LEASE

LEASE IS A FORM OF CONTRACT

TRANSFERRING THE USE OR OCCUPANCY
OF LAND, SPACE, STRUCTURE OR
EQUIPMENT, IN CONSIDERATION OF A
PAYMENT, USUALLY IN THE FORM OF A
RENT.

DICTIONARY OF BUSINESS AND MANAGEMENT

PARTIES IN A LEASE CONTRACT
 LESSOR: CAN BE A COMPANY, A
COOPERATIVE SOCIETY, A PARTNERSHIP
FIRM OR AN INDIVIDUAL IN
MNUFACTURING OR ALLIED SECTOR

 LESSEE: CAN BE EVEN A DOCTOR OR ANY

OTHER SPECIALISTS WHO USE COSTLY
EQUIPMENT FOR THE PRACTISE OF HIS
PROFESSION.
LEASING AS SOURCE OF FINANCE

 MODERNISATION OF BUSINESS
 BALANCING EQUIPMENT
 DURABLE GOODS
 ITEMS ENTITLED TO 100% OR 50%
DEPRECIATION
 ASSETS WHICH ARE NOT BEING
FINANCED BY BANKS/INSTITUTIONS
 STEPS INVOLVED IN LEASING
TRANSACTION
 LESSEE HAS TO DECIDE THE ASSET
REQUIREMENT, SPECIFICATION, THE
PRICE, WARRANTY ETC,.
 LEASE AGREEMENT CONTAINS THE
TERMS AND CONDITIONS OF THE LEASE
SUCH AS PERIOD, AMOUNT,
RENEWAL,TAX, INSURANCE ETC,.
 AGREEMENT SHOULD SIGNED BY BOTH
THE PARTIES AND TRANSFER OF ASSET
WILL TAKES PLACE.
 TYPES OF LEASING
 FINANCIAL LEASE
1) LEVERAGE LEASE
2) SALE AND LEASE BACK
3) CROSS BORDER LEASE
4) FOREIGN TO FOREIGN LEASE
 OPERATIONAL LEASE
 FINANCE LEASE
IT IS ALSO KNOWN AS CAPITAL
LEASE, LONG-TERM LEASE, NET
LEASE AND CLOSE LEASE.
THE LESSEE USES THE
EQUIPMENT EXCLUSIVELY,
MAINTAINS IT, INSURES AND AVAILS
OF THE AFTER SALES SERVICES AND
WARRANTY BACKING IT.
 OPERATING LEASE
IT IS ALSO KNOWN AS SERVICE LEASE,
SHORT TERM LEASE OR TRUE LEASE.
ALL THE RISKS AND REWARDS
INCIDENTAL TO OWNERSHIP ARE NOT
TRANSFERRED TO THE LESSEE BUT
INVOLVES ONLY SHORT TERM HIRE OF
THE EQUIPMENT WITH THE OWNERSHIP
RESTING WITH THE LESSOR.
DIFFERENCE BETWEEN FINANCE
LEASE AND OPERATING LEASE
 OWNERSHIP IS  NO TRANSFER OF
TRANSFERRED AT THE
END OF THE LEASE OWNERSHIP
TERM
 LEASE WITH
PURCHASE OPTION  NO OPTION OF
 LEASE TERM IS ABOUT PURCHASE
OR EQUAL TO THE LIFE  LEASE TERM MAY
OF THE EQUIPMENT
 LEASE PAYMENT BE OF A SHORT
COVER ALMOST ALL PERIOD
THE COSTS OF THE
 NOT NECESSARY
ASSET
 LEVERAGE LEASE
LESSOR PROVIDES THE EQUITY
CAPITAL, WHILE THE BANKS OR THE
FINNCIAL INSTITUTIONS PROVIDE
THE LOAN FUNDS FOR THE
PURCHASE OF THE LEASED ASSET
 SALE AND LEASE BACK

