Leasing & HP

7/30/2019 Leasing & HP

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By

G.Venkatachalam M.Com,MBA,M.Phil,(Ph.D)

Assistant Professor/Finance/JIT

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What is leasing?

Leasing is an arrangement between two parties

the leasing company( lessor ) and the

user/(lessee) , where by the lessor arranges tobuy the capital equipmentfor the use of the

lessee for an agreed period of time in return

for thepayment of rent.

2G.Venkatachalam M.Com, MBA,M.Phil, Ph.D /AP/Finance/JIT


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Why leasing not buying?

Buying office equipmentinvolves:

An initial outlay of cash,

or the need to get a loan.

The equipment may

become obsolete.

Some equipment has a

low resale value.

Leasing involves:

No outlay of cash initially.

minimal initial

expenditures.

Rental pays (by lessee) are

tax deductible .



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Process of leasing:Seller

Lessor

Lessee

UsesBusinessAsset

Purchase the Business Asset

Pays Rent

Agreement to give asset

After agreed period ,lessor takes the asset back

Lessor= owner of asset

Lessee= user of asset



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Types of lease :

lease

Financial

lease

Operating

lease

Leverage

lease

Cross

border

lease

Sale and

lease back



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Financial lease

Capital lease, long term lease, net lease or close lease.

The lessee enters into on irrevocable / non cancelable

contract with the lessor The lessee uses the equipment, maintains it, insures,

bears the risk of obsolescence etc.

Lease with a purchase option where lessee purchases the

equipment after the lease period is over/lease for full

economic life of the equipment



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Operating lease

Service lease, short terms lease or true lease.

Lease for a limited period

Can be terminated by notice.

Maintenance expenses borne by lessor



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DIFFERENCE BETWEEN FINANCIALLEASE AND OPERATING LEASE

Period

Settlement

Maintenance

Risk Assumption

Delivery & Disposal


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Leverage lease

Leasing of those assets which requires huge capital Three parties, lessor lessee & lender.

Lessor borrows money from the lender to purchase theasset.

Lessor provides 20% to 30% finance to own the asset.



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Sale and lease back

A firm first sells the asset to lessor & then takes it on lease.

Asset sold at market value so, the lessee gets cash & as

well as right to use the asset.



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Cross border house:

International leasing/ transnational leasing.

Lease transaction between lesser & lessee of two different

countries includes expert leasing.



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TYPES OF LEASE AGREEMENTS contd

Direct Lease - Under direct leasing, a firm acquires the rightto 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 purposeleasing companies etc

Dry Lease Under dry lease agreement the asset owner

(LESSOR) provides the asset without the energy required to

operate the asset.

Wet Lease - Under wet lease agreement the asset owner

(LESSOR) provides the asset with the energy required to

operate the asset. Mostly in practice in the Airline industry.


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Why has Leasing Grown so Fast?

Beneficial to both lessee and lessor:For Lessee:

Leasing may be the only source of financing

No outside security/collateral needed

Low documentation cost

Leasing can finance a higher % of equipment thanbank loans

Governments allow lessees to deduct full lease

payments from their income before tax.13G.Venkatachalam M.Com, MBA,M.Phil, Ph.D /AP/Finance/JIT


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For Lessor:

Ownership of asset

Transaction costs lower

Lighter regulations, because they are notdeposit taking institutions.

Tax incentives and depreciation shield.

Better control on utilization of funds.



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Disadvantages

Not suitable mode of project finance as

project does not generate cash immediately to

pay rent. Lease does not get the benefit of capital gain

by selling the asset.

The cost of lease finance is higher than debitfinancing ( high rentals ).

If rent is not paid regularly then lessor suffer

from loss.15G.Venkatachalam M.Com, MBA,M.Phil, Ph.D /AP/Finance/JIT


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ADVANTAGES OF LEASING

1. SAVING OF CAPITAL: Leasing covers the full cost of the equipment

used in the business by providing 100% finance. The lessee is not to

provide or pay any margin Manufacturer Lessor.

2. FLEXIBILITY AND CONVENIENCE: The lease agreement can be

tailor- made in respect of lease period and lease rentals according to the

convenience and requirements of all lessees.

3. PLANNING CASH FLOWS: Leasing enables the lessee to plan its

cash flows properly. The rentals can be paid out of the cash coming

into the business from the use of the same assets.4. IMPROVEMENT IN LIQUADITY: Leasing enables the lessee to

improve their liquidity position by adopting the sale and lease back

technique.


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you don't have to pay the full cost of the asset upfront, so you don't use up your cash or have to borrowmoney

you pay for the asset over the fixed period of time thatyou use it

you can spread the cost over a longer period of time,and ease your cash flow by matching payments to yourincome

the business can usually deduct the full cost of leaserentals from taxable income


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you won't have to worry about an overdraft or otherloan being withdrawn at short notice, forcing earlyrepayment

if you use an operating lease or contract hire, you maynot have to worry about maintenance

the leasing company carries the risks if the equipmentbreaks down

on long-funding leases (over seven years, andsometimes over five years) you can claim capitalallowances on the cost of the asset


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REGULATORY AUTHORITY

No specific Act or Authority regulates leasing in India. Some ofthe Acts which indirectly governs are :

Income Tax Act, 1962

Indian Contract Act, 1872

Indian Stamp Act, 1899

Motor vehicles Act, 1988

Recovery of Debts due to Bank and Financial

Institutions Act, 1993

Registration Act, 1908

Reserve Bank of India Act, 1934

G.Venkatachalam M.Com, MBA,M.Phil, Ph.D /AP/Finance/JIT 19


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REGULATORY AUTHORITYCONTED

Sale of Goods Act, 1930

Sick Industrial Companies (Special Provisions)

Act, 1985

Transfer of Property Act, 1882Companies Act, 1956

Consumer Protection Act, 1986

Easements Act, 1882Foreign Exchange Management Act, 2000.

