Leasing

Leasing is a process by which a firm can obtain the use of a certain fixed assets for which it must pay a series of contractual, periodic, tax deductible payments. A lease guarantees the lessee (the renter) use of an asset and guarantees the lessor (the property owner) regular payments from the lessee for a specified number of months or years. Both the lessee and the lessor must uphold the terms of the contract for the lease to remain valid.

History of Leasing
How it began: History of the lease began more than four thousand years ago. It's rich and various like the history of mankind. However, to our surprise, the bases of the lease of those years have much in common with what at first glance seems innovative today. We represent a short overview of the evolution in the sphere of relations and the most important steps in its development. The first transaction: Nobody knows the precise date of the first rent deal in the history of mankind. However, the first real evidence of such activity dates to about 2000 BC. During the excavations, which took place in 1984 at the Sumerian city Ur, archaeologists discovered a prototype for the first rental agreement. These were clay tablets on which the parties set forth their obligations on rent agricultural implements, the right to use water resources, etc. Clay tablets told the scientists that, as usual, the first lessees had been the priests who lived in the temples of Ur. The first rental company: Scientists have found evidence that between 400 and 450 BC to the south-east of Babylon, the first known in the history of mankind rental campaign was run by the Murashu family in the ancient city Nippur The Murashu was an outstanding leader in the market of rental services in the Persian Empire. They specialized in land leasing, but also offered a number of the other services such as rent of cattle, agricultural equipment and seeds for sale in installments. Rent in the Middle Ages: In 1066 AD, suddenly, England was attacked by the Norwegian king and the Norman duke. In two weeks since the beginning of the campaign their ships reached the coast of England. Neither the Norwegian king, nor the Norman duke had owned a sufficient number of ships, and did not have the money and time to build their fleets and pay for running such a campaign. It was a serious military operation for those times. The British could not find any other explanation for the phenomenon, but to refer Gods blessing. Actually, everything was much simpler: the two

leaders had found a source of funding, they rented ships and weapon, hired crew and had completed their "business plan" successfully It was popular to rent horses in the Middle Ages, as well as equipment and facilities for agricultural industry. It is well-known historical fact that some people took on lease knight's armors, which was very expensive. For example, in 1248 Knight Bonfils Manganella Gaeta, who was going to the seventh crusade, rented a full set of knight's armor. Profit amounted to about 25% of the cost of the armor. Development of leasing relations in the XIX century: In the nineteenth century there was a significant increase in leasing activity, mainly due to the increasing diversity of rented items used by the community. Lease became more important because of the rapid development of technology in agriculture, manufacturing and transport. For example, the transport companies, which were building railways, gave other companies, that had driven the trains, to use their rails for rent. And these companies offered trains to the transport companies on lease. The rapid construction of railways has been a great stimulus in the development of leasing as a branch of the United States. Whilst the railways were being built, equipment trusts were involved in raising depositors funds and invested these funds in the purchase of rolling stock and various equipment. These trains and equipment rented to shipping companies and rail companies, carriers, freight and passengers. Private investors received special certificates. Using them, they could get their investment back, plus interest. Lease in the first half of the twentieth century: In the twentieth century lease has become even more important. Now the increasing interest among producers of leasing equipment has become a new stimulus to its development. At the beginning of the century producers realized that it is very difficult to find the funds to purchase expensive equipment simultaneously and in most cases it is really impossible. A great number of producers defined the lease (when the property right belongs to a lessee) as a way of possessing not only property but the technology on which the equipment was based. For example, Bell's telephone company made a decision to give its appliances only on lease. The same phenomena occurred in other industries as long as antitrust legislation was passed, and manufacturers were forced to sell it. Leasing has become a part of life in the United States and Western Europe in the era of cars. The first transaction of taking vehicles on lease was fixed in 1918. However, a car salesman from Chicago, Frank Zollia is considered to be the father of modern auto leasing. He was the first who proposed not only to rent the individual transport vehicles in the early 40s of XX century, but a long-term lease of a whole car park. Birth of leasing: Leasing date of birth is considered to be 1954, when the usual rent received an additional special feature. Then it gave a huge increase in this sector in well-developed Western countries. We meant the possibility of using accelerated depreciation of leased property for tax purposes.