THE COMPANY OWNING AN ASSET

SELLS IT TO A LEASING COMPANY
AND GETS IT BACK ON LEASE FROM
THE LEASING COMPANY.
 CROSS BORDER LEASE
THE LESSOR SUPPLYING THE
EQUIPMENT BEING PLACED IN ONE
COUNTRY AND THE LESSEE HAILING
FROM ANOTHER COUNTRY
 FOREIGN TO FOREIGN
THERE ARE THREE PARTIES, THE
MANUFACTURER OR SUPPLIER IN
ONE COUNTRY, LESSOR IN ANOTHER
COUNTRY AND THE LESSEE WHO IS
THE BENEFICIAL USER IN A THIRD
COUNTRY
 ADVANTAGES OF LEASE
 PERMIT ALTERNATIVE USE OF FUNDS
 FASTER AND CHEAPER CREDIT
 FLEXIBILITY
 FACILITIES ADITIONAL BORROWING
 PROTECTION AGAINST OBSOLESCENCE
 100% FINANCING
 BOON TO SMALL FIRM
DISADVANTAGES OF LEASE
 NOT SUITABLE TO NEW PROJECTS
 FLOATING RATES OF ASSETS
 NO TAX BENEFITS/SUBSIDIES
 LEASE RENTALS ARE GENERALLY HIGH
 TERMINATION OF CONTRACT IS NOT
POSSIBLE
 IRREGULAR PAYMENT OF RENTALS
 LESSEE IS NOT RESPONSIBLE FOR ASSETS
 NO EXCLUSIVE LAW IS EXISTING FOR
LEASE
 EVOLUTION OF LEASING
INDUSTRY IN INDIA
The concept of financial leasing was
pioneered in India during 1973.
Chidambaram group-----1973
Twentieth century leasing company
limited----1979
ICIC-----1983
SBI capital market-----1986
Can bank financial services Ltd
BOB financial services Ltd etc.
Cont…..
Hardly 1% of the industrial
investment in India is covered by the
lease finance.
40% industrial investment in USA,
30% in UK, 10% in Japan.

As per the report of Equipment

Leasing Association of India, leasing
covers both the public and private
sectors.
 PRODUCT PROFILE
 The structured lease falls under the category
of the financial lease
 The lease rates are determined by various
factors
 Most of the agreements are direct lease
 Non-productive assets are not eligible for
assistance by financial institutions
 LEGAL ASPECTS OF
LEASING
 Initially there is no specific law for leasing
 Every company maintains its own
procedure of accounting for leasing
 Treatment for lease contract is done similar
to the bailment
 TAX MANAGEMENT
 Some norms were evolved in 1989 by the
institute of chartered accountants of India
for guidance to all dealing with leasing
companies
 Lessee can claim lease rentals as tax-
deductible expenses
 Lease rentals received by the lessor are
taxable
 ACCOUNTING TREATMENT
 The institute of chartered accountants of India
have come out with guidelines for accounting
practices
 The leased asset is shown in the balance sheet of
lessor
 Depreciation and other tax shields associated with
the leased asset are claimed by the lessor
 The entire lease rentals are treated as income in
the books of the lessor and as expense in the books
of the lessee
STRUCTURE OF LEASING
INDUSTRY
Private sector leasing
Public sector leasing

Private sector leasing consists of:

Pure leasing companies
Hire purchase and Finance companies
Subsidiaries of manufacturing group
companies
 Pure leasing companies
The companies operate independently
without any association with any other
organization.

Ex:Twentieth Century Finance Corporation

Limited
Grover Leasing Limited
 Hire Purchase and Finance
Companies
Some of them do leasing as major activity
and some others do leasing on a small
scale as a tax planning device.

Ex: Sundaram Finance Limited

Motor and General Finance Limited
 Subsidiaries of Manufacturing
Group Companies
These companies consists of two
categories:
Vendor leasing
Companies are formed to boost and
promote the sale of its parent companies
product through offering leasing facilities.
In house leasing
Set up to meet the fund requirements or to
avoid the income tax liabilities of the
group companies
Public sector leasing
 Financial institutions
 Subsidiaries of Banks
 Other public sector organizations
 Financial Institutions
The shipping credit and investment company
of India offers leasing facilities in foreign
currencies for ships, deep seas fishing
vehicles and related equipments to its
clients.
IFCI, ICICI also involved in leasing business.
 Subsidiaries of Banks
The commercial banks in India can, under
section 19(1) of the banking Regulation
Act, 1949, setup subsidiaries for under
taking leasing activities.
SBI was the first bank to start a subsidiary for
leasing business in 1986.
Other Public Sector Organizations
A few public sector manufacturing companies
started to sell their equipment through
leasing.

Ex: BEL, HPCL, ECIL.

REGULATORY FRAMEWORK

CONTRACT OTHER ACTS DOCUMENTS &

AGREEMENTS
ACT
CONTRACT ACT
THERE ARE CERTAIN PROVISIONS
OF LAW OF CONTRACT WHICH ARE
SPECIFICALLY APPLICABLE TO
LEASING TRANSACTIONS.
TYPES OF PROVISIONS OF THE
LAW OF CONTRACT ARE GENERAL
AND SPECIAL PROVISIONS
GENERAL PROVISION
 CONTRACT
 LEGAL OBLIGATION
 LAWFUL CONSIDERATION
 COMPETENT PARTIES
 FREE CONSENT
 NOT EXPRESSLY VOID
 DISCHARGE OF CONTRACTS
 REMEDIES FOR BREACH OF CONTRACT
 INDEMNITY AND GUARANTEE
SPECIAL PROVISION
THE PROVISION OF LAW OF
CONTRACT RELATING TO BAILMENT
ARE SPECIFICALLY APPLICABLE TO
LEASING
CONTRACTS/TRANSACTIONS.

