Assignment on Hire PurchasePaper No: FM - 3103

Submitted By:Ishan Dutta (26)

Azhar Alam (40)Somhita

Semester - IV

Department of Business Administration

Submitted To:Amit Kumar DasAssistant ProfessorDept. of Business AdministrationAssam University, Silchar

1

Contents:1. Introduction Hire Purchase ………………………………………………. 01

2. Evaluation of Hire Purchase …………………………………………….... 04

3. Leasing & Hire Purchase: A vanishing distinction …………………....... 04

4. Standard Provisions ………………………………………………….......... 07

5. Implied Warranties and Conditions to protect the Hirer ……………..... 07

6. The Hirer’s Rights ………………………………………………………… 08

7. The Hirer’s Obligations …………………………………………………… 08

8. The Owner’s Rights ………………………………………………….......... 09

9. Cost of Hire Purchase & its Net Present Value ………………………….. 09

10. Tax Implications of Hire Purchase …………………………………......... 10

11. National Small Industries Corporation (NSIC) & Hire Purchase ……... 11

2

Hire PurchaseHire purchase is a type of investment credit under which the hire-purchaser (hirer) agrees to take goods on hire at a stated rental with an option to purchase the goods. That is, hire purchase is a form of financial arrangement whereby the owner (hiree) provides an asset to the hirer on hire for a consideration of payment (hire charges) in installments for a specific period. The ownership of the asset is transferred to the hirer on payment of the last installment. However, the hirer gets possession of the asset as soon as the hire-purchase agreement is signed. The hirer has the right to terminate the agreement at any time before the transfer of the ownership of the asset. In other words, the hirer has the option to purchase the asset. If the hirer decides to terminate the agreement, the hirer has to either:

i. Return the asset and avoid payment of the installments due thereafter, the amounts already paid by the hirer being deemed to be the hire charges of the asset; or

ii. Pay the future installments either fully or at discount as mutually agreed and take ownership of the asset.

In case a finance company is the hiree, the finance company purchases the equipment from the manufacturer or supplier before it lets it out on hire to the hirer. It is the usual practice for the hirer to make a down payment of a certain percentage of the cost of the asset and pay the balance with interest in installments either in advance or in arrears.

Although the ownership of the asset is passed on to the hirer on payment of the last installment, the hirer is entitled to claim depreciation. When the hirer gets the ownership of the asset, he can also claim the salvage value of the asset. The hire purchase payments are bifurcated into interest payments and principal repayments. The hirer gets tax relief on the interest paid.

A hire purchase is different from an installment sale. In an Installment Sale, the legal ownership of the asset is transferred to the buyer as soon as the agreement is

3

made and after payment of the first installment. The balance amount (installments) is treated as secured loan. It may be noted that installment sale and hire purchase are similar in nature except for the timing of the transfer of ownership.

Essentially, both leasing and hire purchasing are asset-based financing and similar in many respects. The main distinction is in the nature of the assets being financed. Leasing has been used mostly for plants and machinery, while hire purchase has commonly been used for vehicles. In fact, hire purchase in India has thrived as almost the only form of external finance available for commercial vehicles. The hire purchase industry has become synonymous with truck financing. This is mainly because motor vehicle laws give the surest legal protection any law can give to the financier of motor vehicles. Thus, the financier of the vehicle would not have to carry any of the operational risks of a motor vehicle. Any transfer of the vehicle would not be possible without the financier’s assent. On the other hand, in the earlier days, the motivation for leasing was investment allowance available for industrial plants and machinery. But the factors for which leasing was used mostly for plant and machinery and hire purchase for vehicles have vanished over time. Investment allowances have since been abolished and there are no tax preference on a lease.

The RBI treats lease and hire purchase on a par and has stopped the distinctive classification of leasing and hire purchase companies. Accounting norms have the same effect on pre-tax income as also balance sheet values, be it a lease or a hire-purchase transaction. Further, motor vehicle laws now treat leases and hire purchases on a par from the viewpoint of financier-protection. However, leasing and hire purchase are subject to different treatment under tax laws, such as income tax and sales tax. The choice between leasing and hire purchase depends on tax consequences.

4

Evaluation of Hire Purchase

The British concept of hire-purchase has, however, been there in India for more than 6 decades. The first hire-purchase company is believed to be Commercial Credit Corporation, successor to Auto Supply Company. While this company was based in Madras, Motor and General Finance and Installment Supply Company were set up in North India. These companies were set up in the 1920s and 1930s.

