Evolution of Leasing in India Leasing activity was initiated in India in 1973.

The first leasing company of India, named FirstLeasing Company of India Ltd. was set up in that year by Farouk Irani, with industrialist A CMuthia. For several years, this company remained the only company in the country until 20 th Century Finance Corporation was set up - this was around 1980.By 1981, the trickle started and Shetty Investment and Finance, Jaybharat Credit and Investment,Motor and General Finance, andSundaram Financeetc. joined the leasing game. The last threenames, already involved with hire-purchase of commercial vehicles, were looking for a tax break and leasing seemed to be the ideal choice.The industry entered the third stage in the growth phase in late 1982, when numerous financialinstitutions and commercial banks either started leasing or announced plans to do so.ICICI,prominent among financial institutions, entered the industry in 1983 giving a boost to theconcept of leasing. Thereafter, the trickle soon developed into flood, and leasing became the newgold mine. This was also the time when the profit-performance of the two dozen companies,First Leasing and 20th Century had been made public, which contained all the fascination for many more companies to join the industry. In the meantime,International Finance Corporation announced its decision to open four leasing joint ventures in India. To add to the leasing boom,the Finance Ministry announced strict measures for enlistment of investment companies onstock-exchanges, which made many investment companies to turn overnight into leasingcompanies.As per RBI's records by 31st March, 1986, there were 339 equipment leasing companies in Indiawhose assets leased totaled Rs. 2395.5 million. One can notice the surge in number - frommerely 2 in 1980 to 339 in 6 years.Subsequent swings in the leasing cycle have always been associated with the capital market -whenever the capital markets were more permissive, leasing companies have flocked the market.There has been appreciable entry of first generation entrepreneurs into leasing, and in retrospectit is possible to say that specialised leasing firms have done better than diversified industrialgroups opening a leasing division.Another significant phase in the development of Indian leasing was the Dahotre Committee'srecommendations based on which the RBI formed guidelines on commercial bank funding toleasing companies.

The growth of leasing in India has distinctively been assisted by fundingfrom banks and financial institutions.Banks themselves were allowed to offer leasing facilities much later - in 1994. However, even todate, commercial banking machinery has not been able to gear up to make any remarkabledifference to the leasing scenario.The postliberalisation era has been witnessing the slow but sure increase in foreign investmentinto Indian leasing. Starting with GE Capital's entry, an increasing number of foreign-ownedfinancial firms and banks are currently engaged or interested in leasing in India Evolution of Hire-purchase The British concept of hire-purchase has, however, been there in India for more than 6 decates.The first hire-purchase company is believed to be Commercial Credit Corporation, successor toAuto Supply Company. While this company was based in Madras, Motor and General Financeand Instalment Supply Company were set up in North India. These companies were set up in the1920s and 1930s.Development of Hire-purchase took two forms: consumer durables and automobiles.Consumer durables hire-purchase was promoted by the dealers in the respective equipment.Thus, Singer Sewing Machine company, or Murphy radio dealers would provide instalmentfacilities on hire-purchase basis to the customers of their products.The other side developed very fast - hire-purchase of commercial vehicles. The dealers incommercial vehicles as well as pure financing companies sprang up. The value of the asset beinggood and repossession being easy, this branch of financing activity flourished fast, although untilrecently, most of automobile financing business was in hands of family-owned businesses. Leasing and Hire-purchase: A vanishing distinction: Essentially, asset-based financing in India particularly by non-banking financial companies issplit in two documentation modes - lease and hire-purchase. These two are technically differentinstruments, but in essence, there is not much that differs between the two, except for thecaption.In spite of the substantive similarity, historically, there has been a diametric separation betweenthese two forms. The assets usually subject matter of hire-purchase have been different fromthose generally leased out. Leasing has been used mostly for plant and machinery, while hire-purchase has commonly been used for vehicles. Even the players have been different.The reasons for this diametric distinction are more historical than logical. Hirepurchase,essentially a British form, entered India during the Colonial