LEASING AGREEMENT IS
PRIMARILY A BAILMENT
AGREEMENT
LIABILITIES OF LESSEE
 REASONABLE CARE
 NOT TO MAKE UNAUTHORISED USE
 TO RETURN THE GOODS
 NOT TO SETUP AN ADVERSE TITLE
 TO INSURE AND REPAIR THE GOODS
LIABILITIES OF LESSOR
 DELIVERY OF GOODS
 PEACEFUL POSSESSION
 FITNESS OF GOODS
 TO DISCLOSE ALL DEFECTS
OTHER ACTS
 RBI NBFCS DIRECTIONS

 MOTOR VEHICLES ACT

 INDIAN STAMP ACT

 RBI DIRECTIONS

TO COORDINATE, REGULATE AND CONTROL

THE FUNCTIONING OF ALL NBFCS, THE RBI
ISSUES DIRECTIONS FROM TIME TO TIME
UNDER THE RBI ACT

THEY APPLY TO LEASING AS WELL

 MOTOR VEHICLE ACT
THE LESSOR IS REGARDED AS A
DEALER AND ALTHOUGH THE LEGAL
OWNERSHIP VESTS IN THE LESSOR, THE
LESSEE IS REGARDED AS THE OWNER FOR
THE PURPOSE OF REGISTRATION OF THE
VEHICLE UNDER THE ACT AND SO ON.
IN CASE OF VEHICLE FINANCED
UNDER LEASE, THE LESSOR IS TREATED
AS A FINANCIER
 INDIAN STAMP ACT
THE ACT REQUIRES PAYMENT OF
STAMPS DUTY ON ALL
INSTRUMENTS/DOCUMENTS CREATING A
RIGHT/LIABILITY IN MONETORY TERMS

THE CONTRACTS FOR EQUIPMENT

LEASING ARE SUBJECT TO STAMP DUTY
WHICH VARIES FROM STATE TO STATE
LEASE DOCUMENT
A LEASING TRANSACTION REQUIRES A
NUMBER OF COMMERCIAL DOCUMENTS
SUCH AS PURCHASE ORDER, BILLOF SALE,
DELIVERY NOTE, INSURANCE POLICIES,
IMPORT LICENSE ETC,.

THESE DOCUMENTS ARE CALLED

“ATTENDANT” LEASE DOCUMENTS AS
THEY HELP IN TAKING THE DECISION ON
A LEASING PROPOSAL
LEASE AGREEMENTS
 MASTER LEASE AND SUPPLEMENT LEASE
AGREEMENT
 TRIPARTITE LEASE AGREEMENT
 GUARANTEE AGREEMENT
 PROMISSORY NOTE
 RECEIPT OF GOODS
 POWER OF ATTORNEY
 COLLETERAL SECURITY/HYPOTHECATION
AGREEMENT
 FINANCIAL EVALUATION
The process of financial appraisal in a
lease transaction generally involves three
steps
 Appraisal of the client in terms of financial
strength and credit worthiness
 Evaluation of the security/collateral security
offered
 Financial evaluation of the proposal
 LESSEE’S PERSPECTIVE
A lease can be evaluated either is an
investment decision or as a financing
alternative. Lease rental payments are
similar to payments of interest of debt.
The decision criterion used is that Net
present value of leasing(NPV(L))/Net
advantage of leasing .
NPV(L)/NAL=
INVESTMENT COST
(-)PV OF LEASE PAYMENT
(+)PV OF TAX SHEILD ON LEASE PAYMENT
(-)MANAGEMENT FEE
(+)PV OF TAX SHIELD ON MANAGEMENT FEE
(-)PV OF DEPRECIATION SHEILD
(-)PV OF INTEREST SHEILD
(-)PV OF RESIDUAL/SALVAGE VALUE
 If the NPV(L)/NAL is positive, the
leasing alternative should be used,
otherwise the borrowings alternative would
be preferable
The decision criterion is to select the
alternative with the lower present value of
cash outflows
BREAK EVEN LEASE RENTALS

The rental at which the lessee is

indifferent between lease financing and
borrowing and buying. If NAL is zero, it
reflects the maximum level of rental which
the lessee would be willing to pay.
 LESSOR’S VIEW POINT
The lease related cash flow from the
lessor’s view consists of
 Outflows in terms of the initial investment
or acquisition cost of the asset at the
inception of the lease, income-tax on lease
transactions, lease administration expenses
 Inflows such as lease rentals, management
fee, tax shield on depreciation, residual
value and security deposit.
BREAK EVEN LEASE RENTALS

