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INTRODUCTION
Financial Services basically mean all those kinds of services provided in financial
terms where the essential commodity is money. These services include: leasing,
hire purchase, consumer credit, investment banking, commercial banking, venture
capital, insurance, credit rating, bill discounting, and mutual funds , stock
broking, housing finance, vehicle finance, mortgages and car loans, factoring
among other things.
Various entities that provide these services are basically categorized into
(a) Non –Banking Finance Companies
(b) Commercial Banks, and
(c) Merchant Banks.
Financial Services in India is too vast and varied too have evolved at one place
and at one time. One of the main entities that offer financial services in India is
Non-Banking Finance Companies. These NBFCs registered with Reserve Bank of
India mainly perform fund based services to the customer. Fund based services of
NBFCs include: leasing, hire-purchase and other asset based services whereas fee
based services of NBFCs include bill discounting, portfolio management and
other advisory services.
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Lease Financing
LEASING
“A contract where a party being the owner (lessor) of an asset (leased asset)
provides the asset for use by the lessee at a consideration (rentals), either
fixed or dependent on any variables, for a certain period (lease period),
either fixed or flexible, with an understanding that at the end of such period,
the asset, subject to the embedded options of the lease, will be either returned
to the lessor or disposed off as per the lessor's instructions”.
Leasing was prevalent during the ancient Sumerian and Greek civilizations where
leasing of land, agricultural implements, animals mines and ships took place. The
practice of leasing came into being sometime in the later half of the 19th century
where the rail road manufacturers in the U.S.A resorted to leasing of rail cars and
locomotives.
The equipment leasing industry came into being in 1973 when the first leasing
company, appropriately named as First Leasing This industry however remained
relegated to the background until the early eighties, because the need for these
industry was not strongly felt in industry. The public sector financial institutions –
IDBI, IFCI, ICICI and the State Financial Corporations (SCFs) provided bulk of
the term loans and the commercial banks provided working capital finance
required by the manufacturing sector on relatively soft terms. Given the easy
availability of funds at reasonable cost, there was obvious no need to look for
alternative means of financing.
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The credit squeeze announced by the R.B.I coupled with the strict implantation of
the Tandon & Chore committees’ norms on Maximum Permissible Bank Finance
(MPBF) for working capital forced the manufacturing companies to divert a
portion of their long – term funds for their working capital.
The history of leasing dates back to 200BC when Sumerians leased goods.
Romans had developed a full body law relating to lease for movable and
immovable property. However the modern concept of leasing appeared for the
first time in 1877 when the Bell Telephone Company began renting telephones in
USA. In 1832, Cottrell and Leonard leased academic caps, grown and hoods.
Subsequently, during 1930s the Railway Industry used leasing service for its
rolling stock needs. In the post war period, the American Air Lines leased their
jet engines for most of the new air crafts. This development ignited immediate
popularity for the lease and generated growth of leasing industry.
The concept of financial leasing was pioneered in India during 1973. The First
Company was set up by the Chidambaram group in 1973 in Madras. The
company undertook leasing of industrial equipment as its main activity. The
Twentieth century Leasing Company Limited was established in 1979. By 1981,
four finance companies joined the fray. The performance of First Leasing
Company Limited and the Twentieth Century Leasing Company Limited
motivated others to enter the leasing industry. In 1980s financial institutions made
entry into leasing business. Industrial Credit and Investment Corporation was the
first all India financial institution to offer leasing in 1983. Entry of commercial
banks into leasing was facilitated by an amendment of Banking Regulation Act,
1949. State Bank of India was the first commercial bank to set up a leasing
subsidiary, SBI capital market, in October 1986. Can Bank Financial Services
Ltd., BOB Financial Service Ltd., and PNB Financial Services Limited followed
suit. Industrial Finance Corporation’s Merchant Banking division started
financing leasing companies as well as equipment leasing and financial services.
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There was thus virtual explosion in the number of leasing companies rising to
about 400 companies in 1990.
In the subsequent years, the adverse trends in capital market and other
factors led to a situation where apart from the institutional lessors, there were
hardly 20 to 25 private leasing companies who were active in the field. The total
volume of leasing business companies was Rs.5000 crores in 1993 and it is
expected to cross Rs.10, 000 crores by March 1995.
1. The transaction:
2. Parties to a lease:
There are two parties to a lease: the owner and the user, called the lessor and the
lessee. The lessor is the person who owns the asset and gives it on lease. The
lessee takes the asset on lease and uses it for the period of the lease.
Any one can be a lessor, and any one can be a lessee, subject to usual conditions
as to competence to contract, or holding of properties.
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the asset. Thus, a lessee can be a lessor for a sub-lessee, unless the parent lessor
has restricted the right to sub-lease.
The subject of a lease is the asset, article or property to be leased. The asset may
be anything - an automobile, or aircraft, or machine, or consumer durable, or land,
or building, or a factory. Only tangible assets can be leased - one cannot
contemplate the leasing of the intangible assets, since one of the essential
elements of a lease is handing over of possession, along with the right to use.
Hence, intangible assets are assigned, whereas tangible assets may be leased.
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Lease Financing
must be capable of re-delivery: it must be durable (at least during the lease
period), identifiable and severable.
4. Lease period:
The term of lease, or lease period, is the period for which the agreement of lease
shall be in operation. As an essential element in a lease is redelivery of the asset
by the lessee at the end of the lease period, it is necessary to have a certain period
of lease. During this certain period, the lessee may be given a right of
cancellation, and beyond this period, the lessee may be given a right of renewal,
but essentially, a lease should not amount to a sale: that is, the asset being given
permanently to the lessee.
5. Lease rentals:
The lease rentals represent the consideration for the lease transaction. This is what
the Lessee pays to the Lessor.
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If it is a financial lease transaction, the rentals will simply be the recovery of the
lessor's principal, and a certain rate of return on outstanding principal. In other
words, the rentals can be seen as bundled principal repayment and interest.
6. Residual value:
Put simply, "residual value" means the value of the leased equipment at the end of
the lease term.
If the lease contains a buy out option with the lessee, residual value would mostly
mean the value at which a lessee will be allowed to buy the equipment.
If there is no embedded purchase option, residual value might mean the value that
the lessee or some one else assures will be the minimum value of the equipment at
the end of the lease term. This is typical in case of financial leases where the
lessor cannot grant a buyout option to the lessee; for the lessor to protect himself
against asset-based risks, he would take an assured residual value commitment
either from the lessee himself or from a third party, typically an insurance
company.
The residual value might also the value that the lessor assures to pay-back to the
lessee in case the lessee returns the asset to the lessor: that is, it might be the value
the lessor assures as the minimum value of the equipment. Such a lease, obviously
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an operating lease because the lessor is taking a risk on asset values, is a full
payout lease, but the lessor agrees to refund the guaranteed value on the lessee
returning the equipment at the end of the lease term.
