LEASING AND HIRE PURCHASE

Presented by : Abhishek Saran Maharath Mayukh Amit Kumar Jayaswal Anuj Jha Yogeshwar Tiwari Aditya Shukla MBA 4th semester (2012-13)

Definition of leasing
Process by which a firm, can obtain the use of certain fixed asset, for which it must make a series of contractual and periodic payments. Lessor Lessee

Essential elements Parties to the contract

Asset
Ownership separated from user Term of lease Lease rentals

Types of leasing Finance lease : it is for terms that approach economic life of asset. Total payments over term of lease > lessors initial cost of leased asset Operating lease : for a term, shorter than economic life of the asset. Total payments over term of lease < lessors initial cost of leased asset

 Sales & lease back

Equipment/ Asset Owner (Lessee)

Sells to Leases back to

Leasing company (Lessor)

Direct lease Two types: Bipartite lease Tripartite lease

 Single investor lease : only two parties Leveraged lease : lessor acts as an equity participant supplying a fraction of the total cost of the asset while the lender supplies the major part Domestic lease International lease Two types: Import lease Cross border lease

Tax Aspects of Leasing

Income tax Sales tax

Income tax consideration

For Lessor Taxability of Lease RentalsProfit and gains of business and profession. Income from other sources.

Deductability of Expenses
Depreciation Rent, rates, repairs & insurance Interest on borrowed capital

Income tax consideration(For Lessor)

Amortisation of certain preliminary expenses Bad debt All expenses incurred in furtherance of trade Entertainment expenses subjected to prescribed limit Travel expenses as per approved norms

Depreciation
Calculation methods Written down Value Straight line basis

Depreciation
Important conditions (in sec 32) Asset is owned by the assesee Asset is used by the assesee for the purpose of business Asset is in form of buildings, furniture, machinery & plant

Depreciation
Amount of annual depreciation of an asset is determined by The actual cost of the asset Its classification in the relevant block of assets

For Lessees
Major consideration for the Lessees are Allowability of Lease rentals Deductability of incidental expenses Tax planning -Flexibility restructuring of Lease rentals -Transfer of investment related unabsorbed tax shield

Sales Tax Aspects

Three important elements from the view point of sales tax The purchase of an asset by a lessor for purpose of leasing to a lessee, The transfer of right to use an asset to a specified period of time. The sale of asset at the expiry of lease.

Lease Rentals
Constitution act, 1982 tax on transfer of right to use any goods for any purpose (whether or not for a specified period of time) for cash deferred payment or other valuable consideration was included in tax on purchase/ sales of goods.

Features of sales tax

It is payable on annual taxable turnover of the lessor. In addition several states, surcharge, additional surcharge, additional sales tax on turnover exceeding a specified limit are also levied on the lease rental. Lessor with an annual taxable turnover beyond specified limits must seek registration as dealer.

Hire Purchase
Hire purchase is a peculiar kind of transaction in which the goods are let on hire with the option to hirer to purchase them .

In other words
a transaction where goods are purchased and sold with

the stipulation that payment will be made by

instalments, each instalments will be treated as a hire charge so that if default is made in the payment of even in the last instalment, the seller will be entitled to take away the goods without compensation the hire purchase

in any way and in case all instalments are paid, the goods
will be treated as sold and property will pass to the purchaser.

In simple words
Hire purchase system is a special system of purchase and sale. When goods are bought under the system. The purchaser pays the price in instalments which may be monthly, quarterly, six monthly, yearly or any other period. The buyer acquires the possession of the goods immediately on signing the hire purchase agreement but becomes its owner only on paying the last instalment.

 Hire Purchase is an agreement. The essence of the agreement is:

The property in the goods does not pass at the time of agreement but remains in the intending seller, and only passes later when the option is exercised by the intending purchaser.

Features
1) Purchase is on credit.

2) Purchase price is paid in instalments.

3) Goods are delivered to the buyer.

4) Buyer has a right to use these goods.

