Leasing

Lease financing is based on the observation

made by Donald B. Grant:
“Why own a cow when the milk is so cheap?
All you really need is milk and not the cow.”
 Introduction
• 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.
• The lessee is the receiver of the services or the assets
under the lease contract
• Lessor is the owner of the assets.
• The relationship between the tenant and the landlord
is called a tenancy, and can be for a fixed or an
indefinite period of time (called the term of the lease).
• The consideration for the lease is called rent
• The important feature of a lease contract is separation
of the ownership of the asset from its usage.
 Introduction
• A contract by which one party (lessor) gives to
another (lessee) the use and possession of
equipment for a specified time and for fixed
payments.
• The document in which this contract is
written.
• A great way companies can conserve capital.
• An easy way vendors can increase sales.
 Advantages
• Leasing helps to possess and use a new piece of machinery or
equipment without huge investment.
• Leasing enables businesses to preserve precious cash reserves.
• The smaller, regular payments required by a lease agreement
enable businesses with limited capital to manage their cash flow
more effectively and adapt quickly to changing economic
conditions.
• Leasing also allows businesses to upgrade assets more frequently
• It offers the flexibility of the repayment period being matched to
the useful life of the equipment.
• It gives businesses certainty because asset finance agreements
cannot be cancelled by the lenders and repayments are generally
fixed.
• However, they can also be structured to include additional benefits
such as servicing of equipment or variable monthly payments
depending on a business’s needs.
 Advantages
• It is easy to access because it is secured – largely or entirely
– on the asset being financed, rather than on other
personal or business assets.
• The rental, which sometimes exceeds the purchase price of
the asset, can be paid from revenue generated by its use,
directly impacting the lessee's liquidity.
• Lease installments are exclusively material costs.
• Using the purchase option, the lessee can acquire the
leased asset at a lower price, as they pay the residual or
non-depreciated value of the asset.
• For the national economy, this way of financing allows
access to state-of-the-art technology otherwise
unavailable, due to high prices, and often impossible to
acquire by loan arrangements.
 Limitations
• It is not a suitable mode of project financing because rental is
payable soon after entering into lease agreement while new project
generate cash only after long gestation period.
• Certain tax benefits/ incentives/subsidies etc. may not be available
to leased equipments.
• The value of real assets (land and building) may increase during
lease period. In this case lessee may lose potential capital gain.
• The cost of financing is generally higher than that of debt financing.
• A manufacturer(lessee) who want to discontinue business need to
pay huge penalty to lessor for pre-closing lease agreement
• There is no exclusive law for regulating leasing transaction.
• In undeveloped legal systems, lease arrangements can result in
inequality between the parties due to the lessor's economic
dominance, which may lead to the lessee signing an Un-favourable
contract.
 Types
• Financial lease
• Operating lease
• Sale and lease back
• Leveraged leasing and
• Direct leasing
 Financial lease
• Long-term, non-cancellable lease contracts
• it contains a condition whereby the lessor agrees to transfer the
title for the asset at the end of the lease period at a nominal cost
• At lease it must give an option to the lessee to purchase the asset
he has used at the expiry of the lease
• Under this lease the lessor recovers 90% of the fair value of the
asset as lease rentals and the lease period is 75% of the economic
life of the asset.
• The lease agreement is irrevocable
• Practically all the risks incidental to the asset ownership and all the
benefits arising there from are transferred to the lessee who bears
the cost of maintenance, insurance and repairs.
• Only title deeds remain with the lessor.
• Financial lease is also known as 'capital lease‘.
• In India, financial leases are very popular with high-cost and high
technology equipment
 Operating 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.
• Normally the lease is for a short period and even
otherwise is revocable at a short notice.
• Mines, Computers hardware, trucks and automobiles
are found suitable for operating lease because the rate
of obsolescence is very high in this kind of assets.
 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.
 Leveraged leasing
• 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.
 Direct leasing
• Under direct leasing, a firm acquires the right
to use an asset from the manufacturer
directly.
• The ownership of the asset leased out remains
with the manufacturer itself.
• The major types of direct lessor include
manufacturers, finance companies,
independent lease companies, special
purpose leasing companies etc
 Differences between financial lease
and operating lease
Financial lease Operating lease
long term arrangement between the short term arrangement between the
lessee (user of the asset) and the lessee and the owner of asset
owner of the asset
all expenses such as taxes, insurance all expenses are paid by the owner of
are paid by the lessee the asset
covers the entire economic life of the Does not cover the entire economic
asset life of the asset
lessee cannot terminate or end the lessee can end the lease anytime
lease unless otherwise provided in before expiration date of lease
the contract
rent which is paid by the lessee is rent which is paid by the lessee may
enough to fully amortize the asset not be enough to fully amortize the
asset
 Regulatory frame work for Leasing in
India
• There is no separate statue for leasing in India, the
provisions relating to bailment in the Indian Contract Act
govern equipment leasing agreements as well
• section 148 of the Indian Contract Act defines bailment as:
“The delivery of goods by one person to another, for some purpose, upon a
contract that they shall, when the purpose is accomplished, be returned or
otherwise disposed off according to the directions of the person delivering
them. The person delivering the goods is called the ‘bailor’ and the person
to whom they are delivered is called the ‘bailee’”

• Obligations of the lessor and the lessee are similar to those

of the bailor and the bailee (other than those expressly
specified in the least contract) as defined by the provisions
of sections 150 and 168 of the Indian Contract Act.
 Implications of the provisions
• The lessor has the duty to deliver the asset to the
lessee, to legally authorise the lessee to use the
asset, and to leave the asset in peaceful
possession of the lessee during the currency of
the agreement
• The lessor has the obligation to pay the lease
rentals as specified in the lease agreement, to
protect the lessor’s title, to take reasonable care
of the asset, and to return the leased asset on the
expiry of the lease period.
 Contents of a lease agreement
• Description of the lessor, the lessee, and the equipment.
• Amount, time and place of lease rentals payments.
• Time and place of equipment delivery.
• Lessee’s responsibility for taking delivery and possession of the leased
equipment.
• Lessee’s responsibility for maintenance, repairs, registration, etc. and the
lessor’s right in case of default by the lessee.
• Lessee’s right to enjoy the benefits of the warranties provided by the
equipment manufacturer/supplier.
• Insurance to be taken by the lessee on behalf of the lessor.
• Variation in lease rentals if there is a change in certain external factors like
bank interest rates, depreciation rates, and fiscal incentives.
• Options of lease renewal for the lessee.
• Return of equipment on expiry of the lease period.
• Arbitration procedure in the event of dispute
 Problems of leasing in India
• Unhealthy competition – oversupply of lessor
• Lack of qualified personnel
• Tax Consideration - taxes like sales tax, wealth
tax, additional tax , surcharge etc, add to the
cost of leasing
• Stamp Duty – heavy stamp duty is imposed
• Delayed payment and bad debts
 Presentations
• Hire purchase – concept, legal framework,
features, comparison with lease
• Taxation Aspects of leasing, Lease Accounting
and Reporting