7. End-of-term options:
The options allowed to the lessee at the end of the primary lease period are called
end-of-term options. Essentially, one, or more, of the following options will be
given to the lessee at the end of the lease term:
In any lease, which option will be suitable depends on the nature of the lease
transaction, as also the applicable regulations. For example, in a full payout
financial lease, the lessor would have recovered the whole or substantially the
whole of his investment during the primary lease period. Therefore, it is quite
natural that the lessee should be allowed to exhaust the whole of the remaining
value of the equipment. Regulation permitting, the lessor provide the lessee a
bargain purchase option to allow the lessee to complete the purchase of the
equipment.
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Lease Financing
Fair market value options, either for purchase of equipment, or for renewal, are
typical of operating leases, but are really speaking no more than assuring to the
lessee a continued use of the equipment. If equipment has to be bought at its
prevailing market value, it can be bought from the market rather than from the
lessor - therefore, the fair market value option carries no value for the lessee.
8. Upfront payments:
Lessors may require one or more of the following upfront, that is, instant
payments from a lessee:
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Between advance lease rent and initial lease rent - the difference is only technical.
The whole of the initial lease rental is supposed to be appropriated to income on
the date of its receipt, whereas advance rental is still an advance - normally an
advance against the last few rentals. Therefore, the advance rental will remain as a
deposit with the lessor to be adjusted against the last few rentals.
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TYPES OF LEASING
FINANCE LEASE
A lease is defined as finance lease if it transfers a substantial part of the risks and
rewards associated with ownership from the lessor to the lessee. According to the
International Accounting Standards Committee (IASC), there is a transfer of a
substantial part of the ownership-related risks and rewards if:
i. The lease transfers ownership of the asset to the lessee by the end of the lease
term; (or)
ii. The lessee has the 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 and, at the inception of the lease, it is reasonably certain that
the option will be exercised; (or)
iii. The lease term is for a major part of the useful life of the asset. The title
may or may not eventually be transferred; (or)
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iv. The present value of the minimum lease payments (See Glossary) is greater
than or substantially equal to the fair market value of the asset at the
inception of the lease. The title may or may not eventually be transferred.
The aforesaid criteria are largely based on the criteria evolved by the Financial
Accounting Standards Board (FASS) of USA. The FASS has in fact defined
certain cut-off points for criteria (iii) and (iv). According to the FASS definition
of a finance lease, if the lease term exceeds 75 percent of the useful life of the
asset or if the present value of the minimum lease payments exceeds 90 percent
of the fair market value of the asset at the inception of the lease, the lease will
be classified as a 'finance lease'
As you might notice, in the above example, the lessee has been put virtually in the
position of an asset owner - he has the right to use the asset for 5 years, with a
power to extend the lease period for another 5 years.
The first 5 years are called the primary lease period and
The primary
and secondary the extended period is called the secondary lease period.
lease period :
The lease is non-cancelable during the primary lease
period - that is, the lessee cannot return the asset and not
pay balance of the lessor's rentals. For the secondary period, the lessee will have
no incentive of returning the asset, as what the lessee has to pay is nominal,
whereas the asset might still carry substantial value. Thus, the asset will be
enjoyed by the lessee virtually for the whole of its economic life.
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Full payout The lessor too has no significant risk/reward other than that
lease: of a virtual money-lender: he would continue getting the
lease rentals for the primary period which will fully-payout the lessor's
investment in the lease as also give him his desired return on investment,
irrespective of the state, value or utility of the asset. If the lessee performs as per
agreement, the lessor would get no more, and no less, than such pre-fixed return
on investment.
Financial leases allow the asset to be virtually exhausted by the same lessee.
Financial leases put the lessee in the position of a virtual owner.
The lease is non-cancelable, meaning the lessee cannot return the asset and not
pay the whole of the lessor's investment.
In this sense, they are full-payout, meaning the full repayment of the lessor's
investment is assured.
As the lessor generally would not take any position other than that of a
financier, he would not provide any services relating to the asset. As such, the
lease is net lease.
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The risk the lessor takes is not asset-based risk but lessee-based risk. The
value of the asset is important only from the viewpoint of security of the lessor's
investment.
In financial leases, the lessor's payback period, viz., primary lease period is
followed by an extended period to allow exhaustion of asset value by the lessee,
called secondary lease period. As the renewal is at a token rental, this option is
called bargain renewal option. Alternatively, if the regulations permit, the lessee
may be given a purchase option at a nominal price, called bargain buyout or
purchase option.
In financial leases, the lessor's rate of return is fixed: it is not dependant upon
the asset-value, performance, or any other extraneous costs. The fixed lease
rentals give rise to an ascertainable rate of return on investment, called implicit
rate of return.
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gets shifted to the hire-vendor. If the asset were to become obsolete during the
pendency of the hire term, the hirer may off-hire the asset and closes the contract,
leaving the owner with less than a full-payout.
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In each case, treating the lease as a lease or, based on substance, a financing
transaction, may lead to completely different implications.
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However, such ideal is never achieved. There are two reasons to this - one, to an
extent, laws, regulators and taxmen are conditioned by the legal fabric of a
transaction. And two, lessors would emphasize upon on one or more structural
differences between a lease and a loan, and be able to create a situation by which
the substance rule fails.
Therefore, financial leasing all over the World continues to live with, or rather
thrive on, differing approaches to its character - it being treated at par with loans
for some purposes, and distinguished from loans in for some others. Besides, the
lease/loan treatment also depends upon the maturity of a country's regulatory
system to appreciate the substance of a deal by exploding its form -
understandably, doing so is not easy because it would mean going beyond the
apparent form of a contract.
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Lease Financing
Based on the 4 major areas listed above (general regulation, asset rights, taxation
and accounting), there might be numerous combinations treating financial leases
as loans on security for some purpose and true lease for some other purposes.
Accountings standards are the first (perhaps because they are least dependent on a
statute) to realize the indifference between leases and loans. Taxation,
particularly, income-tax, moves close to accounting standards. General property
laws are the last to do so, because often, for enforcement of a contract, the way
the parties create their mutual rights apparently is more important than what could
have been their intent behind such creation.
For the purpose of determining the present value, the discount rate to be used by
the lessor will be the rate of interest implicit in the lease and the discount rate to be
used by the lessee will be its incremental borrowing rate.
Therefore, a lease is to be classified as a finance lease if one of the conditions (iii) or
(IV) is satisfied.
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OPERATING LEASE
a.. The lease term is significantly less than the economic life of the equipment.
b. The lessee enjoys the right to terminate the lease at short notice without any
significant penalty.
c. The lessor usually provides the operating know-how, suppliers, the related
services and undertakes the responsibility of insuring and maintaining the
equipment in which case an operating lease is called a 'wet lease'. An
operating lease where the lessee bears the costs of insuring and maintaining
the leased equipment is called a 'dry lease'.
