LEASE FINANCINGLEASE FINANCING LEASINGLEASING is widely used in Western is widely used in Western

countries to finance investments. In countries to finance investments. In USA, which has the largest leasing USA, which has the largest leasing industry in the world, lease industry in the world, lease financing contributes one-third of financing contributes one-third of total business investments. In the total business investments. In the changing economic and financial changing economic and financial environment of India, it has environment of India, it has assumed an important role.assumed an important role.

Lease Financing Lease Financing

LEASE is a contract between a lessor,,the owner of the LEASE is a contract between a lessor,,the owner of the asset, and a lessee, the user of the asset.asset, and a lessee, the user of the asset.

A lease may be defined as a contract whereby the A lease may be defined as a contract whereby the

owner of an asset grants to another party the owner of an asset grants to another party the exclusive right to use the asset without actually exclusive right to use the asset without actually receiving ownership title, for an agreed period of time receiving ownership title, for an agreed period of time in return for the periodic payment of pre-determined in return for the periodic payment of pre-determined rentals (normally spread of the lease period). The rentals (normally spread of the lease period). The former is called ‘lessor’ and the latter ‘lessee’. The former is called ‘lessor’ and the latter ‘lessee’. The lessee acquires most of the economic values lessee acquires most of the economic values associated with the asset without acquiring title.. associated with the asset without acquiring title..

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Types of LeasingTypes of Leasing

Operating Lease/Real Operating Lease/Real Lease/ Service LeaseLease/ Service Lease

Financial Lease/Capital Financial Lease/Capital LeaseLease

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Operating LeaseOperating Lease It is a short-term lease on a period to period It is a short-term lease on a period to period

basis. The lease period in such a contract is basis. The lease period in such a contract is less than the usual life of the asset.less than the usual life of the asset.

The lease is usually cancellable by the The lease is usually cancellable by the lessee.lessee.

The lessee usually has the option of The lessee usually has the option of renewing the lease after the expiry of lease renewing the lease after the expiry of lease period.period.

The lessor is generally responsible for The lessor is generally responsible for maintenance, insurance and taxes. maintenance, insurance and taxes.

Lease rentals are higher as compared to Lease rentals are higher as compared to other leases.other leases.

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Financial LeaseFinancial Lease

A financial lease is a non- cancellable A financial lease is a non- cancellable contractual commitment on the part of a contractual commitment on the part of a lessee to make a series of payments to the lessee to make a series of payments to the lessor for the use of an asset. With a financial lessor for the use of an asset. With a financial lease, the lease period generally corresponds lease, the lease period generally corresponds to the economic life of the asset. to the economic life of the asset.

Most of the leases in India are financial leases Most of the leases in India are financial leases that are commonly used for leasing land, that are commonly used for leasing land, buildings, office equipments, diesel buildings, office equipments, diesel generators, earth moving equipments, generators, earth moving equipments, locomotives and hotel equipment etc.locomotives and hotel equipment etc.

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Financial LeaseFinancial Lease

The present value of the total lease rentals The present value of the total lease rentals payable during the period of the lease payable during the period of the lease exceeds or is equal to the substantially the exceeds or is equal to the substantially the whole of the fair value of the leased asset.whole of the fair value of the leased asset.

As compared to the operational lease, a As compared to the operational lease, a financial lease is for a long period of time.financial lease is for a long period of time.

It is usually non-cancelable by the lessee It is usually non-cancelable by the lessee prior to its expiration date.prior to its expiration date.

The lessee is generally responsible for The lessee is generally responsible for maintenance, insurance and service of the maintenance, insurance and service of the asset.asset.

Forms of Financial Lease Forms of Financial Lease

Sale and Lease backSale and Lease back Direct leasingDirect leasing Leveraged LeasingLeveraged Leasing Straight Lease and Modified LeaseStraight Lease and Modified Lease Primary and secondary LeasePrimary and secondary Lease

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Sale and Lease BackSale and Lease Back Under a sale and lease back arrangement, a Under a sale and lease back arrangement, a

firm sells an asset to another party, and this firm sells an asset to another party, and this party leases it back to the firm. party leases it back to the firm.

