Lease financing denotes procurement of assets through lease. The subject of leasing falls in the category of finance.

Leasing has grown as a big industry in the USA and UK and spread to other countries during the present century. In India, the concept was pioneered in 1973 when the First Leasing Company was set up in Madras and the eighties have seen a rapid growth of this business. Lease as a concept involves a contract whereby the ownership, financing and risk taking of any equipment or asset are separated and shared by two or more parties.

The lessor may finance and lessee may accept the risk through the use of it while a third party may own it. Alternatively the lessor may finance and own it while the lessee enjoys the use of it and bears the risk.

MEANING 0F LEASE FINANCING

A lease transaction is a commercial arrangement whereby an equipment owner or Manufacturer conveys to the equipment user the right to use the equipment in return for a rental. In other words, lease is a contract between the owner of an asset (the lessor) and its user (the lessee) for the right to use the asset during a specified period in return for a mutually agreed periodic payment (the lease rentals).

Essentials of Lease Transactions

1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Two Parties A contract to hire a specific asset The third party Specification of asset by lessee Payment by lessor Useful possession with lessee Payment of specified rent Contract to be valid for a specific period Ownership and user Mode of termination

Types of Leases
Financial Lease
A lease is classified as a finance if it secures for the lessor,the recovery of his capital outlay plus a return on the fund invested during the lease term. According to International Accounting Standard IAS 17 A finance lease is one where the lessor transfer to the lessee substantially all the risk and reward incidental to the ownership of the asset whether or nit the title is eventually transferred.

 Operating Lease

A lease is classified as an operating lease if it does not secure for the lessor the recovery of his capital outlay plus a return on the funds invested during the lease term.
According to International Accounting Standard IAS 17 A lease which is not a finance lease This lease agreement gives to the lessee only a limited right to use the asset. The lessor is responsible for the upkeep and maintenance of the asset. The lessee is not given any uplift to purchase the asset at the end of the lease period.

Types of Finance Lease

Leveraged Lease Sale and Lease Back Tripartite Lease Syndicated Lease Big Ticket Lease International Lease Export Lease Cross-border Lease Dry Lease Consumer Lease Closed-ended Lease Swap Lease

Full Pay Out Lease Manufacturing Lease Single Investor Lease Master Lease Sales-aid Lease Import Lease Domestic Lease Currency Lease Wet Lease Balloon Lease Open-ended Lease Wrap Lease

Difference Between a Finance Lease and Operating Lease

Sr No Finance Lease 1 2 3 4 Operating Lease Ownership is transferred at the No transfer of ownership. end of lease term. Lease with purchase option No option of purchase

Lease term is about or equal to Lease term may be of a shorter period the life of the equipment. Lease payments cover almost all Not necessary the costs of the equipments and interest on financing the purchase. The Risk of obsolescence is assumed by the lessee Contracts are non cancellable Air craft, Land & Building etc. Leasing Company assumes risk of obsolescence. Usually cancellable Computer, office equipments etc.

5 6 7

Advantages of leasing to Lessee

Full Financing Additional Source of Finance

Cheaper Source of Finance

Improving Borrowing Capacity Tax Benefits Simplicity Flexibility Eliminates Risk of Obsolescence

Disadvantages of leasing to Lessee

Deprival of Ownership Restriction on Use

Financial Commitment
Loss of Residual Value Understatement of lessees Assets Double sales Tax Loss of Incentives

Advantages of leasing to Lessor

Tax Shields Full Security

High Profitability
Trading on Equity Growth Potential

Disadvantages of leasing to Lessor

Lack of Control Competition

Tax burden
Tax Sharing

Leasing Process
Lessor Purchase Contract Title to equipment Payment of Purchase Price Lease contract Right to use Lease rental Delivery of equipment Manufacturer/supplier Maintenance Payment for maintenance Lessee

Lease Evaluation
Funding Option Cost of Alternative Funding

Tax paying/Non-tax Paying Companies

Effect of Add-ons Cash flow and Discount Rates

Lease Rental Calculation

Cost of Asset

Primary Lease Period

Lessors pre-tax cost of capital Lessors pre-tax rate of return
Year P.V Factor Lease Rental 350.03 Lease rental * PV factors 287