From the features of an operating lease, it is evident that this form of a lease does
not shift the equipment-related business and technological risks from the lessor
to the lessee. The lessor structuring an operating lease transaction has to depend
upon multiple leases or on the realization of a substantial resale value (on expiry
of the first lease) to recover the investment cost plus a reasonable rate of return
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• If the lease has a cancellable period, during which rentals forming more
than 10% in present value terms of the fair value of the asset are received;
• If part of the rentals are contingent or conditional, and such rentals form
more than 10% in present value terms of the fair value of the asset;
• If the lessor relies upon unguaranteed residual value, and such value forms
more than 10% in present value terms of the fair value of the asset;
• If the lessor relies upon guaranteed residual value, but such value is
guaranteed by a third party, and such third-party-guaranteed residual value
forms more than 10% in present value terms of the fair value of the asset -
in this case, the lease will be regarded as a financial lease for the lessor but
an operating lease for the lessee;
• If the lessor's IRR and the lessee's incremental borrowing rate differ: the
lease may be a financial lease for the lessor and an operating lease for the
lessee
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A classic example of this type of transaction is the sale and leaseback of safe
deposit vaults resorted to by commercial banks is Under this arrangement the bank
sells the safe sells the safe deposit vaults in its custody to a leasing company at a
market price which is substantially higher than the book value.
LEASE TRANSACTION
LESSEE LESSOR
LEASE RENTALS
The leasing company offers these lockers on a long-term lease to the bank. The
advantages to the bank are:
a. It is able to unlock its investment in a low income yielding asset.
b. It is able to enjoy the uninterrupted use of the lockers (which can be leased to
its customers).
c. It can invest the sale proceeds (which are not subject to the reserve ratio
requirements) in high income yielding commercial loans.
In general, the 'sale and leaseback' arrangement is a readily available source of
funds for financing the expansion and diversification programs of a firm. In case
where capital investments in the past have been funded by high cost short-term
debt, the sale and lease back transaction provides an opportunity to substitute the
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DIRECT LEASE
A direct lease can be defined as any lease transaction which is not a "sale and
leaseback" transaction. In other words, in a direct lease, the lessee and the owner
are two different entities. A direct lease can be of two types: Bipartite Lease and
Tripartite Lease.
Bipartite Lease
In a bipartite lease, there are two parties to the transaction - the equipment
supplier cum-lessor and the lessee. The bipartite lease is typically structured as an
operating lease with in-built facilities like up gradation of the equipment
(upgrade lease) or additions to the original equipment configuration. The
lessor undertakes to maintain the equipment and even replaces the equipment
that is in need of major repair with similar equipment in working condition
(swap lease). Of course, all these add-ons to the basic lease arrangement are
possible only if the lessor happens to be a manufacturer or a dealer in the class of
equipments covered by the lease.
Tripartite Lease
A tripartite lease on the other hand is a transaction involving three different
parties -the equipment supplier, the lessor, and the lessee. Most of the equipment
lease transactions fall under this category. An innovative variant of the tripartite
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lease is the sales-aid lease where the equipment supplier catalyzes the lease
transaction. In other words, he arranges for lease finance for a prospective
customer who is short on liquidity. Sales-aid leasing can take one of the
following forms:
a.. The equipment supplier can provide a reference about the customer to the
leasing company.
b. The equipment supplier can negotiate the terms of the lease with the
customer and complete the necessary paper work on behalf of the leasing
company.
c. The supplier can write the lease on his own account and discount the lease
receivables with the designated leasing company.
The effect of the transaction is that the leasing company owns the equipment and
obtains an assignment of the lease rental. By and large, sales-aid lease is supported
by recourse to the supplier in the event of default by the lessee. The recourse can
be in the form of the supplier offering to buyback the equipment from the lessor
in the event of default by the lessee or in the form of providing a guarantee on
behalf of the lessee.
LEVERAGED LEASE
In a leveraged lease transaction, the leasing company (called equity investor)
invests in the equipments by borrowing a large chunk of the investment with full
recourse to the lessee and without any recourse to it. The lender (also called the
loan participant)
Obtains the assignment of the lease and the rentals to be paid by the lessee, and a
first mortgage on thee leased asset. The transaction is routed through a trustee who
looks after the interests of the lender and the lessor. On receiving the rentals from the
lessee, the trustee remits the debt- service component of the rental to the loan
participant and the balance to the lessor. A schematic representation of transaction is
represented in the figure:
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Leveraged Lease
Lender
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Second, as the payments to the supplier and the lease are denominated in
different currencies, the economies of the transactions from the points of view of
both the lessor and the lessee tend to be affected by the variations in the relevant
exchange rates. In short, international lease transactions unlike domestic lease
transactions are affected by two additional sources of risk – country risk and
currency risk.
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(7) Off-The-Balance-Sheet-Financing:
Leasing provides "off balance sheet" financing for the lessee, in that the lease is
recorded neither as an asset nor as a liability.
(2) Risk of being deprived the use of asset in case the leasing company winds
up.
(3) No Alteration In Asset:
Lessee cannot make changes in asset as per his requirement.
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“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 ‘bailor’ and the person to whom they
are delivered is called the ‘bailee’.
1. The lessor has the duty to deliver the asset to the lessee, to legally authorise
the lessee to use the asset, and to leave the asset in peaceful possession of the
lessee during the currency of the agreement.
2. The lessor has the obligation to pay 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.
The lease agreement specifies the legal rights and obligations of the lessor
and the lessee. It typically contains terms relating to the following:
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The present structure of leasing industry in India consists of (1) Private Sector
Leasing and (2) Public Sector Leasing.
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(b). In House Leasing: In house leasing or capture leasing companies are set up
to meet the fund requirements or to avoid he income tax liabilities of the group
companies.
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(i). Financial Institutions: The financial institution such as IFCI, ICICI, IRBI
and NSIC have set up their leasing divisions or subsidiaries to do leasing
business. The shipping credit and Investment Company of India offers leasing
facilities in foreign currencies for ships, deep seas fishing vehicles and related
equipment to its clients.
(ii). Subsidiaries of Banks: The commercial banks in India can, under section
19(1) of the Banking Regulation Act, 1949, setup subsidiaries for undertaking
leasing activities. The SBI was the first bank to start a subsidiary for leasing
business in 1986.
Leasing in SBI is transacted through, Strategic Business Unit (SBU) of the bank.
Each SBU is manned by specially trained staff and is equipped with the latest
technological aids to meet the needs of top corporate clients. For the bank as a
whole, leasing is considered as a high growth area. Now the bank is concentrating
only on ‘Big Ticket Leasing’ which is generally of Rs.5 crore and above. So far
SBI disbursed more than Rs.300 crores by way of leasing with the average size of
deal being Rs.25 crores.
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In nutshell, from the point of view of the lessee, a lease transaction represents an
off-the balance-sheet transaction and this appears to be an important advantage
associated with leasing. It may be noted that in countries like the United States
and the United Kingdom, where leasing is very popular, leases which meet certain
criteria are capitalised in the books of the lessee. This essentially implies that:
a. The leased asset and the corresponding liability (reckoned at the present
value of the stream of rental payments) are shown on the balance sheet of the
lessee.
b. Depreciation charges are claimed by the lessee, and
c. The lease rental is split into two parts, the interest component (which is
charged to the profit and loss statement) and the principal repayment
component.