Usually the asset is sold at its market value. The Usually the asset is sold at its market value. The firm receives sale price in cash and the economic firm receives sale price in cash and the economic use of the asset during the lease period. In turn, use of the asset during the lease period. In turn, it contracts to make periodic lease payments and it contracts to make periodic lease payments and gives up the title of the asset. Residual value will gives up the title of the asset. Residual value will now belong to the lessor and not to the firm. now belong to the lessor and not to the firm.

Lessors engaged in this include insurance Lessors engaged in this include insurance companies, finance companies and other companies, finance companies and other institutional investors. institutional investors.

This provide liquidity as well as possible tax This provide liquidity as well as possible tax gains to the lessee. gains to the lessee.

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Primary and Secondary Lease Primary and Secondary Lease (Front-ended and back-ended (Front-ended and back-ended

Lease)Lease)

Under primary and secondary lease, the Under primary and secondary lease, the lease rentals are charged in such a lease rentals are charged in such a manner that the lessor recovers the cost manner that the lessor recovers the cost of asset and acceptable profits during of asset and acceptable profits during the initial period of the lease and then the initial period of the lease and then secondary lease is provided at nominal secondary lease is provided at nominal rentals. In other words, the rent charged rentals. In other words, the rent charged in the primary period are much more in the primary period are much more than that of the secondary period.than that of the secondary period.

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Direct LeasingDirect Leasing Under Direct leasing, a firm acquires the use Under Direct leasing, a firm acquires the use

of an asset that it does not already own. of an asset that it does not already own. A direct lease may be arranged either from the A direct lease may be arranged either from the

manufacturer or through the leasing company. manufacturer or through the leasing company. A wide variety of direct leasing arrangements A wide variety of direct leasing arrangements meet various needs of firms. meet various needs of firms.

For leasing arrangements involving all but For leasing arrangements involving all but manufacturers, the vendor sells the asset to manufacturers, the vendor sells the asset to the lessor, who in turn leases it to the lessee. the lessor, who in turn leases it to the lessee. In certain cases, the lessor may achieve In certain cases, the lessor may achieve economies of scale in the purchase of capital economies of scale in the purchase of capital assets and may pass them on to the lessee at assets and may pass them on to the lessee at lower lease rentals.lower lease rentals.

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Leveraged leaseLeveraged lease

A leveraged lease is an arrangement under which the A leveraged lease is an arrangement under which the lessor borrows funds, for purchasing the asset, from a lessor borrows funds, for purchasing the asset, from a third party called lender, which is usually a bank or third party called lender, which is usually a bank or finance company. Generally 20% to 50% of cost is finance company. Generally 20% to 50% of cost is contributed by the lessor. The loan is usually secured contributed by the lessor. The loan is usually secured by the mortgage of the asset and the lease rentals to by the mortgage of the asset and the lease rentals to be received from the lessee. From the standpoint of be received from the lessee. From the standpoint of lessee there is no difference between this lease and lessee there is no difference between this lease and any other lease. any other lease.

In this type of lease, a wide range of equipments such In this type of lease, a wide range of equipments such as rail-road rolling stocks, coal mining, electricity, as rail-road rolling stocks, coal mining, electricity, generating plants, pipelines, ships etc. are acquired.generating plants, pipelines, ships etc. are acquired.

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Straight Lease and Modified Straight Lease and Modified LeaseLease

Straight lease requires the lessee firm to Straight lease requires the lessee firm to pay lease rentals over expected life of the pay lease rentals over expected life of the asset and does not provide for any asset and does not provide for any modifications to the terms and conditions of modifications to the terms and conditions of the basic lease.the basic lease.

Modified Lease, on the other hand, provides Modified Lease, on the other hand, provides several options to the lessee during the several options to the lessee during the lease period. For example, the option of lease period. For example, the option of terminating lease may be provided by either terminating lease may be provided by either purchasing the asset or returning the same.purchasing the asset or returning the same.

