Presentation On

Lease and Hire Purchase

Introduction To LeaseLease financing denotes procurement of assets through lease. The subject of leasing falls in the category of finance. Leasing has grown as a big industry in the USA and UK and spread to other countries during the present century.

In India, the concept was pioneered in 1973 when the First Leasing Company was set up in Madras and the eighties have seen a rapid growth of this business. Lease as a concept involves a contract whereby the ownership, financing and risk taking of any equipment or asset are separated and shared by two or more parties.

The lessor may finance and lessee may accept the risk through the use of it while a third party may own it. Alternatively the lessor may finance and own it while the lessee enjoys the use of it and bears the risk.

MEANING 0F LEASE FINANCING

A lease transaction is a commercial arrangement whereby an equipment owner or Manufacturer conveys to the equipment user the right to use the equipment in return for a rental. In other words, lease is a contract between the owner of an asset (the lessor) and its user (the lessee) for the right to use the asset during a specified period in return for a mutually agreed periodic payment (the lease rentals).

Essentials of Lease Transactions1. Two Parties2. A contract to hire a specific asset3. The third party4. Specification of asset by lessee5. Payment by lessor6. Useful possession with lessee7. Payment of specified rent8. Contract to be valid for a specific period9. Ownership and user10. Mode of termination

Types of LeasesFinancial Lease

A lease is classified as a finance if it secures for the lessor,the recovery of his capital outlay plus a return on the fund invested during the lease term.

According to International Accounting Standard IAS 17

“ A finance lease is one where the lessor transfer to the lessee substantially all the risk and reward incidental to the ownership of the asset whether or nit the title is eventually transferred.”

Operating LeaseA lease is classified as an operating lease if it does not secure for the lessor the recovery of his capital outlay plus a return on the funds invested during the lease term.According to International Accounting Standard

IAS 17 “ A lease which is not a finance lease”

This lease agreement gives to the lessee only a limited right to use the asset. The lessor is responsible for the upkeep and maintenance of the asset. The lessee is not given any uplift to purchase the asset at the end of the lease period.

Types of Finance LeaseLeveraged Lease Full Pay Out

LeaseSale and Lease Back Manufacturing LeaseTripartite Lease Single Investor LeaseSyndicated Lease Master LeaseBig Ticket Lease Sales-aid LeaseInternational Lease Import LeaseExport Lease Domestic LeaseCross-border Lease Currency LeaseDry Lease Wet LeaseConsumer Lease Balloon LeaseClosed-ended Lease Open-ended LeaseSwap Lease Wrap Lease

Difference Between a Finance Lease and Operating LeaseSr No

Finance Lease Operating Lease

1 Ownership is transferred at the end of lease term.

No transfer of ownership.

2 Lease with purchase option No option of purchase

3 Lease term is about or equal to the life of the equipment.

Lease term may be of a shorter period

4 Lease payments cover almost all the costs of the equipments and interest on financing the purchase.

Not necessary

5 The Risk of obsolescence is assumed by the lessee

Leasing Company assumes risk of obsolescence.

6 Contracts are non cancellable

Usually cancellable

7 Air craft, Land & Building etc.

Computer, office equipments etc.

Advantages of leasing to Lessee

Full FinancingAdditional Source of FinanceCheaper Source of FinanceImproving Borrowing CapacityTax BenefitsSimplicityFlexibilityEliminates Risk of Obsolescence

Disadvantages of leasing to Lessee

Deprival of OwnershipRestriction on UseFinancial CommitmentLoss of Residual ValueUnderstatement of lessee’s AssetsDouble sales TaxLoss of Incentives

Advantages of leasing to Lessor

Tax ShieldsFull SecurityHigh ProfitabilityTrading on EquityGrowth Potential

Disadvantages of leasing to Lessor

Lack of ControlCompetitionTax burdenTax Sharing

Leasing ProcessLessor

Purchase Contract

Title to equipment

Payment of Purchase Price

Delivery of equipment

Lease contract

Right to use

Lease rental

Manufacturer/supplier Maintenance

Lessee

Payment for maintenance

Lease Evaluation

Funding OptionCost of Alternative FundingTax paying/Non-tax Paying CompaniesEffect of Add-onsCash flow and Discount Rates