There were some 500 odd leasing companies in India about 5 years ago. Now, not
more than 50 serious operators are left, who are searching for ways to survive in
the coming 5 years. In my view, it is high time for those 50 players to join hands
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together, and cry out loud: "We will not write a single penny of lease transactions
in India, unless the Government speaks out its mind. Enough is enough. A
business can survive taxes, and duties, and sanctions, but no business can survive
uncertainty. So, unless the Government clarifies what does it have in mind
regarding income-tax, sales-tax, accounting and other issues that have been
drifting like the nebula for last 20 years, we cannot, and shall not write a single
lease."
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Every industry needs a safe harbour: more so for lease transactions which
envisage long term investments. It is the duty of the State to define what is it
policy towards a business.
This is absolute rubbish. Accounting standards are meant for preparation of books
for account, not for guidance of tax officers. As things exist, accounting
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depreciation and tax depreciation are miles apart. There are plenty of countries all
over the world where leases may be capitalised for accounting purposes by
lessees, and yet depreciated for tax purposes by lessors.
UK itself is a prominent example. South Africa is yet another. Even in the largest
leasing market in the World, USA, tax and accounting principles for leasing
depreciation are markedly different and the difference is honoured and settled
over time.
So, there is no scope for the popular fear that if India adopts IAS-17-type
capitalization by lessees, it would lead to loss of tax depreciation. Unless the tax
department also thinks alike (which would be a disaster, as I explain below), there
is no linkage between tax treatment and accounting treatment when it comes to
depreciation. Merely because a lease is capitalized by the lessee for accounting
purposes does not entitled the lessee, or disentitled the lessor to claim
depreciation.
Has the accounting distinction between financial and operating leases served
any purpose?
Under the revised standard, disclosure is required for non-cancellable leases in the
books of the lessee, irrespective of whether the lease is a financial lease or
operating lease. In other words, as far as the lessee is concerned, accounting
standards no more distinguish between a financial and an operating lease.
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• Different for the lessor and the lessee (in case of the lessor, his IRR is
used; in case of the lessee, his incremental borrowing rate is used)
• Subjective, as the incremental borrowing rate for the lessee is an arguable
issue
• Prone to manipulation by using structuring elements like security deposit
which are not used in computing the present value test.
Almost the whole of civilized world has adopted. Much smaller and lesser
developed economies have adopted IAS 17, many years ago, and leasing has
continued to grow there. Leave aside unfamiliar names, all our neighbors - Bangla
Desh, Sri Lanka and Pakistan, adopted IAS 17 several years back. That has not
deterred the growth of leasing in any way in any of these countries.
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asset, but one of mere funding. There are tests in many countries to distinguish
between true leases and financial transactions, which can be used in our country.
Besides this, it might make sense to use a simple but very powerful limitation:
leasing tax shelter not being used against non-leasing incomes. Several countries,
such as Malaysia, Sri Lanka, South Africa, have enacted this rule. This rule
allows the leasing tax shelter to be absorbed within the leasing business, but not to
be used against other incomes. This by itself would curb the misuse of leasing
depreciation.
It has been made out that the new accounting standard is drawn in accordance
with international accounting standard no. 17. However, this is not true as the IAS
17 itself underwent revision in 1997. ICAI's AS 19 is based on the pre-1997
version of IAS 17.
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lessee will record, as a liability, the present value of lease rentals payable,
in other words, the principal inherent in future lease rentals.
• The lessor will take to revenue only the interest or finance charges
inherent in lease rentals, which will also be debited as expense by the
lessee.
• In case of operating leases, the lessor will account for the asset as his own
asset, and depreciate the same as per regular depreciation policy of the
lessor. The rentals will be recognised as income by the lessor and expense
by the lessee, subject to evening out in case of structured rentals. The
asset/liability will be off-the-books of the lessee.
• If a sale and leaseback transactions results into a financial lease, no profit
on sale will be booked by the seller-lessee who will treat the sale proceeds
as a liability.
• If a sale and leaseback transaction results into an operating lease, a lessee
will book profit/loss on sale irrespective of the sale price of the asset,
depending on the fair value of the asset.
The fears expressed before that the new method of accounting will result
into loss of tax benefits by the lessor have now been allayed. In Feb.,
2001, the CBDT issued a circular clarifying that the change of accounting
rules will have no bearing on the tax treatment.
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In other words, to the profit as reported in profit and loss account, the
principal portion of lease rentals not recognised as income will be added
for tax purposes and depreciation will be allowed.
be quite a tough time for the tax officers to negotiate through this
dichotomous rule. In essence, when things are tough for the tax officers,
they are tougher for the tax payers!
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Lease Financing
There is no information in the guidance note on lease accounting, 1995, for non-
performing assets. The general accounting principles for non-performing assets is
contained in accounting standard 9 on Revenue Recognition which is more or less
on the lines of the International Accounting Standards on the issue.
• If the uncertainty is prevalent at the time of raising the claim for the income,
the recognition of the income shall be postponed
• If the uncertainty arises subsequent to the claim being made, there shall be a
provision made to the extent of the uncertainty.
This statement lays down the basic difference between a provision against an
income, and non-recognition of income, which is very significant. The
accounting for non-performing assets is guided by the Prudential Norms of the
RBI
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Lease Financing
A provision shall be made to mark the deterioration in the under lying security
value on the basis of the depreciation of the asset as per the Companies Act.
The NBFCs should make provisions against NPAs with correlation to the net
book value of the assets in four stages at 10, 40, 70 and 100 per cent as follows :
⇒ Sub-standard assets :
where any amounts of hire charges or 10 percent of the lease
rentals are overdue for more than 12 months net book value
but up to 24 months
⇒ Doubtful assets :
Where any amounts of hire charges or lease 40 percent of the
rentals are overdue for more than 24 months net book value
but up to 36 months
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Lease Financing
46
Lease Financing
in the lease. If, explicitly or implicitly, it is apparent that the lessor has agreed to a
permanent beneficial enjoyment of the asset by the lessee, the lease may be
treated as a hire purchase or a plain financing transaction.
The tax-payer claiming depreciation should own the asset. No doubt, the lessor
owns the asset, but as discussed earlier, it is not legal ownership alone that is
sufficient; the lessor must establish himself to be the beneficial owner as well. It
is on the failure of the condition of beneficial ownership that the legal owner in
case of hire-purchase is not allowed depreciation. The lessor's beneficial
ownership of the leased asset is proved essentially by the right of reversion of the
asset at the end of the lease period - this highlights the significance of proving that
the lessor has a substantive and not merely notional or technical right of reversion
of the asset.
The lessor may be a joint owner or a single owner. In case of joint ownerships,
depreciation was not allowable until 1996 when a specific amendment was
inserted to make syndicated leases possible; confusion, however, persists on
whether two or more lessors jointly leasing an asset will be treated for tax
purposes as a separate assessable entity.