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OTHER TYPES OF LEASEOTHER TYPES OF LEASE

MASTER LEASEMASTER LEASE PERCENTAGE LEASEPERCENTAGE LEASE WET and DRY LEASEWET and DRY LEASE UPDATE LEASEUPDATE LEASE CLOSED and OPEN ENDED LEASECLOSED and OPEN ENDED LEASE

Percentage LeasePercentage Lease

Percentage lease provide for a fixed Percentage lease provide for a fixed rent plus some per cent of the rent plus some per cent of the previous year’s gross revenue to be previous year’s gross revenue to be paid to the lessor.This ensures paid to the lessor.This ensures protection against inflation.protection against inflation.

Master leaseMaster lease

Master lease provides a longer period Master lease provides a longer period than asset’s life and hold the lessor than asset’s life and hold the lessor responsible for providing equipments responsible for providing equipments in good operating condition during in good operating condition during the lease period.the lease period.

Update LeaseUpdate Lease

Update lease is intended to protect Update lease is intended to protect the lessee against the risk of the lessee against the risk of obsolescence. The lessor agree to obsolescence. The lessor agree to replace obsolete asset with new one replace obsolete asset with new one at specified rent.at specified rent.

Close and Open endedClose and Open ended

In the close ended lease, the asset get In the close ended lease, the asset get transferred to the lessor at the end, transferred to the lessor at the end, and the risk of obsolescence, residual and the risk of obsolescence, residual value value etc.remain with the lessor being the etc.remain with the lessor being the legal owner of the asset. In open ended legal owner of the asset. In open ended lease, the lessee has option of lease, the lessee has option of purchasing the asset at the end of purchasing the asset at the end of lease.lease.

Wet and Dry LeaseWet and Dry Lease

In the aircraft industry, when the In the aircraft industry, when the lease involves financing as well as lease involves financing as well as servicing and fuel, it is called wet servicing and fuel, it is called wet lease. Dry lease provide only for lease. Dry lease provide only for financing.financing.

Lease AgreementLease Agreement

A lease agreement being a contractual agreement, A lease agreement being a contractual agreement, has to fulfill all the conditions of an agreement to has to fulfill all the conditions of an agreement to make both the parties binding. make both the parties binding. Generally a lease Generally a lease agreement contains the following:agreement contains the following:

1. Details of the lessor and the lessee.1. Details of the lessor and the lessee. 2. Description of the asset.2. Description of the asset. 3. Date, Time and Place of asset delivery.3. Date, Time and Place of asset delivery. 4. Amount, time period (Yearly, half-yearly, monthly) 4. Amount, time period (Yearly, half-yearly, monthly)

from and place of lease rental payment.from and place of lease rental payment. 5. Responsibility of lessee for taking delivery of 5. Responsibility of lessee for taking delivery of

asset, its maintenance etc.asset, its maintenance etc. 6. Insurance of the asset undertaken by the lessor or 6. Insurance of the asset undertaken by the lessor or

the lessee.the lessee.

Lease AgreementLease Agreement

7. Provision regarding the alteration in the amount of 7. Provision regarding the alteration in the amount of lease rental, depreciation rate, tax rate, interest rate lease rental, depreciation rate, tax rate, interest rate etc.etc.

8. Details of option for the renewal of the lease.8. Details of option for the renewal of the lease. 9. Return of asset after the expiry of lease period, in 9. Return of asset after the expiry of lease period, in

case lessee is not allowed to purchase the asset.case lessee is not allowed to purchase the asset. 10. Arbitration process in case of dispute.10. Arbitration process in case of dispute. All the contents of lease agreement should better be All the contents of lease agreement should better be

free from all ambiguities. It is always good to have all free from all ambiguities. It is always good to have all the terms and conditions of the agreement in writing. the terms and conditions of the agreement in writing. Both the parties must evaluate each and every part of Both the parties must evaluate each and every part of the agreement in detail to minimise the chances of the agreement in detail to minimise the chances of any misunderstanding in future. any misunderstanding in future.

