Types of Leasing

Introductiony Meaning of Lease: y Leasing is a process y by which a firm can obtain the use of a certain fixed asset y for which it must make series of contractual periodic

tax-deductable payments(Lease rentals). Definition: y Leasing is a contractual arrangement , where y The owner (Lessor) of the Asset(Equipment) y Transfers the possession / right to use the Asset(Equipment) to another(Lessee) y For an agreed period of time in return for rental.

Definition of Leasingy Leasing is a contractual arrangement , where y The owner (Lessor) of the Asset(Equipment) y Transfers the possession / right to use the Asset (Equipment)

to another/user Lessee) y For an agreed period of time in return for rental. y At the end of the period y the asset reverts to the Lessor, or y provision for the renewal of the Lease Contract, or y option to transfer the ownership to the Lessee.

Essential Elements of LeasingParties to a Lease Contract: Essentially two parties y Lessor is the owner of the asset that is being Leased. y Lessee is the receiver of the services of the asset under a Lease contract. y Lessor and Lessee can be Individual or legally recognised party. y Lease broker big ticket Leases use him. y Major Players in Lease Market: y Banks- Indian & Foreign /FIs y subsidiaries of Banks/FIs, y NBFCs

Essential Elements of Leasingy Asset Subject matter of Leasing contract; Automobiles, Plant &

y y y y

Machinery, Equipments, Land & building, Factory, a running business, aircraft, Ships, etc. Ownership remains with the Lessor Use - of the asset is allowed to the Lessee. Lease Term Primary /secondary Lease Term. Lease Rentals is the consideration for the lease transaction. So structured to recover the investment cost, during agreed period.

Classification of Leasey Finance Lease and Operating Lease y Sale & Lease back and Direct Lease y Single Investor Lease and Leveraged Lease y Domestic Lease and International Lease

Finance LeaseDefinition according to IAS-17: y The Lessor transfers to the Lessee, substantially all the risks and rewards incidental to ownership of the asset, whether or not the title is eventually transferred. y Substantial Risk and Rewards: i. Ownership transferred to the Lessee by the end of the Lease term, or ii. The Lessee has an option to purchase the asset at a price which is expected to be sufficiently lower than the fair market value, at the date the option becomes exercisable that, at the inception of the Lease, it is reasonably certain that the option will be exercised, or

Finance Leasey Substantial risk & rewards (continued) y iii. The Lease term is for a major part of the useful life of the asset. y Useful Life means, minimum of, (a) Physical Life,(b)

technological Life (Obsolete), and (iii) product market Life. y The criteria/cut-off point is that if the Lease Term exceeds 75% of the useful Life of the equipment, it is a Finance Life.

Financial LeaseIV. The Present Value(PV) of the minimum Lease Payment(rentals) is greater than, or substantially equal to, the fair market value of the asset at the inception of the Lease(cost of equipment).y The cut-off point is that the PV exceeds 90% of the Fair market value of

the asset. y PV should be computed by using a discount rate equal to the rate of implicit in the lease in the case of Lessor and the incremental borrowing rate by the Lessee.

y In Indian condition, only conditions iii and iv are applicable, as

conditions I and ii amounts to Hire purchase. y Financial Lease is also known as Full Payout Lease and Hell or High water clause (Lease).

Features of Financial ServiceA Financial Lease is structured to include: y The Lessee selects the equipment meeting his requirement y The Lessee negotiates the price, delivery schedule, installation, warranties, maintenance, etc. y The Lessee informs the above details and Lessor makes the payment directly to the Seller(manufacturer /distributor). y The equipment is directly delivered to the Lessee by seller. y The Lessee enjoys exclusive and peaceful possession and use of the equipment. y Enters in to the Lease agreement with Lessor. y The Lessor pays the amount directly to Seller(Manufacturer/supplier).

Features of Financial Leasey The Lessee may be provided a right or option , to purchase

the equipment at a future date.(This practice is rarely found in India). y Lease Period Primary and secondary. y Primary lease Period y covers significantly the economic life of the equipment, y The Lease is non-cancellable during primary period ( if cancelled it attracts very heavy penalty). y Lessor recovers his investment along with some profit. y Secondary period y lease period will be shorter (covering residual period, if any), y Rental will be substantially lower, compared to market rate.