5) Ownership of goods remains with the seller till the payment to last instalments. 6) Hire purchaser becomes the owner of the goods on payment of the last instalment.

Features
7) It is the duty of the purchaser to keep the goods in good conditions till the payment of last instalment. 8) Hire purchaser has a right to terminate the agreement at any time. 9) If default is made in payment of any instalment, the seller becomes entitled to take away the goods. 10)The hirer is free to return the goods without being required to pay any further installments falling due after the return.

Installment sale
Installment sale: is a contract of sale in which the ownership is transferred to the buyer but the price is paid in specified installments over a definite period.

Hire-Purchase Vs Installment Payment

1) Call option: to purchase the goods at any time and the right of the hirer to terminate the agreement ./ buyer is committed to pay the full price. 2) Ownership

Hire purchase v/s leasing

1) 2) 3) 4) 5) 6) Ownership: Depreciation: Magnitude: Extent: Maintenance: Tax Benefits:

Legal Framework
There is no exclusive legislation dealing with hire purchase transaction in India. The Hire purchase Act was passed in 1972. An Amendment bill was introduced in 1989 to amend some of the provisions of the act. However, the act has been enforced so far.

 The Dealer, contracts with finance co. for financing his hire purchase deals. The customer selects the goods for HP, and dealer arranges for the complete set of documents. Down payment by customer on completion of proposal form. Dealer sends documents to finance co. with request to purchase the goods, and accept the HP transaction. The finance co. signs the agreement and sends copy along with EMI details to dealer. Dealer delivers the goods to the customer, property passes on to the finance co.. Hirer pays EMIs, and on last payment , the ownership passes on to him, with loan completion certificate by the finance co.

Process

Business asset are suitable for financing using hire purchase

- Plant and machinery - Business cars - Commercial vehicles - Agricultural equipment.. - Hotel equipment - Medical and dental equipment - Computers, including software packages -Office equipment

Taxation Aspect Of Hire-purchase

The taxation of hire-purchase transactions can be divided into three parts : Income tax Sales tax Interest tax

Income tax
Hire-purchase as a financing alternative, offers tax benefit to both to the hire-vendor and the hire-purchase. Assessment of hire-purchase: The hire purchaser is not the owner of the asset but he is entitled to claim depreciation as a deduction on the entire purchase price. He can also claim for the finance charge (finance charge is the difference between the hire purchase price and cash price). Assessment of hire-vendor: The consideration of hire income received by the hire-vendor is liable to tax under the head of profit and gain of business where hire purchase constitutes the business(main stream activity) of the assesee, other wise as income from other source.

Sales tax
Sales tax is payable when the ownership of goods convert from seller to the buyer. The sales tax is payable once the goods are delivered by the owner(hire-vendor) to the hirer(hire-purchaser) when the transaction are converted into sales. The sales tax is consider the total amount of the goods which is agreed to be paid before the transfer of the goods take place in a hire purchase contract.

Interest tax
The hire-purchase finance companies, like other credit finance companies, have to pay interest-tax under the interest tax act, 1974. Interest tax is payable on the total amount of interest earned less bad debts in the previous year. The tax is treated as a tax deductible expense for the purpose of computing the taxable income under the income tax Act.

Financial evaluation of hirepurchase

From the point of view of the hire purchaser

Cost of hire-purchase(CHP): Down payment + service charge + present value of hire purchase discounted by cost of debt(Kd) - present value of depreciation tax shield discounted by cost of capital(Kc) - present value of net salvage value discounted by cost of capital (Kc)

From the point of view of the hire-vendor

Net present value of hire purchase plan (NPV(HPP)): Present value of hire-purchase instalment + document and service fee + present value of tax shield on initial direct tax - loan amount - initial cost - present value of interest tax on finance income (interest) - present value of income tax on finance income (interest) meted for interest tax - present value of income tax on documentation and service fee

References
M Y khan www.finacialservices.gov.in

Thank you