HIRE PURCHASEHIRE PURCHASE

It is type of installment credit in It is type of installment credit in which goods are purchased on which goods are purchased on installments, whereby ownership is installments, whereby ownership is transferred on the payment of last transferred on the payment of last installment.installment.

It is popular in automobile sector.It is popular in automobile sector.

manufacturer hirerhiree

Difference between Difference between Hire purchase and Hire purchase and

Lease FinancingLease Financing HIRE PURCHASEHIRE PURCHASE Depreciation Depreciation : Hire is : Hire is

entitled to claim entitled to claim depreciation tax shielddepreciation tax shield

Hire purchase paymentHire purchase payment include interest and include interest and repayment of principal. Hire repayment of principal. Hire get tax benefits only on get tax benefits only on interest.interest.

SALVAGE VALUESALVAGE VALUE: once the : once the hirer has paid all hirer has paid all installments, he becomes installments, he becomes owner of the asset and can owner of the asset and can claim salvage value. claim salvage value.

Involve necessary purchase Involve necessary purchase of asset.of asset.

LEASE FINANCINGLEASE FINANCING Lessee is not entitled to Lessee is not entitled to

claim depreciation tax claim depreciation tax shield.shield.

Lease paymentsLease payments : Lessee : Lessee can charge the entire can charge the entire lease payments for tax lease payments for tax purposes. Thus, he/she purposes. Thus, he/she saves tax on lease saves tax on lease payments.payments.

SALVAGE VALUESALVAGE VALUE : Lessee : Lessee does not become owner does not become owner of the asset. Therefore, of the asset. Therefore, he has no claim over the he has no claim over the asset’s salvage value.asset’s salvage value.

Mau or may not.Mau or may not.

Difference between HIRE Difference between HIRE PURCHASE and INSTALLMENT PURCHASE and INSTALLMENT

CREDIT CREDIT

Under hire purchase ownership is Under hire purchase ownership is transfer on the payment of last transfer on the payment of last installment, but in installment credit installment, but in installment credit ownership is transfer by paying 1ownership is transfer by paying 1stst installment.installment.

Advantages of lease to the Advantages of lease to the LesseeLessee

Avoidance of Initial Cash OutlayAvoidance of Initial Cash Outlay Minimum DelayMinimum Delay Easy source of financeEasy source of finance Shifting the risk of obsolescenceShifting the risk of obsolescence Enhanced LiquidityEnhanced Liquidity Tax planning and AdvantageTax planning and Advantage Higher return on capital Higher return on capital

employedemployed Convenience and FlexibilityConvenience and Flexibility

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DisadvantagesDisadvantages

Higher CostHigher Cost Risk of being deprived of the use of Risk of being deprived of the use of

assetasset Loss of ownership incentivesLoss of ownership incentives Penalty on termination of leasePenalty on termination of lease Loss of salvage value of the assetLoss of salvage value of the asset No alteration or change in assetNo alteration or change in asset

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Advantages of Leasing to the Advantages of Leasing to the LessorLessor

Higher profitsHigher profits Tax BenefitsTax Benefits Quick ReturnsQuick Returns Increased SalesIncreased Sales Benefits of residual valueBenefits of residual value

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Limitations of Leasing to the Limitations of Leasing to the LessorLessor

High risk of ObsolescenceHigh risk of Obsolescence Competitive Market Competitive Market Price-level ChangesPrice-level Changes Management of cash flowsManagement of cash flows Increased cost due to the loss of user Increased cost due to the loss of user

benefitbenefit Long-term investmentLong-term investment

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Why Lease is not popular in Why Lease is not popular in Asian countries, like India?Asian countries, like India?

Because of psychological reasons, Because of psychological reasons, people prefer to own assets rather people prefer to own assets rather than taking it on lease.than taking it on lease.