Madule 4

MODULE 4Lease and Hire purchase

Meaning of Lease

•James C. Van Horne-“Lease is a contract whereby the owner of an asset (lessor) grants to another party (lessee) the exclusive right to use the asset usually for an agreed period of time in return for the payment of rent.”

•Leasing is a process by which a firm can obtain the use of a certain fixed asset for which it must make a series of contractual periodic tax deductible payments (lease rentals).

Parties in Leasing

•Lessor: is the owner of the asset that is being leased.

•Lessee: is the receiver of the services of the asset under a lease contract.

Types of leasing

•1. Financial Lease

•2. Operating Lease

•3. Leverage Lease

•4. Cross Border Lease and

•5. Sale and lease back

Financial Lease•A financial lease is also known as

Capital lease, Long-term lease, Net Lease and Close lease. In a financial lease, the lessee selects the equipments, settles the price and terms of sale and arranges with a leasing company to buy it. He enters into a irrevocable and non-cancelable contractual agreement with the leasing company.

•Lessee uses the equipment exclusively, maintains it, insures and avails of the after sales service and warranty backing it. He bears the risk.

•Ex.- High cost office equipment, diesel generators, machine tools, textile machinery, containers etc.

Operating lease

•It is also known as Service lease, Short term lease or True lease or Wet lease. In this lease, the contractual period between lessor and lessee is less than the full expected economic life of equipment. This means that the lease is for a limited period, may be a month, six months, a year or few years.

•The risk of obsolescence is enforced on the lessor who will also bear the cost of maintenance and other relevant expenditure.

•Ex.- Computers, copy machines and other office equipment, vehicle.

Distinction between a financial lease and operating lease

Characteristics

Financial Lease Operating Lease

SpecificityThe asset leased out is

use-specific for the lessee

The asset leased out may be used commonly by a

number of users in sequence

Ownership Risks

The lessee bears the risks and rewards associated with the use of the asset

leased

The risks and rewards associated with the use of the asset leased is borne

by the lessor

Obsolescence Risk

The lessee bears the of obsolescence

The lessor bears the risks of obsolescence

Cancelability Can’t be cancelled Cancelled

Distinction between a financial lease and operating lease

Lease Period

Long time Short time

Maintenance

The cost of repairs and maintenance are borne by the lessee

Borne by the lessor

Pay-out

It is a full pay-out lease, where a single

lessee repays the cost of the asset, together with the

interest

It is usually a non-pay out lease, as the lessor is in

the business of leasing the asset to various users

several times

Leverage lease•A leverage lease is used for financing

those assets which require huge capital outlay.

•The leverage lease agreement involves three parties, the lessee, the lessor and the lender.

•The lessor acquires the assets as per the terms of the lease agreement but finances only a part of total investment, say 20% to 50%.

SALE AND LEASE BACK

•Under this type of lease, a firm which has an asset sells it to the leasing company and gets it back on lease.

• The asset is generally sold at its market value. The firm receives the sale price in cash and gets the right to use the asset during the lease period.

CROSS BORDER LEASE

•Cross border lease is international leasing and is known as transnational leasing.

•It relates to a lease transaction between a lessor and lessee domiciled in different countries and includes exports leasing.

•Ex.- Air bus or air crafts etc.

Legislative frameworks

•As there is no separate statute for equipment leasing in India, the provision relating to bailment in the Indian Contract Act govern equipment leasing agreements.

•u/s 148 “The delivery of goods by one person to another, for some purpose, upon a contract that they shall, when the purpose is accomplished, be returned or otherwise disposed off according to the directions of the person delivering them. The person delivering the goods is called the ‘bailer’ and the person to whom they are delivered is called the ‘bailee’.”

Legal implications

•For the lessor has the duty to deliver the asset to the lessee, to legally authorize the lessee to use the asset, and to leave the asset in peaceful possession of the lessee during the currency of the agreement.

•For the lessee has the obligation to pau the lease rentals as specified in the lease agreement, to protect the lessor’s title, to take reasonable care of the asset, and to return the leased asset on the expiry of the lease period.

Matters on Depreciation

•The depreciation of leased assets should be on a basis consistent with the normal depreciation policy of the lessor for similar assets.1. The depreciation recognized in the statement of profit and loss for the period.2. Impairment losses recognized in the statement of profit and loss for the period.3. Impairment losses reversed in the statement of profit and loss for the period.

MATTERS ON TAX

•Income tax provision relating to leasing

•Sales tax provisions pertaining to leasing

•Income tax provision relating to leasing

•1. The lessee can claim lease rentals as tax-deductible expenses.

•2. The lease rentals received by the lessor are taxable under the head of ‘Profits and Gains of Business or Profession’.

•3. The lessor can claim investment allowance and depreciation on the investment made in leased assets.

•Sales tax provisions pertaining to leasing

•Sales tax consists of the Central Sales Tax Act 1957(CST) enacted by the Government of India and Sales Tax Acts (STAs) of the various states. The CST deals with the levy and collection of sales tax on the inter-state sale of goods only. The tax on sale of goods with in state (intra-state sale) is governed by the provisions of the respective STAs.

•In other words, as per the present framework, a lease transaction attracts sales-tax at 3 stages:1. Purchase of equipment by lessor,2. Transfer of the right to a lessee to use the equipment for a lease rentals, and3. Sale of asset by the lessor at the end of the lease period.