When a movable property becomes a permanent fixtures to land not belonging to
the lessor, the lessor ceases to be the legal owner of such fixture. This basic legal
might create problems for Indian lessors leasing out assets that are in the nature of
permanent fixtures to ground. Such intent is even reflected from the recent
Supreme Court ruling in First Leasing Company of India where the Supreme
Court distinguished a lease from hire-purchase on the ground whether the transfer
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Lease Financing
of right to use in a lease resulted into a permanent effective right of use being
transferred, preparatory to a sale.
The other condition for depreciation is that the taxpayer should be using the asset.
It is understood clearly that the taxpayer uses the asset in the business of leasing;
hence, it is on the strength of the lessor's use that depreciation is claimed and not
on the strength of the lessee's use. Use or its absence by the lessee should not,
therefore, cast any implication on the lessor's depreciation claim.
Depreciation is allowed in India on a pooling basis: all assets eligible for the same
rate of depreciation under a particular class of assets will be treated as one pool,
or block of assets. Acquisition of fresh assets is treated as addition to the block,
and the sales or transfers, at whatever be their transfer consideration, are netted
off from the block. Therefore, no regard is had to the profit or loss on sale of an
individual asset.
4. Rates of depreciation:
Rates of depreciation are listed in the Schedule to the Income-tax Rules. Like
under the English system, India makes distinction between "plant or machinery"
and other assets based on the functional test. The age-old functional test in
Yarmouth v. France holds in India. Based on this test, any assets that the lessor
leases out are obviously income-earning tools in his business, and would
therefore, be regarded as plant or machinery for his business.
Under this caption, the applicable depreciation rates on some of the generally
eased assets are given in the Table below :
Motor cars 20%
General plant or machinery (residuary rate) 25%
Lorries, buses or taxies plying on hire, aeroplanes, moulds used in 40%
plastic or rubber factories
Bottles and crates 50%
Computers (proposed) 60%
Pollution control devices, energy saving devices, renewable energy 100%
devices, rollers in flour mills, gas cylinders, etc.
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Lease Financing
This provision is applicable only where the seller is the lessee; in other words, not
applicable for every lease of second-hand assets. However, in such cases, the fair
valuation rule that existed earlier, in Explanation (3) to sec. 43 (1) shall continue
to apply.
This case cannot be taken to be a trend-setter because the facts in this case were
not materially different from most other financial leases. If this case is a
precedent, then lease rentals are not tax-deductible in any single financial lease.
However, even the Supreme Court has differentiated between lease and hire-
purchase in the latest First Leasing Company of India case. Therefore, most likely
49
Lease Financing
the Centre for Monitoring of Indian Economy case will not be able to withstand at
higher judicial forums
The major sales tax provisions relevant for leasing are as follows:
1. The lessor is not entitled for the concessional rate of central sales tax because the
asset purchased for leasing is meant neither for resale nor for use in manufacture.
(It may be noted that if a firm buys an asset for resale or for use in manufacture it
is entitled for the confessional rate of sales tax).
2. The 46th Amendment Act has brought lease transitions under the purview of ‘sale’
and has empowered the central and state government to levy sales tax on lease
transactions. While the Central Sales Tax Act has yet to be amended in this
respect, several state governments have amended their sales tax laws to impose
sales tax on lease transactions.
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Lease Financing
In a Finance Lease, NBFCs are the owner of the Goods and the lessee only has
the right to use the goods on payment of lease rentals. It is a contract of hiring or
bailment. Hence there is no “sale “as defined.
However, there is a transfer of the right to use the goods from us to the lessee.
And this has become taxable as a deemed sale. The Sales Tax, also called "Lease
Tax ", is leviable on the Transfer of Right to Use the goods from us to the lessee.
And the tax is charged as each rental for use of the lease asset becomes due and
payable.
It may be noted that Lease Tax is a case of taxing a non-sale -the consumption of
utility of goods - though there is no transfer of title. . Whether it is good law or
will the Courts strike down this Tax ? We are not sure, but NBFCs are agitating
the matter in a Court.
Lease is a sale followed by a transfer of right to use. Supplier S sells to the NBFC
and the NBFC gives the goods on lease to Customer C (Transfer of the right to
use the goods). Hence, there are two sale transactions - the sale proper, and the
lease.
In HP, also, there are 2 sales. Supplier S sells to the NBFC and the NBFC
simultaneously sells to the Customer C by entering into a hire purchase
agreement. Commercially speaking, the two transactions are not different. There
are two contracts in either case, usually bundled in a single delivery from the
supplier to the end-user.
Therefore, in a Lease, there will be a Sales Tax on the Sale and a Lease Tax (if
any) on the transfer of the right to use. In a Hire Purchase there will be 2 Sales
Taxes applicable on 2 separate sales. However, sales-tax laws (for historical
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Lease Financing
reasons only) treat lease and hire purchase substantially differently. Since the
choice of the instrument, viz., lease or hire purchase, may lead to material sales-
tax difference, it is important that the sales-tax implications are analyzed before
choosing the instrument or concluding the transaction.
That state where the inter state movement commences has the jurisdiction and the
rate chargeable is also that applicable in that state for CST transactions.
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Lease Financing
The Budget deals a body blow to the already moribund leasing and hire purchase
sector - imposing a service tax on not just the income but the entire receivables
out of lease and hire purchase transactions.
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Lease Financing
Not only are leasing and hire purchase companies proposed to be brought under
tax, they are also grossly discriminated against: as loans from banks, an
alternative to lease and hire purchase, have not been brought under the tax.
54
Lease Financing
With both leasing and bank financing involving credit decisions and financial
risks, the key differences are that two additional factors apply to leasing
companies:
55
Lease Financing
First, they have knowledge of the asset (and often the industry), and hence are
lending to some degree on an asset basis. This is different from collateral-based
lending, however, in that they are lending based on the ability of the asset to
contribute to cash flow (either to the lessee or in case of forced sale/liquidation).
Banks and other lenders tend to look at the balance sheet value of collateral.
The second is that leasing companies are more sales and service oriented—they
are using their specialized knowledge to “bridge the gap” between suppliers and
purchasers, and the specialized knowledge of leasing companies may also give
them an advantage in disposing of the repossessed leased assets. Suppliers are
generally not specialists in finance or credit decisions, while lessees are not
specialists in finance or equipment acquisition; leasing companies specialize in
finance, credit and equipment acquisition and disposal (equipment dealing). In
effect, both the supplier and the lessee are “outsourcing” certain portions of their
business to a service provider that also happens to have a certain capacity to
borrow and lend money.
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Lease Financing
both the lender and lessor have legal rights to reclaim/repossess assets.
■ The risks and costs of ownership, including maintenance and obsolescence,
remain with the borrower and lessee. Also, under both a loan or a financial
lease, if the asset appreciates, neither the lender nor the lessor benefits.
■ The agreements are non-cancelable until either the lessor or the lender has
recovered its outlay.
■ The borrower or lessee can either settle the agreement (in the case of the
lease) or repay the loan early.