Operating Leasey IAS 19 defines Lease as an Operating Lease if it does not

transfer substantially all the risks and rewards incidental to ownership (to the Lessee). y Risks y idle capacity of the equipment, y Technological obsolescence y Variations in revenue to changes in economy. y Reward y Profitable operation y Appreciation in residual value of the asset.

Operating Leasey Characteristics of an Operating Lease: y The Lease term is significantly less than the economic

life of the equipment. y The Lessee enjoys the right to terminate the Lease at short notice without any significant penalty. y The Lessor usually provides the operating know-how, suppliers related service, and y undertakes the responsibility of insuring and maintaining (repair and technical service) the equipment (Called as Wet Lease or Service Lease), or y Lessee bears the costs of insuring and maintaining the equipment(called as Dry Lease)

Examples of Operating Leasey Chartering of Aircrafts and Ships, along with crew, fuel and

support services (Wet Lease). y Hiring of Computers (Dry Lease) and with Operators and maintenance(Wet Lease). y Hiring Bus/ Taxis with Drivers, for a specific travel or for a fixed term. Lessor is expected to have full knowledge of maintenance and upkeep and resale market.

Sale and Lease back and Direct LeaseSale and Lease back: y The owner(Lessee) of the equipment sells it to a Leasing company (Lessor). y The Lessor, leases the equipment back to the Lessee. Direct Lease: y Bipartite Lease Equipment supplier-cum-Lessor and Lessee. y Tripartite Lease (Sales-aid-Lease) Equipment supplier, Lessor and Lessee. y Equipment supplier takes the lead, y Negotiates the terms and enters into Lease agreement with Lessor and discounting lease renals. y Leasing company owns the equipment and obtains an assignment of lease rental. y Sales-aid-Lease is with recourse to the supplier, to buy-back the equipment/guarantee, in case of default by the Lessee.

Single Investor Lease and Leveraged LeaseSingle Investor Lease: Only two parties Lessor and Lessee. Leasing company (Lessor) funds the entire investment, having appropriate mix of Equity-cum-Debt. Finance raised by the Lessor, is without recourse to the Lessee.

Leveraged LeaseLeveraged Lease:y 3 parties to the transaction. y Lessor ( Equity investor) y Lender y Lessee.

y The Leasing company (Equity investor), y buys the equipment, through substantial borrowing, and y with full recourse to the Lessee and without recourse to it. y The Lender obtains an assignment of the Lease and a first

mortgage of the quipment. y A Trustee will act as an intermediary on reciept of rentals,remits debt part to Lender and balance to Lessor.

Other types of Leasey International Lease y Import Lease y Cross-border Lease y Major Players in Leasing industry in India: y Independent Leasing companies- enjoy financial & technological y y y y

collaboration. NBFCs. Manufacturer-Lessors. Banks and Financial Institutions. In-house Lessors.

Advantages of Leasingy Flexibility- Lease rental fixed suiting the cash flow of the y

y y y y y y

Lessee ( Equated, Stepped up, Ballooned and Deferred). User oriented variants: upgrade Lease (to beat risk of obsolescence or cross border lease risks, service related lease, etc.). Tax benefits: Lessor shares the tax benefits with Lessee lower lease rentals. Less paper work and expeditious disbursement Convenience 100% financing Better utlisation of locked funds ( say, release of office equipments). Off-Balance Sheet financing.

Advantages of Leasing to Lesseey Easy and 100% Financing of Capital goods. y An additional source of Finance y Less costly y Ownership preserved y Avoids cumbersome Institutional finance. y Flexibility in structuring of rentals. y Simplicity of documentation and terms. y Tax benefits. y Obsolescence Risks averted

Advantages of Leasing to Lessory Full security as ownership retained y Tax benefit y High profitability y Trading on Equity High Debt:Equity Ratio. y High growth potential

Limitations of Leasingy Restrictions on use of Equipment no additions/alterations. y Limitations of Financial use payout obligations, benefits of y y y y

warranties. Residual value benefit Consequences of default of terms by Lessee. Understatement of Lessees Asset in B/S. Double Sales-Tax, both by Lessor (purchase) and Lessee (at the time of Lease).