Actually, the whole history of the leasing industry in the West illustrates that the accelerated depreciation for tax purposes is one of the main features which differ rent from the lease. Rent combined with accelerated depreciation allows leasing companies to "pass" the benefit of accelerated depreciation to the tenants. As a result we have a reduction in the cost of the lease. In most cases rent included the obligation or right of the lessee to purchase the rented item at the end of the contract. On the one hand, the accelerated depreciation allowed lessee to optimize taxation in the duration of the contract. On the other hand, there was no additional taxation on the transfer of property in the ownership of the lessee, as equipment has been almost completely amortized. The institution of accelerated depreciation was the basis of leasing birth. Also it made leasing competitive compared to a conventional lease or a loan.

Types Of Leasing:
Following are some types of leasing. 1) Financial lease: It is a contractual period between the lessor and the lessee and is generally equal to the expected full economic life of the asset .Here the lessor act as a financer and the lessee takes the responsibility of maintenance and services of the asset.it is also called the capital lease. 2) Operating lease: An operating lease is a lease whose term is short compared to the useful life of the asset or piece of equipment (an airliner, a ship, etc.) being leased. An operating lease is commonly used to acquire equipment on a relatively short-term basis. Thus, for example, an aircraft which has an economic life of 25 years may be leased to an airline for 5 years on operating lease .The rentals are far high in it than finance leasing. All the maintenance cost is beard by the lessor. 3) Sale And Lease Back: It is a sub-part of finance lease. Under this, the owner of an asset sells the asset to a party (the buyer), who in turn leases back the same asset to the owner in consideration of lease rentals. However, under this arrangement, the assets are not physically exchanged but it all happens in records only. This is nothing but a paper transaction. Sale and lease back transaction is suitable for those assets, which are not subjected depreciation but appreciation, say land. The advantage of this method is that the lessee can satisfy himself completely regarding the quality of the asset and after possession of the asset convert the sale into a lease arrangement. 4) Leveraged Leasing: Under leveraged leasing arrangement, a third party is involved beside lessor and lessee. The lessor borrows a part of the purchase cost (say 80%) of the asset from the third party i.e., lender and the asset so purchased is held as security against the loan. The lender is paid off from the lease rentals directly by the lessee and the surplus after meeting the claims of the lender goes to

the lessor. The lessor, the owner of the asset is entitled to depreciation allowance associated with the asset.

5) Direct Leasing: A contractual financing arrangement in which the lessor, typically a bank, purchases the property directly from the manufacturer and leases that property to the lessee.

Leasing In Pakistan
With the development of Pakistan's economy during the past decade and the privatization, deregulation and other industrial policies of the Government of Pakistan, the economy received a boost after a prolonged period of sluggish economic activity over the '70s and '80s. The first leasing company was established in 1985. The growth of the leasing industry in Pakistan initially lacked momentum due mainly to a general lack of awareness regarding its nature and benefits. From 1985 to 1997, 32 leasing companies were incorporated with the minimum capital of Rs. 100 million. The minimum capital requirement was raised to Rs. 200.00 million by June 2000. This lead to mergers and acquisition. Thereby the number of leasing companies is reduced to 27. In addition Nine leasing Modarabas & 3 Investment Banks are actively involed in leasing business. In the mid-nineties annual average growth was in the range of 30 - 35 percent. The real growth in the leasing came in the period 1992 - 95, when over 20 leasing companies were set up. In October 1995, leasing companies' paid-up capital was Rs.7.572 billion, with market capitalization of Rs.6.0 billion as on 30-06-2002. Leasing is not a very old phenomenon in Pakistan, but has gained acceptance very rapidly. The reasons are: growing awareness, ease in obtaining the facility compared to conventional forms of financing (bank loans), inherent tax benefits, simple procedure and flexibility to cater to the needs of the customer. Profit is earned through the use of the asset, not the ownership. In leasing, the ownership is vested in the leasing company and in return for rental payments, the 'lessee' has virtually unrestricted use of the asset. Leasing is a medium to long term hire of assets. It effectively increases a company's total availability of capital and leaves other sources of funds available for more profitable use. The leasing sector in general has experienced commendable growth over the years and has adequately proved to be an alternative source of finance. In case of an expected economic revival, the overall Leasing Sector is likely to regain its initial momentum particularly in the backdrop of Islamization of the economy effective fiscal year 2002 - 2003 due to its inherent potential of being in close conformity to one of the permissible modes of financing under Shariah. However, in order to improve the near future demand prospects of Leasing Sector in particular, the leasing companies need to develop innovative products along with encouraging leasing of plant, machinery and equipment relating to priority sectors of the economy including