PROBLEMS OF LEASING
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Lease Financing
1. Unhealthy Competition:
The market for leasing has not grown with the same pace as the number
of lessors. As a result, there is over supply of lessors leading to competitor. With
the leasing business becoming more competitive, the margin of profit for lessors
has dropped from four to five percent to the present 2.5 to 3 percent. Bank
subsidiaries and financial institutions have the competitive edge over the private
sector concerns because of cheap source of finance.
3. Tax Considerations:
Most people believe that lessees prefer leasing because of the tax
benefits it offers. In reality, it only transfers; the benefit i.e. the lessee’s tax shelter
is lessor’s burden. The lease becomes economically viable only when the
transfer’s effective tax rate is low. In addition, taxes like sales tax, wealth tax,
additional tax, surcharge etc. add to the cost of leasing. Thus leasing becomes
more expensive form of financing than conventional mode of finance such as hire
purchase.
4. Stamp Duty:
The states treat a leasing transaction as a sale for the purpose of making
them eligible to sales tax. On the contrary, for stamp duty, the transaction is
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Lease Financing
Asset-liability mismatch:
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Lease Financing
Over past couple of years, the economy itself has done pretty badly. The demand
for capital equipment has been at one of the lowest ebbs. Automobile sales have
come down; corporate have found themselves in a general cash crunch resulting
into sticky loans.
Most NBFCs have learnt a very hard way to distinguish between a good credit
prospect and a bad credit prospect. When a credit decision goes wrong, it is trite
that in retrospect, it invariably seems to be the silliest mistake that ever could
have been made, but what Indian leasing companies have suffered are certainly
problems of infancy. Credit decisions were based on a pure financial view, with
asset quality taking a back-seat.
Tax-based credits:
In most of the cases of frauds or hopelessly-wrong credit decisions, there has been
a tax motive responsible for the transaction. India has something which many
other countries do not- a 100% first year depreciation on several assets.
Apparently, the list of such assets is limited and the underlying fiscal rationale
quite holy and sound - certain energy saving devices, pollution control devices etc
qualify for such allowance. But that being the law, it is left to the ingenuity of our
extremely competent tax consultants to widen the range with innovative ideas of
exploiting these entries in the depreciation schedule. Thus, there have been cases
where domestic electric meters have been claimed as energy saving devices, and
the captive water softenizer in a hotel has been claimed as water pollution control
device! As leasing companies were trying to exploit these entries, a series of
fraudsters was successful in exploiting, to the hilt, the propensity of leasing
companies to surpass all caution and all lending prudence to do one such
60
Lease Financing
transaction to manage its taxes, and thus, false papers for non-existing wind mills
and never-existing bio-gas plants were fabricated to lure leasing companies into
losing the whole of their money, to save the part that would have gone as
government taxes!
As they say, it does not rain, it pours. Several problems joined together for leasing
companies - the public antipathy created by the CRB episode and subsequent
failures of some good and several bad NBFCs, regulation by the RBI requiring
massive amount of provisions to be created for assets that were non-performing,
etc. It certainly was not a good year to face all these problems together
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Lease Financing
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Lease Financing
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Lease Financing
Twenty five years ago, Farouk Irani quit his high profile job in
Citibank to launch his dream project: a leasing company in India. On 10th Sept.,
1973, Irani was able to convince Dr A C Muthia, Industrialist, to have the First
Leasing Company of India incorporated.
For several years, First Leasing Company remained the Only Leasing Company.
Ever since IFC, Washington decided to support Indian leasing with investment in
companies in 4 metros, Indian leasing has never looked back. This was about
1980. Early eighties' capital market boom found many young entrepreneurs riding
the leasing wave.
As it celebrates its 25th Birthday, Indian leasing is today a central part of the
financial system. On its way, it has passed through several twists and turns.
Financial industry World-over has a very high beta factor: it is hyper-sensitive to
changes in economic scenario. Periods of general prosperity are extremely good
for the leasing industry; downturns in economic cycle cost is extremely high. That
apart, financial system is invariably affected by the contagion effect: failures of a
few players affect even the healthy ones.
India at the 14th largest place in World leasing sounds incredible! But it is
true, and true contrary to the internationally available statistics published by the
London Financial Group. The Group's data, published every year in the World
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Lease Financing
Leasing Yearbook would place India at some 36th place, but admittedly that data
is only the estimate of the author thereof, and the author of the data might have
ranked Indian leasing volume based on India's per capita income ! When it comes
to size, India has the obvious advantage of being such a vast nation.
Center for Monitoring of Indian Economy compiles data about Indian leasing
volumes, which is carried as a part of India Leasing Yearbook published by the
Association of Leasing and Financial Services Cos. The data compiled by the
Center shows aggregate balance sheet value of leased and hired assets (though for
balance sheet purposes, lease and hire-purchase transactions are distinguished,
there is no material difference between the two - hence the volumes have been
clubbed here) at about Rs. 261 billion (End March 1997). This is based on
reporting by 226 companies, whereas the business, particularly hire-purchase, is
spread amongst some 3000 large and small companies. Estimated outstanding
business done by these firms is about Rs. 15 billion (at Rs. 5 million per such
firm).
That apart, the data also excludes the massive annual volume of business by the
Indian Railway Finance Corporation (IRFC). IRFC is a hundred percent
subsidiary of Indian Railways, and its leases are dedicated to the parent Railways
only. Of late, almost entire floating stock acquisition by Railways is being
acquired on lease from IRFC. The outstanding value of leases done by IRFC adds
to about Rs. 120 billion.
Thus, the aggregate volume comes to about Rs. 396 billion, which is about USD
11 billion as per then-prevailing exchange rates.
USD 11 billion of outstanding volume cannot by itself give India a ranking in the
London Financial Group data, since these rankings are based on incremental
volume. However, a rough estimate of new business can be made from the above
data (unfortunately, the Centre for Monitoring of Indian Economy data do not
give any idea of new leasing and hire-purchase volume). Supposing 30% of the
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Lease Financing
outstanding business of last year was paid, and there was a 20% growth in net
business (as can be seen from the Chart above), there was a 50% new business,
over the volume outstanding at the beginning of the year. Relative to the business
at the end of the year, the incremental volume should have been about 33%
(50/150).
Therefore the annual leasing volume in India is estimated at about USD 3.67
billion, on a rough and conservative estimate.
In London Financial Group data, this should put India at 12-13th place, close to
Hong Kong. This would also be the third largest market in Asia, next only to
Japan and Korea.
The only infirmity in the above ranking is that the London Financial Group data
are not as of March 1997 - that, however, should not seriously disrupt the ranking
of India, because other Asian markets in 1996-7 period have generally registered
a negative growth.
With the exception of 1996-97 and 1997-98, the 1990s have generally been a
good decade for Indian leasing. The average rate of growth on compounding basis
works out to 24% from 1991-92 to 1996-97. Broadly, the following factors have
been responsible for the growth of Indian leasing, in no particular order:
• No entry barriers :
Any one could float a leasing entity, and even an existing company not in
leasing business can write a lease purely for tax shelters.
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Lease Financing
The post -liberalization era saw a spate of new ventures and fresh investments
by existing ventures. Though primarily funded by the capital markets, these
ventures relied upon leasing as a source of additional or stand-by funding.
