Leasing

1. What is the difference between a lessee and a lessor?

Lessee is the user of the property and lessor is the owner of the property. A lease is usually a
non-cancelable agreement in which the lessor conveys the right to use property, plant or
equipment, usually for a stated period of time, to the lessee.

2. What is the difference between an operating lease and a capital/finance lease?

Operating Lease include both financing and maintenance services. They are for a time shorter
than the economic life of the asset. Computers and office copying machines, together with
automobiles and trucks, are the primary types of equipment covered by operating leases.

Operating lease ordinarily calls for the lessor to maintain and service the leased equipment. The
payments required under the lease contract are not sufficient to recover the full cost of the
equipment. Contains a cancelation clause giving the lessee the right to cancel the lease and
return the equipment.

A financial lease is one that does not provide for maintenance services, is not cancellable, and is
fully amortized. It is for term that approaches the economic life of the asset.

3. What is a sale-and-leaseback transaction?

Under a sale and leaseback arrangement, a firm sells an asset to another party, and this party
leases it back to the firm. Usually, the asset is sold at approximately its market value. The
company receives the sales price in cash and the economic use of the asset during the basic
lease period. In turn, it contracts to make periodic lease payments and gives up title to the asset.

Lessors engaged in a sale and leaseback arrangement include insurance companies, other
institutional investors, finance companies, and independent leasing companies.

4. What are the requirements for a lease to be tax deductible?

The full amount of the annual lease payments is deductible for income tax purposes- provided
the Internal Revenue Department (IRD) agrees that a particular contract is a genuine lease and
not simply an instalment loan called a lease.

Following are the major requirements for bona fide lease:

a) The term must be less than 30 years; otherwise the lease is regarded as a form of
sale.
b) The rent must represent a reasonable return to the lessor.
c) The renewal option must be bona fide.
d) There must be no repurchase option

5. How do you determine the net advantage to leasing?

The advantages of leasing are:

a) Leasing is used as a means of off balance-sheet financing. It can avoid negatively

affecting the debt-asset ratio and other mechanical indicators of riskiness. Market is
naive, and is “fooled” by off-balance-sheet financing.
b) Leasing achieves operational objectives by facilitating asset acquisition to overcome
uncertainty or cash flow problems and fear of obsolescence.
c) Leasing achieves tax objectives by lowering lease payments for lessee if it allows the
lessor to retain ownership and thus benefit from ITC and Depreciation deductions when:
 The lessee has little or no taxable income and will get little benefit from
depreciation deductions.
 The lessee has sufficient taxable income to take advantage of the depreciation
deductions, but is in lower tax brackets than lessor.