Development of Hire-purchase took two forms: consumer durables and automobiles.

Consumer durables hire-purchase was promoted by the dealers in the respective equipment. Thus, Singer Sewing Machine Company, or Murphy radio dealers would provide installment facilities on hire-purchase basis to the customers of their products.

The other side developed very fast - hire-purchase of commercial vehicles. The dealers in commercial vehicles as well as pure financing companies sprang up. The value of the asset being good and repossession being easy, this branch of financing activity flourished fast, although until recently, most of automobile financing business was in hands of family-owned businesses.

Leasing and Hire-purchase: A vanishing distinction:

Essentially, asset-based financing in India particularly by non-banking financial companies is split in two documentation modes - lease and hire-purchase. These two are technically different instruments, but in essence, there is not much that differs between the two, except for the caption. 

In spite of the substantive similarity, historically, there has been a diametric separation between these two forms. The assets usually subject matter of hire-purchase has been different from those generally leased out. Leasing has been used mostly for plant and machinery, while hire-purchase has commonly been used for vehicles. Even the players have been different.

5

The reasons for this diametric distinction are more historical than logical. Hire-purchase, essentially a British form, entered India during the Colonial era, and thrived as almost the only form of external finance available for commercial vehicles. For the financiers, as witnessed World-over, commercial vehicles were the natural choice for several asset-features he loves: lasting value, ready secondary market, self-paying feature, etc. Hence, the industry of hire-purchase became synonymous with truck-financing. Besides, the motor vehicles laws gave the surest legal protection any law could give to a financier: the financier would not have to carry any of the operational risks of a motor vehicle, and yet, any transfer of the vehicle would not be possible without the financier's assent.

Leasing, essentially a US-innovation, entered the country significantly in the early 80s, and was propagated as an alternative to traditional modes of industrial finance. Besides, the early motivation (which continues with a number of players even now) of leasing was capital allowances, more significantly the investment allowance, which was not available for transport vehicles. Hence, the leasing form historically clung to industrial plant and machinery.

For several years, there was no lease of vehicles, because the Motor Vehicles law protection was not applicable to a lease, and there was no investment allowance on vehicles and for reciprocal reasons, there was no hire-purchase of industrial machinery.

These reasons have vanished over time.

The Motor Vehicles law now treats leases and hire-purchase at par from the viewpoint of financier-protection.

Investment allowance has been abolished, and hence, there are no predominant tax-preferences to a lease.

The RBI treats lease and hire-purchase at par and has stopped giving a distinctive classification to leasing and hire-purchase companies.

The accounting norms lead to the same effect on pre-tax income, as also balance sheet values, be it a lease or hire-purchase transactions.

Therefore, income-tax and sales-tax treatment apart, there is not much that is different between lease and hire-purchase. The choice between the two is by and large open, subject to tax consequences.

6

7

Standard Provisions:To be valid, Hire Purchase agreements must be in writing and signed by both parties. They must clearly set out the following information in a print that all can read without effort:

1. A clear description of the goods2. The cash price for the goods3. The HP price, i.e., the total sum that must be paid to hire and then purchase

the goods4. The deposit5. The monthly installments (most states require that the applicable interest rate

is disclosed and regulate the rates and charges that can be applied in HP transactions) and

6. A reasonably comprehensive statement of the parties' rights (sometimes including the right to cancel the agreement during a "cooling-off" period).

7. The right of the hirer to terminate the contract when he feels like doing so with a valid reason.

Implied Warranties and Conditions to Protect the Hirer:The extent to which buyers are protected varies from jurisdiction to jurisdiction, but the following are usually present:

1. The hirer will be allowed to enjoy quiet possession of the goods, i.e. no-one will interfere with the hirer's possession during the term of this contract

2. The owner will be able to pass title to, or ownership of, the goods when the contract requires it

3. That the goods are of merchantable quality and fit for their purpose, save that exclusion clauses may, to a greater or lesser extent, limit the Finance Company's liability

4. Where the goods are let by reference to a description or to a sample, what is actually supplied must correspond with the description and the sample.