Hire Purchase Act, 1972



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PLAYERS IN LEASING

Financial Institutions (FIs):

Commercial Banks:

Foreign banks:Non-banking Finance Companies(NBFCs):

Foreign Institutional Investors (FIls):



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Income taxtreatment of lease:

For lessee:

Lease rentals are tax-deductible expenses.

For lessor: Lease rentals received by the lessor are taxable under the

head of 'Profits and Gains of Business or Profession'.

The lessor can claim investment allowance anddepreciation on the investment made in leased assets



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Accounting treatment of lease:

The leased asset is shown on the balance sheet of the

lessor.

Depreciation and other tax shields associated with the

leased asset are claimed by the lessor.

The entire lease rental is treated as income in the

books of the lessor and as expense in the books of the

lessee.



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Leasing industry in India:

In the year 1973 Leasing finance started in India.

First company was set up by the Chidambaram Groups

in 1973 at Madras.

Governed in India as per Indian contract Act (Sec.148-

Bailment)



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PUBLIC SECTOR LEASING:

Financial institutions

Financial institutions like ICICI, IFCI, has set up leasing

divisions.

Subsidiaries of bank

bank establishes subsidiaries for leasing such SBI started

in 1986.

Other public sector organization Public sector manufacturing companies like Bharat

Electronic ltd. (BHEL), ECIL have started leasing

equipment.



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PRIVATE SECTOR LEASING

Pure leasing Companies

Independent company without link with any other

organization.

The twentieth century finance corporation ltd. & Grover

leasing ltd.

Hire purchase & finance Companies

Companies prior to 1980 do hire purchase & financing of

vehicles, but after 1980 it was extended to leasing.

Sundaram finance ltd. & General Finance ltd.



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What is Hire purchase?

Hire purchase is a method of selling goods where by the

goods are let out on hire by a creditor (hiree) to the hire

purchase customer (hirer).

The buyer is required to pay an agreed amount in periodical

installments during a given period.

The ownership of property remains with the creditor (hiree)

and passes on to hirer only after the payment of last

installment.

Hire purchase is regulated under the Hire Purchase Act 1972



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Features

Under hire purchase system, the buyer takes

possession of goods immediately & agrees to paythe total hire purchase price in instalments

Each instalments is treated as hire charges The ownership of goods passes from buyer to seller

on the payments of the last instalments

In case the buyer makes any default in payments of

any instalments the seller has right to repossess thegoods

Normally a deposit is requested i.e. 10%


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Difference between leasing and hirepurchase:

BASIS LEASE FINANCING HIRE-PURCHASE

ownership The ownership sets with thelessor throughout theagreement.

ownership lies with thehiree till the lastinstalment is paid

by the hirer.Method of financing Its a method of financing

business assets.Its a method of financingboth business assets andconsumer

articles

Option to user No option is given to lesseeto buy the leasedassets.(except in financiallease)

Purchase option is therewith hirer.



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Contd

BASIS LEASE FINANCING HIRE-PURCHASE

Maintenance It is borne by lessee infinancial lease and lessorin operating lease.

It is borne by hirer.

Nature of expenditure Rentals are revenueexpenditure and entirerental is tax deductible.

Only interest oninstallment is revenuein nature and taxdeductible not the entireinstallments.

Salvage value Lessee not being theowner of the asset,doesnt enjoy thesalvage value of theasset.

Hirer, after being theowner of the asset enjoysthe salvage value of theassets .



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Standard provisions according to HP ACT 1959

To be valid, hire purchase agreements must be in writing andsigned by both parties. They must clearly set out the followinginformation in a print that all can read without effort:

a clear description of the goods

the cash price for the goods

the HP price, i.e., the total sum that must be paid to hire and

then purchase the goods

the deposit

the monthly instalments and

a reasonably comprehensive statement of the parties' rights

(sometimes including the right to cancel the agreement during a

"cooling-off" period).

The right of the hirer to terminate the contract when he feels like

doing so with a valid reason


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The owner's rights

The owner usually has the right to terminate theagreement where the hirer defaults in paying theinstalments or breaches any of the other terms in theagreement. This entitles the owner

to forfeit the deposit

to retain the instalments already paid and recover thebalance due

to repossess the goods (which may have to be byapplication to a Court depending on the nature of thegoods and the percentage of the total price paid)

to claim damages for any loss suffered.


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The hirer's obligations

The hirer usually has the following obligations: to pay the hire instalments

to take reasonable care of the goods (if the

hirer damages the goods by using them in anon-standard way, he or she must continue to

pay the instalments and, if appropriate,

compensate the owner for any loss in assetvalue)

to inform the owner where the goods will be

kept.


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Advantages of HirePurchasing Cash flow: payment by

instalments.

Writing down

allowances apply. Hire purchase is an

alternative funding lineto bank overdrafts

Attracts fixed rateinterest.

Others same as OutrightPurchase.

Disadvantage of hirepurchasing

Inflexible: difficult to

escape the outstandingsettlement if say, avehicle is no longerrequired.

High deposit compared

to contract hire. Business hire purchase

appears as a debt onthe balance sheetwhich could inhibit

future borrowing. More expensive than

contract hire

Burden of controllingand running fleet


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Leasing & HP

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