BLER represents the minimum lease

rental which he can accept. If NAL is zero,
the discount rate to compute the NAL is the
marginal overall cost of funds to the lessor.
GROSS YEILD BASED PRICING
The yield on an investment before the
deduction of taxes and expenses.
Gross yield is expressed in percentage
terms. It is calculated as the annual
return on an investment prior to taxes
and expenses divided by the current
price of the investment.
 IRR BASED PRICING
Some companies evaluate lease using
criterion of NAL.
It is the rate of interest at which the
NAL is zero.
Lease accepted only of IRR is greater
than marginal cost of capital
NEGOTIATION OF LEASE
RENTLS
The break even rentals of the lessor and
the lessee represents the range of acceptable
level of rentals.
The actual rental has to be negotiated
with in the range.
A rental within the range implies a
positive NAL for both the parties.
 ASSESSMENT OF LEASE
RELATED RISK
 Default/credit risk
 Residual value risk
 Interest rate risk
 Purchasing risk
 Political risk
 Currency and cross boarder risk
LEASE VS BUY DECISIONS
For a company to decide whether to buy any
equipment or take on lease two alternative
computations are needed:

 Net cost of buying, which is equal to the cost of

asset less the present value of tax saving on
depreciation, etc., associated with the purchase of
the asset. Tax deducted under each head of lease
and buy decision have to be compared. The net
cost of buying is compared with the post tax
present value of the lease rental outflows.
Cont…..
Post tax present value of the cash outflow
under the buy option. All the after-tax cash
flows are discounted to the present value,
over the life of the asset, say five years.
If NPV of buying=X and
NPV of leasing=Y and
if Y is lower, leasing is the option to chosen.
if X is lower, buying is the option to chosen.
 HIRE PURCHASE
Hire purchase is the legal term for a
contract, in this persons usually agree to
pay for goods in parts or a percentage at a
time.
It is also called closed-end leasing.
In cases where a buyer cannot afford to pay
the asked price for an item of property as a
lump sum but can afford to pay a
percentage as a deposit, a hire-purchase
contract allows the buyer to hire the goods
for a monthly rent.
When a sum equal to the original full price
plus interest has been paid in equal
instalments, the buyer may then exercise an
option to buy the goods at a predetermined
price.
FEATURES OF HIRE PURCHASE
AGREEMENT

 POSSESSION OF GOODS
 HIRE CHARGES
 OWNERSHIP
 RIGHTS OF REPOSSESSION
 RIGHTS TO TERMINATE
 LEGAL POSITION
THE HIRE PURCHASE ACT, 1972
DEFINES A HIRE PURCHASE
AGREEMENT AS, AN AGREEMENT
UNDER WHICH GOODS ARE LET ON
HIRE AND UNDER WHICH THE HIRER
AS AN OPTION TO PURCHASE THEM
IN ACCORDNCE WITH THE TERMS OF
AGREEMENT
HIRE PURCHASE AGREEMENT
THERE IS NO PRESCRIBED FORM FOR A
HIRE PURCHASE AGREEMENT, BUT IT HAS
TO BE IN WRITING AND SIGNED BY BOTH
PARTIES TO THE AGREEMENT
AGREEMENT MUST CONTAIN
 DESCRIPTION OF GOODS
 PRICE OF THE GOODS
 DATE OF COMMENCEMENT
 AMOUNT, DUE DATE, NO. OF
INSTALLMENTS
HIRE PURCHASE AND LEASING
 OWNERSHIP
 METHOD OF FINANCING
 DEPRECIATION
 TAX BENEFITS
 SALVAGE VALUE
 DEPOSIT
 RENT-PURCHASE
 EXTENT OF FINANCE
 MAINTENANCE
 REPORTING
 TAXATION ASPECTS
The taxation aspects 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 benefits both to the hire-
vendor(hire-purchase finance company) and
the hire-purchaser(user of the asset).
 Assessment of hire-purchaser
 Assessment of owner
 SALES TAX
The salient features of sales tax pertaining
to hire-purchase transactions after the
constitution act, 1982 are:
 Hire-purchase as sale
 Delivery vs. transfer of property
 INTEREST TAX
 Hire-purchase finance company has 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 @ 2%.
 The tax is treated as a tax-deductible
expense.
FINANCIAL EVALUATION

The framework of financial evaluation of a

hire-purchase deal covers both the hirer’s as
well as the finance company’s viewpoint.
 VIEWPOINT OF HIRER
Down payment
(+)Service charge
(+)Pv of hp payments discounted by cost of
debt
(-)Pv of dep.Tax shield discounted by cost of
capital
(-)Pv of net salvage value discounted by cost
of capital.
 VIEWPOINT OF FINANCE
COMPANY
Pv of hire purchase installments
(+) Documentation and service fee
(+)Pv of tax shield on initial direct cost
(-)Loan amount
(-)Initial cost
(-)Pv of interest tax on finance income
(-)Pv of income tax on finance income
(-)Pv of income tax on document and service fee.