrangement can be in the form of finance or
operating lease.
SALE & LEASE BACK DEAL
ICBC will provide IndiGo financial solutions for the introduction of A320 and
other aircraft to the fleet in the form of sale and lease back or financial lease or
commercial lending. The majority of IndiGo's fleet is financed through sale
and leaseback agreements - under which a third party owns the planes and
then rents them to the airline - and is one factor analysts say has helped keep
the airline profitable while India's other big carriers lose money in a highly
competitive market.
Bipartite and Tripartite lease/ Direct Lease
Bipartite lease:
– lessor (equipment supplier) (ii) lessee.
– Lessee acquires the asset directly from lessor (equipment supplier) It
may be structured in the form of operating lease and provide facilities
to upgrade or swap the asset.
DIRECT LEASE
Tripartite lease
(i) Equipment supplier (ii) lessor (lease finance Co.) (iii) lessee
Equipment supplier arranges for lease finance for the lessee.
Writes lease on his own account.
Gets lease rentals discounted from lease finance company
Lease company now owns the asset
Lease rentals are assigned to the lessor
Supplier may have to buy back the equipment from lessor if
lessee defaults.
–Also called sales aid lease as they are usually with recourse to the
supplier if lessee defaults.
Leveraged Lease
There are three parties to this transaction
(i) lessor (equity investor)
(ii) Lessee
(iii) lender.
Lessor or the leasing company buys the asset with his own
equity and substantial borrowing from lender.
Lender gets secured by first mortgage on leased assets,
assignment of lease rentals.
Trustee looks after the interest of lender and lessor.
Trustees receive the lease rentals from lessee and remits the
debt service component to the lender and balance to the lessor.
Suitable for high investment intensive assets like ships, aircrafts
etc.
Domestic & International Lease
Domestic lease: If lessee, lessor and equipment supplier are all
domiciled in same country.
International lease
• Import lease- Lessor & lessee are domiciled in same country
whereas the equipment supplier located in different country.
9. Tax advantages.
10. Low maintenance cost.
Advantages to Lessor
Tax benefit
High profitability
Prompt returns
Increased sales
Full security
Less cumbersome and time consuming
Limitations
1. Restriction on the use of assets (additions, alterations,
insurance)
2. Limitation of finance lease
1. No warranty for lessee.
2. Premature termination option not available or costly.
3. Loss of residual value.
4. Consequences of default.
Operating lease- asset repossessed.
Finance lease- lessee to pay damages or accelerated lease rentals.
5. Understatement of lessee’s asset. (op. lease)
6. Double sales tax.
TAX ASPECT OF LEASING
TAX CONSIDERATION
PURCHASE OF EQUIPMENT
Transaction between equipment supplier & leasing company is called first sale & is
subject to CST or STA.
Transaction between lessor & lessee is also a deemed sale & called second sale.
Normally second sale is exempted from levy of sales tax. However, this exemption is
not available in leasing transactions.
Hence, EQUIPMENT LEASE TRANSACTIONS SUFFER MULTIPLE POINT LEVY OF
SALES TAX
• Sales Tax is leviable on sale of goods by a dealer.
• From the viewpoint of sales-tax, the meaning of the word “sale” has been
expanded by including several transactions which are not sales in normal
parlance. A “transfer of right to use goods” is included in this expanded definition.
A delivery of goods on hire purchase is also included.
• In a Finance Lease , NBFCs are the owner of the Goods and the lessee only has
the right to use the goods on payment of lease rentals. It is a contract of hiring
or bailment . Hence there is no " sale " as defined.
• However , there is a transfer of the right to use the goods from the lessor to the
lessee . And this has become taxable as a deemed sale.
• Since in an operating lease also, there is transfer of right to use goods, there is a
sale.
• VAT is a tax on value added, that is, on the difference between the cost of
“inputs” and the value “outputs”.
• In terms of actual imposition, sales-tax is computed on the value of the output
first. Then, the sales-tax actually paid, in the State, on the inputs will be deducted
(set-off) from the tax calculated on outputs. The net tax is paid to the
government.
Lease Hire Purchase
B. Buy Option
• Initial Cost -45.00
• Depreciation 15.00 15.00 15.00
•Tax saved on Depreciation 6.00 6.00 6.00
•Cash Flow -45.00 6.00 6.00 6.00
B. Present value (Buy) -29.31 -45.00 5.60 5.22 4.87
NAL (A-B) 1.07 45.00 -16.80 -16.80 -16.80
>0; leasing
is profitable
Present 0 1 2 3
Value
B. Buy Option
• Initial Cost -45.00
• Depreciation 15.00 15.00 15.00
•Tax saved on Depreciation 5.60 5.60 5.60
• Salvage Value Realized 3.00
•Cash Flow -45.00 5.60 5.60 8.60
B. Present value (Buy) -27.92 -45.00 5.22 4.87 6.98
NAL (A-B) -0.32 45.00 -16.40 -16.40 -19.40
<0
Buying is
profitable
Leasing Vs. Buying-Evaluation
A firm has to install a generator set costing Rs.1500 lakh. A leasing firm has offered it
on lease for a period of its useful life of 5 years on a lease rent of Rs. 450 lakh per
annum. Alternatively, the firm can buy the generator by borrowing at 20%, claim
depreciation of 25% on written down value basis and realize a salvage value of
Rs.100 lakh. Evaluate whether the firm should buy or lease the generator set. Tax
rate is 35%.
Steps
1. Post tax cost of borrowing
2. Lease evaluation (A)
3. Dep. Schedule
4. Tax saved on capital loss
5. Buying evaluation (B)
1. Tax saved on dep
2. Tax saved on capital loss
3. Salvage value
6. Present value of cash flows
7. Net advantage of lease (A-B)
Year Present 0 1 2 3 4 5
Value
Lease
options(A)
Lease rentals -450 -450 -450 -450 -450
Buying Option
(B)
Cash flow- buy -1500