Rs. 1000 5 Years 20.00% p.a 2.11% p.a

Lease Rental = 1000/2.86 = 350( Rounded off)

0.82

2
3 4 5

0.67
0.55 0.45 0.37

350.03
350.03 350.03 350.03

234.5
192.5 157.5 128.5

2.86

1750

1000

Introduction to Hire Purchase

Hire Purchase is a mode of financing machinery,

vehicles and consumer durable. In a hire purchase transaction, goods are let on hire, the purchase price is to be paid in installment and hirer is allowed an option to purchase the goods by paying all the outstanding installment at any time during life of the hire purchase contract. The hire purchase form of finance started in India in 1920, with establishment of Auto Supply company Ltd , which was subsequently known as commercial credit corporation

 The Government of India constituted several

committees such has Masani Committee,Saraiya Committee,James Raj Committee etc. There committee have recognized the significant role played by hire purchase companies in financing the road transport industry as they enjoyed certain advantages which may not be available to commercial bank or other Financial Institutions. Through an amendment to the banking Regulation Act 1949, the government of India permitted commercial banks to undertake the hire purchase business in 1984.

Meaning of Hire Purchase

The Hire purchase Act, 1972 defines a hire purchase agreement as An agreement under which goods are let on hire and under which the hirer has an option to purchase them in accordance with the term of the agreement. This also includes an agreement under which : ( I ) The possession of goods is delivered by the owner thereof, to a person on condition that the person pays the agreed amount in periodical installment. ( II ) The property in the goods is to pass to such person on payment of the last of such installment. ( III ) Such person has right to terminate agreement at any time before the property so passes.

Stipulation of Hire Purchase

Payment is to be made in instalments over a specified

period. The possession is delivered to the purchase at the time of entering into a contact. The property in the goods to the purchaser on payment of the last instalment Each instalment is treated as hire charge so that if default is made in payment of any one installment, the seller is entitle to take away the goods. The hirer/purchaser is free to return the goods without being required to pay any further installment falling due after the return.

Hire purchase process

Hire purchase company

Installment

Right to use

Payment

Order

Hire

Supplies

Equipment Manufacture supplire

Hire Purchase Installment calculation

Value Of Asset
Tenure Margin

Financial Charges

Rs 100000 60 Months 20 percent 15 percent

Find out Installment Amount.

Value of Asset Less: Margin (20%) Eligible amount of finance Add: Finance charges (15%) (80000 x 0.15 x 5) Hire purchase price Monthly instalment Annual instalment

Rs. Rs. Rs. Rs. Rs. Rs. Rs.

1,00,000 20,000 80,000 60,000 1,40,000 1,40,000/60 = Rs 2,333 140000/5 = Rs 28,000

Taxation Aspect

A ) Income Tax 1.Assessment of hirer 2.Assessment of owner hire purchase company 3.Hire purchase and Tax planning B ) Sales Tax 1.Hire Purchase as sale 2.Delivery vs Transfer of property 3.States entitled to imposed Tax 4.Taxable Quantum 5.Rate of Tax C) Interest Tax

Difference Between Lease and Hire Purchase

Sr No 1 Leasing Equipment etc., chosen from manufacturer but leased from bank subsidiary leasing company. Lessee never becomes the owner. No deposit required. Lessee is not entitled to claim depreciation tax shield. Hire Purchase As opposite; or direct from manufacturer.

2 3 4 5

The user becomes the owner usually on finally on final payment. Often 20% (or so) deposit called for. Hirer is entitled to claim depreciation tax shield.

Salvage value ,lessor does not become owner Salvage value once the hirer has paid all of the asset. Therefore, he has no claim over instalments, he becomes the owner of the asset the assets salvage value. and can claim salvage value.

Lease can be financial with a primary period and thereafter continued leasing at nominal rent.
The latter in (6) is advantageous for leased items which are subject to technological change.

Terms of H/P agreement can cover, items covered by financial or operational basis mentioned opposite.
As opposite, but only if agreement allows users change/update items.

Sr No 8

Leasing Lessee can charge the entire lease payment for tax purpose.Thus he/she saves taxes on the lease payment.

Hire Purchase Hire purchase payment include interest and repayment of principal.Hirer gets tax benefits only on the interest.