Lease Rental CalculationCost of Asset Rs. 1000Primary Lease Period 5 YearsLessor’s pre-tax cost of capital 20.00%

p.aLessors pre-tax rate of return 2.11%

p.aYear

P.V Factor Lease Rental

Lease rental * PV factors

1 0.82 350.03 287

2 0.67 350.03 234.5

3 0.55 350.03 192.5

4 0.45 350.03 157.5

5 0.37 350.03 128.5

2.86 1750 1000

Lease Rental = 1000/2.86 = 350( Rounded off)

Introduction to Hire PurchaseHire Purchase is a mode of financing machinery,

vehicles and consumer durable. In a hire purchase transaction, goods are let on hire, the purchase price is to be paid in installment and hirer is allowed an option to purchase the goods by paying all the outstanding installment at any time during life of the hire purchase contract.

The hire purchase form of finance started in India in 1920, with establishment of Auto Supply company Ltd , which was subsequently known as commercial credit corporation

The Government of India constituted several committees such has Masani Committee,Saraiya Committee,James Raj Committee etc. There committee have recognized the significant role played by hire purchase companies in financing the road transport industry as they enjoyed certain advantages which may not be available to commercial bank or other Financial Institutions.

Through an amendment to the banking Regulation Act 1949, the government of India permitted commercial banks to undertake the hire purchase business in 1984.

Meaning of Hire PurchaseThe Hire purchase Act, 1972 defines a hire purchase agreement as “ An agreement under which goods are let on hire and under which the hirer has an option to purchase them in accordance with the term of the agreement.

• This also includes an agreement under which :( I ) The possession of goods is delivered by the

owner thereof, to a person on condition that the person pays the agreed amount in periodical installment.

( II ) The property in the goods is to pass to such person on payment of the last of such installment.

( III ) Such person has right to terminate agreement at any time before the property so passes.

Stipulation of Hire PurchasePayment is to be made in instalments over a

specified period.The possession is delivered to the purchase at the

time of entering into a contact.The property in the goods to the purchaser on

payment of the last instalmentEach instalment is treated as hire charge so that if

default is made in payment of any one installment, the seller is entitle to take away the goods.

The hirer/purchaser is free to return the goods without being required to pay any further installment falling due after the return.

Hire purchase process

Hire purchase company

Installment Right to use Payment Order

Equipment Manufacture

supplireHire Supplies

Hire Purchase Installment calculationValue Of Asset Rs 100000Tenure 60 MonthsMargin 20 percentFinancial Charges 15 percent

Find out Installment Amount.

Value of Asset Rs. 1,00,000Less: Margin (20%) Rs. 20,000Eligible amount of finance Rs. 80,000Add: Finance charges (15%) Rs. 60,000(80000 x 0.15 x 5)Hire purchase price Rs. 1,40,000Monthly instalment Rs. 1,40,000/60

= Rs 2,333Annual instalment Rs.

140000/5= Rs 28,000

Taxation AspectA ) Income Tax1.Assessment of hirer2.Assessment of owner hire purchase company3.Hire purchase and Tax planningB ) Sales Tax1.Hire Purchase as sale2.Delivery vs Transfer of property3.States entitled to imposed Tax4.Taxable Quantum5.Rate of TaxC) Interest Tax

Difference Between Lease and Hire PurchaseSr No Leasing Hire Purchase

1 Equipment etc., chosen from manufacturer but leased from bank subsidiary leasing company.

As opposite; or direct from manufacturer.

2 Lessee never becomes the owner. The user becomes the owner — usually on finally on final payment.

3 No deposit required. Often 20% (or so) deposit called for.

4 Lessee is not entitled to claim depreciation tax shield.

Hirer is entitled to claim depreciation tax shield.

5 Salvage value ,lessor does not become owner of the asset. Therefore, he has no claim over the asset’s salvage value.

Salvage value once the hirer has paid all instalments, he becomes the owner of the asset and can claim salvage value.

6 Lease can be ‘financial’ with a primary period and thereafter continued leasing at nominal rent.

Terms of H/P agreement can cover, items covered by ‘financial’ or ‘operational’ basis mentioned opposite.

7 The latter in (6) is advantageous for leased items which are subject to technological change.

As opposite, but only if agreement allows users change/update items.

Sr No Leasing Hire Purchase

8 Lessee can charge the entire lease payment for tax purpose.Thus he/she saves taxes on the lease payment.

Hire purchase payment include interest and repayment of principal.Hirer gets tax benefits only on the interest.

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