Most leasing companies, who were also merchant bankers, would have funded
their clients who hired them for issue management services.
Needless to state with facts, the growth in car leasing volume has been the
highest over these years - the spurt in car sales with the entry of several
new models was funded largely by leasing plans.
• Tax motivations:
Data would establish a clear connection between bullish stock markets and
the growth in both number of leasing entities and lease volumes. Year
1994-1995 saw the peak of primary market activity where a company,
even if a new entrant in business, could price itself on unexplainable
premium and walk out with pride.
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Lease Financing
Most leasing companies in India have relied, some heavily, on retail public funds
in the form of deposits. Most of these deposits were raised for 1 year tenure, and
on promise of high rates of interest, at times even more than the regulated rate
(which was lifted in 1996 to be reintroduced in 1998).
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Lease Financing
Figure 1-1 shows the role leasing plays in emerging economies and in developed
economies and the room for growth in the use of leasing in emerging economies.
The chart shows that leasing can provide a valuable additional source of finance
within these markets. The effect of leasing can be further accelerated and
strengthened where the in country conditions allow for investment by IFC and
other international financial institutions, with these institutions recognizing the
positive effects of leasing and introducing medium-term finance into markets
where no alternative currently exists.
In many markets, discussion of leasing often focuses on “large-ticket” leasing,
cross border structures, or tax implications. While these are also important, any
discussion of leasing should be kept as broad as possible and consider the effects
for all businesses, including small and medium-size enterprises.
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Lease Financing
Business Need
Il&FS ETS created K-Yan Design Center, an independent research group to
create a new approach to learning. Prof. Kirti Trivedi was appointed to head the
project. The KDC team envisaged a comprehensive learning environment and
wanted a software created that would function as the primary resource of this
learning environment.
The biggest challenge was that the requirements were not clear. It was a dream in
which the achievables were known, but not the deliverables. It was not known
how or what exactly needed to be done, it was not even known for sure whether
it’s possible. To add to that the funds available were limited.
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Lease Financing
evolving manner.
The Problems
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Lease Financing
The Solution
The captive failed to improve its service. As a result, when faced with the need to
acquire several hundred additional PC’s, the company chose the same brand
equipment, but a different lessor. Following the recommendations of executives
from companies similar to its own, it gave CSI Leasing a test run. These
references attested to the dependability and accuracy of the services they received
from CSI. With CSI, they gained a single point of contact for all ordering, as well
as a local account executive immediately responsive to their various needs.
Four years later, CSI Leasing is handling all of this company’s IT leasing needs.
A remarkable side note to this story - it took the captive leasing company five
months to realize it had lost the company’s business.
Unlike manufacturers’ captive leasing arms, CSI does not exist to drive product
sales for a parent company. Since we do not make the products we finance, we
realize the only way to create a loyal customer is to master the principles of
account management. We started by getting the basics right – quick turnaround on
orders, accurate invoices and documentation, and responsive service. Online
invoice information, quick vendor payment and simple end of lease procedures
further increased satisfaction. At CSI, we truly believe there is no excuse for less
than exceptional service.
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Lease Financing
Honda
Working together on the specification for the pre-let, ProLogis and Honda
developed a design which would enhance the functions of office and warehouse,
helping to make Honda’s logistics operations far more efficient. ProLogis then
worked with award-winning architect Michael Sparks Associates to gain planning
permissions and design and deliver a bespoke 350,000 sq ft (32,516 sq m)
distribution warehouse, before Honda’s crucial lease break of April 2006.
The resulting building responds to the aims of Honda Logistics UK. The
company sought a design which would project the division’s status within the
group and display the Honda brand in a dynamic application of the corporate
livery.
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Lease Financing
The external design reflects its use as Honda’s state-of-the-art distribution center.
Elevations use crisp detailing, creating a natural rhythm with the alternate use of
different profiles and colors of external cladding.
Smooth transition:
The layout of the site and the orientation of the building are ideally arranged for
the smooth and efficient operation of a major logistics facility. Offices are
positioned to allow adequate supervision of the service area, while a service road
provides 360-degree circulation. Particular attention was paid both to the
intensive demands of heavy vehicles and to security.
In January 2006, Honda began a smooth transition into its new home. ProLogis
was able to meet Honda’s precise requirements in a timeframe of just ten months.
Honda Logistics UK now uses ProLogis’ state-of-the-art facility to supply car
parts, motorbikes and power equipment nationwide.
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Lease Financing
Company Background:
Rapid growth in its five years in business continues to present a need for
Cherokee Carpet to minimize its capital requirements. Cherokee Carpet
Industries had a need for a Plantex 36 End Extruder for polypropylene and
nylon carpet yarns, an industrial piece of equipment. Cherokee Carpet
considered a straight purchase of $3.5 million for the piece of equipment,
but discovered that leasing afforded them the opportunity to leverage their
financial resources. When the company weighed the opportunity costs of a
straight out purchase against the lease payments, leasing offered a better
solution.
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Lease Financing
available for the operation of the company and for business growth
investments.
Results:
Company Background:
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Lease Financing
that would satisfy the health systems' billing needs. At present, ETCS leases
$500,000 annually in equipment to this customer.
ETCS recognized that having the hospital lease copiers from Canon
Financial Services would offer more flexible leasing terms, reduce its costs
in procuring the equipment and enable the company to pay for the
equipment as it is being used. Thus, lending to the efficiency and
productivity of the business.
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Lease Financing
Results:
The flexible lease that ETCS developed with Canon Financial Services,
afforded the hospital the ability to lease six to 10 copiers per month; thus,
reducing monthly capital outlay while affording the hospital the equipment
needed to supply their growing demand for copiers. This arrangement
allowed ETCS to win the hospital's business and steadily increase its volume
leased through Canon Financial Services based on equipment demand.
easing their copiers afforded the health system the ability to both leverage
their capital, in addition to, protecting themselves from technical
obsolescence.
Customer Quote:
"CFS structured the billing cycle to the individual cost centers, making it
more convenient for the hospital's different invoicing needs," said Greg
Walker, ETCS President. "Not all financing sources would be as flexible or
accommodating as CFS. In this industry there are several, national faceless
equipment dealers and leasing companies who have the "me too" attitude.
CFS really proved to be extremely customer service- oriented, just as we
like to be at ETCS."
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Lease Financing
Hamid Lahcen, Chairman and CEO of Spacemakers, was considering options for
financing $1 million of new forklifts needed for the commercial storage facilities.
Because there was no corporate tax in Kuwait, Spacemakers could not take
advantage of the equipment's depreciation tax shield. Hence Lahcen was
considering a fifteen year lease of the equipment.
The Canadian lessor, Hardware Leasing Co., had offered to structure a capital
lease for Spacemakers, as long as Hardware Leasing could arrange non-recourse
financing for the equipment. Hardware wished to purchase the forklifts with
$200,000 of its own cash and $800,000 borrowed from ABN AMRO Bank in
Dubai at 7.5%. The leasing company's effective tax rate was 30%, and Canadian
tax laws permit use of the double-declining balance method for leasing
companies. The forklifts had a tax life of seven years.