8

The Hirer's Rights:The hirer usually has the following rights:

1. To buy the goods at any time by giving notice to the owner and paying the balance of the Hire Purchase price less a rebate (each jurisdiction has a different formula for calculating the amount of this rebate)

2. To return the goods to the owner — this is subject to the payment of a penalty to reflect the owner's loss of profit but subject to a maximum specified in each jurisdiction's law to strike a balance between the need for the buyer to minimize liability and the fact that the owner now has possession of an obsolescent asset of reduced value

3. With the consent of the owner, to assign both the benefit and the burden of the contract to a third person. The owner cannot unreasonably refuse consent where the nominated third party has good credit rating

4. Where the owner wrongfully repossesses the goods, either to recover the goods plus damages for loss of quiet possession or to damages representing the value of the goods lost.

The Hirer's Obligations:The hirer usually has the following obligations:

1. To pay the hire installments2. To take reasonable care of the goods (if the hirer damages the goods by

using them in a non-standard way, he or she must continue to pay the installments and, if appropriate, compensate the owner for any loss in asset value)

3. To inform the owner where the goods will be kept.4. A hirer can sell the products if, and only if, he has purchased the goods

finally or else not to any other third party.

9

The Owner's Rights:The owner usually has the right to terminate the agreement where the hirer defaults in paying the installments or breaches any of the other terms in the agreement. This entitles the owner:

1. To forfeit the deposit2. To retain the installments already paid and recover the balance due3. To repossess the goods (which may have to be by application to a Court

depending on the nature of the goods and the percentage of the total price paid)

4. To claim damages for any loss suffered.

The advantages and/or disadvantages of hire purchase can be summed up as relative to the length of time the hirer needs to have the repayment done. An advantage is that a hire purchase is a medium term funding facility that cannot be withdrawn if the business makes the payments on time. One disadvantage is that a hire purchase is not easily removed. The penalties for early removal may far outweigh the benefits of the purchase.

Cost of Hire Purchase and its Net Present Value:A hirer is required to make payments in equated periodical installments spread over a certain period. The interest component of each installment is determined with reference to a specified flat rate of interest. But the equivalent effective rate of interest will be different and can be calculated by different methods.

On the lines of defining the cost of lease, the cost of hire purchase (COHP) is defined as follows:

COHP = Immediate payment (down payment) + PV of hiring charges (installments) + PV of service charges – PV of depreciation tax shield – PV of net salvage value

10

From a hiree’s angle, the Net Present Value of a hire purchase (NPV(HP)) is as follows:

NPV(HP) = - Cost of the asset – initial costs + PV of hire purchase installments – PV of tax on interest component of the hire purchase installments + PV of tax shield on initial costs

As far as accounting is concerned, the cash purchase price of the asset is capitalized and the unpaid installments are recorded as a secured loan in the books of the hirer. In other words, the hirer shows all hire purchase assets as fixed assets in the balance sheet (without any note thereto) even when he is not the owner of such an asset till the hire purchase period is over.

In the books of the hiree, the hire purchase installments are shown as current assets under the head “stock on hire” and the unearned finance component of the hire purchase installments is shown as current liability under the head “unmatured finance charges”.

Tax Implications of Hire Purchase:According to Income Tax Act, the hirer is entitled to tax shields on depreciation calculated with reference to the cash purchase price of the asset and tax shield on the “consideration for hire”. From the hiree’s (owner’s) angle, the consideration for the hire received from the hirer is liable to tax.

Hire purchase transactions are subject to sales tax. For the purpose of levying sales tax, a sale is deemed to take place only when the hirer exercises the option to purchase. The amount of sales tax is determined with reference to the depreciated value of the goods at the time when the hirer exercises the purchase option. The state in which the goods have been delivered to the hirer is the state entitled to levy and collect sales tax. Since the inter-state movement of goods would have occurred before the hirer exercises the option to buy, no hire purchase transaction is likely to be subject to central sales tax.

11

National Small Industries Corporation (NSIC) & Hire Purchase:Small scale firms can acquire industrial machinery, office equipment, vehicles, etc., without making full payment through hire purchase. With the help of assets acquired through hire purchase they can produce and sell. From the earning payments can easily be made in installments. Ultimately the ownership of assets can be acquired. Now several agencies like National Small Industries Corporation (NSIC) provide machinery and equipment to small scale units on hire purchase basis and on lease basis. NSIC follows the following Hire Purchase procedure and Hire Purchase Scheme for financing plant and machinery to small scale units.