energy (CNG), IT (Computer hardware, software and accessories), textiles, engineering etc subject to their intrinsic value. Agriculture sector is receiving special focus. The presence of commercial banks and DFI's in the lease market has impacted the leasing company's margin, but their capability of offering large ticket leasing has enhanced the acceptability of leasing options. There are basically two patterns of leasing followed in Pakistan: 1) Islamic Leasing (Ijarah): Ijara in Arabic literally mean 'to give something on rent'. The term Ijarah has two meanings in Islamic perspective. One meaning of Ijarah is to employ the services of a person on wages given to him as a consideration for his hired services." The employer is called 'mustajir' while the employee is called 'mu`jir'. Second meaning of Ijarah relates to the usufructs of assets and properties, and not to the services of human beings. 'Ijarah' in this sense means 'to transfer the usufruct of a particular property to another person in exchange for a rent claimed from him.' In this case, the term 'Ijarah' is analogous to the English term 'leasing'. Here the lessor is called 'Mujir', the lessee is called 'mustajir' and the rent payable to the lessor is called ujrah. It is a lease agreement under which a certain asset is leased out by the lessor to a lessee against specific rent or rental for a fixed period. Ijara contract is used to finance lease for items such as real estates, buildings, equipments, machineries, computers, motor vehicles, and other goods except the things that are haram or prohibited in Islam. Also the things that cannot be used without consuming cannot be leased out e.g. money, edibles, fuel, etc. Two fundamental principles of Islamic finance are: It has to be asset based financing: The first fundamental principle of Shariah is that as opposed to conventional financial dealing, profit is generated when something having intrinsic utility is sold or offered for use. Money has no intrinsic value. As such dealing in money cannot generate profit unless converted into real assets. There has to be the element of risk:

The second basic element of Shariah is that one cannot claim a profit or fee for a property/transaction, the risk of which was never borne by him. 2) Conventional Lease: It is a process by which a firm can obtain the use of a certain fixed assets for which it must pay series of contractual, periodic, tax deductible payments. The lessee is the receiver of the services or the assets under the lease contract and the lessor is the owner of the assets.

Comparison between Ijarah and Conventional leasing: Ijara and conventional lease both are types of lease, and are two similar concepts. However thereare some specific prohibitions which render conventional lease to be forbidden under Shariah.Following characteristics were studied to find the differences and similarities in both types of leasing contracts: Ownership: Who owns the asset after the lease contract? Risk bearer: After the agreement on lease contract, the risk of ownership lies with whom? Starting time for rental obligation: When would the rental obligation start after the lease contract or agreement? Usefulness of property: What is the minimum useful life of the equipment? Penalty: Can penalty be charged if lessee fails to fulfill the obligation?

Role of leasing
The point of view of a developing country leasing is: A flexible investment instrument. A way of broadening the financing options available to local companies. An efficient way to finance investment in capital assets by new companies, companies with no credit history. Attractive for financing small and medium enterprises.

In Pakistan leasing is facilitated by some of the independent leasing companies and banks. Following is the list of companies which are involved in leasing. Leasing companies in Pakistan: Orix leasing Sigma leasing corporation Askari leasing Saudi Pak leasing company Grays leasing Pak gulf leasing company Security leasing corporation limited SME leasing limited Standard chartered leasing