Hardware Leasing estimated that it could sell the equipment for $200,000 (the
residual value after 15 years). Spacemakers, the lessee, had requested an early
buyout option (an "EBO") after ten years. Immediately upon purchase, the lessor
would lease the equipment to the lessee for fifteen years. Rents would be paid
monthly, on the same day the debt services were due, and the rents always would
be sufficient to pay debt service.
When Lahcen received a fax summarizing the terms of the lease, he could hardly
believe his eyes. The lessor offered Spacemakers a 15-year lease with 180 equal
monthly payments of $8,052. This included an effective interest rate of only 6.5%
per annum. Not only was the rate very attractive, but Spacemakers would also
receive 100% financing with no downpayment. He decided to push his luck and
try for the early buyout option. He scribbled "Accepted, as long as we get the
EBO!" on the term sheet, signed it, and faxed it back to Toronto.
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Lease Financing
Over past couple of years, the economy itself has done pretty badly. The demand
for capital equipment has been at one of the lowest ebbs. Automobile sales have
come down; corporates have found themselves in a general cash crunch resulting
into sticky loans.
Most NBFCs have learnt a very hard way to distinguish between a good credit
prospect and a bad credit prospect. When a credit decision goes wrong, it is trite
that in retrospect, it invariably seems to be the silliest mistake that ever could
have been made, but what Indian leasing companies have suffered are certainly
problems of infancy. Credit decisions were based on a pure financial view, with
asset quality taking a back seat.
In most of the cases of frauds or hopelessly wrong credit decisions, there has been
a tax motive responsible for the transaction. India has something which many
other countries do not- a 100% first year depreciation on several assets.
Apparently, the list of such assets is limited and the underlying fiscal rationale
quite holy and sound - certain energy saving devices, pollution control devices etc
qualify for such allowance. But that being the law, it is left to the ingenuity of our
extremely competent tax consultants to widen the range with innovative ideas of
exploiting these entries in the depreciation schedule. As leasing companies were
trying to exploit these entries, a series of fraudsters was successful in exploiting,
to the hilt, the propensity of leasing companies to surpass all caution and all
lending prudence to do one such transaction to manage its taxes, and thus, false
papers for non-existing wind mills and never-existing bio-gas plants were
fabricated to lure leasing companies into losing the whole of their money, to save
the part that would have gone as government taxes!
A number of factors will precipitate the consolidation in Indian leasing, and the
process is already on. First, bifurcation of leasing and non-leasing activities, such
as merchant banking, will go a long way in breaking the financial conglomerates,
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Lease Financing
who may find themselves better focusing on investment banking rather than
dabbling into leasing at the same time. Second, in whichever forms of business,
mass distribution is possible, that is, where the customer is more or less
homogenous, larger firms will eat up the shares of the smaller ones. This is
something everyone can see happening in the car finance market. Three, reduced
rates by the industry leaders will set benchmark rates in the market which will
force many marginal players out. Fourth, regional players will survive but will
find their relevance in a new avatar as "lease brokers", or to use a better word,
"lease originators". These firms will originate small ticket leases, sell their
portfolios to larger players, thereby encashing their wafer-thin spreads and
walking out to originate another transaction. Such activity has flourished in USA,
and we will see much of the same story in India too.
During the initial phases of growth of any industry, there is a trend towards
diversification: firms try to attain growth in numbers by unfocused diversification,
but soon realize that diversified presence creates organizational pressures, which
are difficult to cope with. This leads to a trend towards consolidation and focused
growth. Leasing firms of yesteryears were everything: money market players,
merchant bankers and discount houses. Gradually, both regulators and industry
participants have realized that clearer roles are necessary for stability.
There are so many merits in vendor-based leasing that it is surprising that it has
not made its debut in India still. For the asset vendor, a leasing plan is a sales-aid,
and for the lessor, it is easy access to a vast market, with equipment support from
the vendor. In 1997-98 and after, many lessors will be forced to leave general
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True asset-based funding is an extension of the vendor lease market. The two
generally go together to develop into operating leasing. Full scale operating
leasing, that is, leases will in-built cancellation options, will take quite some time
to develop in India, but features of operating leases will be introduced once
vendor tie-ups take place.
However, the near future for the NBFC Sector seems to be far from satisfactory.
Given the present state of the economy and industry, lack of confidence by
investors, apathy from banks, chaotic and multiple tax regime, non existence of
effective recovery mechanism and unfair competition provided by MNCs, FI’s,
the surviving NBFCs have a tough time before them. However, the country is at a
turning point and the requirement of capital equipments for industrial expansion
and huge infrastructural projects will once again lead to the spurring demand for
lease and hire purchase finance and the efficient and cost effective NBFCs
therefore, could have a bright future. Moreover with various issues like change in
accounting norms, sales and service tax on lease rentals and tax issues facing the
leasing industry, the future of this sector seems to be very bleak.
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METHODOLOGY
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ANNEXURES
LEASE
A contract in which one party conveys the use of an asset to another party
for a specific period of time at a predetermined rate.
The periodic rental payment to a lessor for the use of assets. Others may
define lease rate as the implicit interest rate in minimum lease payments.
LESSEE
LESSOR
The party to a lease agreement who has legal or tax title to the equipment,
grants the lessee the right to use the equipment for the lease term, and is
entitled to the rentals.
LEVERAGED LEASE
OPEN-END LEASE
A conditional sale lease in which the lessee guarantees that the lessor will
realize a minimum value from the sale of the asset at the end of the lease.
OPERATING LEASE
Any lease that is not a capital lease. These are generally used for short
term leases of equipment. The lessee can acquire the use of equipment for
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just a fraction of the useful life of the asset. Additional services such as
maintenance and insurance may be provided by the lessor.
RESIDUAL VALUE
SALE-LEASEBACK
SALES-TYPE LEASE
TAX LEASE
A lease wherein the lessor recognizes the tax incentives provided by the
tax laws for investment and ownership of equipment. Generally, the lease
rate factor on tax leases is reduced to reflect the lessor's recognition of this
tax incentive.
VENDOR LEASING
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Lease Financing
. CAPITAL LEASE
The period of time during which an asset will have economic value
and be usable.
The effective rate (to the lessee) of cash flows resulting from a lease
transaction. To compare this rate with a loan interest rate, a company must
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include in the cash flows any effect the transactions have on federal tax
liabilities.
The first amendment lease gives the lessee a purchase option at one or
more defined points with a requirement that the lessee renew or continue
the lease if the purchase option is not exercised. The option price is
usually either a fixed price intended to approximate fair market value or is
defined as fair market value determined by lessee appraisal and subject to
a floor to insure that the lessor's residual position will be covered if the
purchase option is exercised.
FINANCE LEASE
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A lease in which the lessor recovers, through the lease payments, all costs
incurred in the lease plus an acceptable rate of return, without any reliance
upon the leased equipment's future residual value.
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