era, and thrived as almost the onlyform of external finance available for commercial vehicles. For the financiers, as witnessedWorld-over, commercial vehicles were the natural choice for several assetfeatures he loves:lasting value, ready secondary market, self-paying feature, etc. Hence, the industry of hire-purchase became synonymous with truck-financing. Besides, the motor vehicles laws gave thesurest legal protection any law could give to a financier: the financier would not have to carryany of the operational risks of a motor vehicle, and yet, any transfer of the vehicle would not bepossible without the financier's assent.Leasing, essentially a USinnovation, entered the country significantly in the early 80s, and waspropagated as an alternative to traditional modes of industrial finance. Besides, the earlymotivation (which continues with a number of players even now) of leasing was capitalallowances, more significantly the investment allowance, which was not available for transportvehicles. Hence, the leasing form historically clung to industrial plant and machinery

y Rupee far more stable than other currencies in the Asian region.Most of the global majors who entered Indian leasing have focussed on the vehicles segment.Citibank has been active in cars financing for last decade or so; recently branched out incommercial vehicles also. GE Capital began by acquiring a prominent commercial vehiclesfinancing company, and has since been out buying portfolios of many small and regional playersthrough securitisation option.The machinery segment has unlimited scope for growth, currently not being tapped by lessorsdue to bad experience in the past. The past experience was due to lack of good credit analysisand management. Acquisition of a corporate financing company by ICICI, one of the premieredevelopment finance companies, should lead to an organised focus on machinery leasingsegment. Needless to say, any one that enters this segment with adequate capital and technology,and more significantly, at volumes which justify very sound credit management, would find ahuge untapped

potential.Infrastructure financing is another area where foreign entry will be welcome. There is only onecompany currently devoted to infrastructural needs. With massive government plans to developinfrastructure, long-term investors in infrastructural segment will find good market, secureclientele mostly with government backing, and reasonably good rates of return. Leasing as a tax-shelter: Though substance-over-form is the general dictum followed in tax laws in India as for most other countries, India does not have a set of well-defined guidelines as to what constitutes a true leasefor tax purposes. Hence, most leases, even though they are intrinsically financial leases, qualifyas eligible for capital allowances which are granted to the owner of the capital asset. The onlypractical exception to this rule is a hire-purchase transaction, where an option to buy is clearlygiven to the hirer.In any financial lease, the lessors recovery from the lessee is partly his real income and partlyrealisation of his own capital. The latter, though not an income in true sense, if offered for tax, aspart of the whole realised by the lessor and accounted for as lease rental. This is the tax loss thelessor suffers. As against this, the lessor has a tax gain in form of the capital allowances. Over n number of years, the sum total of capital allowances charged necessarily has to equal to thecapital recovery which in turn is the capital invested in the transaction. Hence, the tax benefitequals the tax loss, over a number of years. However, by its very nature as the residue left after recovery of the finance income, the capital recovery takes a back-heavy pattern. On the other hand, capital allowances for tax purposes normally, and universally for India, have a frontheavypattern. This results into a timing difference between the tax gain and the tax loss, the net being again in the initial years of the lease and an accelerating loss over the later part of the lease.The actual value (computed in present value terms) of this tax deferment may not be significantat all, and in Indian situation, it is mostly a zerosum game. But so great is the psychologicalvalue of the tax deferment that there is an irresistible tendency to write leases for the sake of taxbenefits.

Thus, it is possible to say that the absence of any cogent rules for distinguishing between trueleases and financial leases, the tax system has propelled demand for leases in quite a number of ways:1. All non-banking finance companies, and a number of public sector financial institutionshave resorted to leasing for the sake of immediate tax relief.2. There being no restrictions on utilisation of leasing tax shelter against other incomes, alot of other players one-off lessors have also used leasing to a substantial extent.3. Psychological motivation for deferring taxes, though the difference is merely a timingdifference, has been aided by two significant quantitative factors: o The absence of deferred tax accounting rules, whereby the tax deferred can beclaimed by the managers as income earned by them, with all resulting distortionsin EPS, reported net worth, etc. o Over last few years, tax rates have come down from 51.75% to 35%, adding acash value component to the present-value of tax deferments.1. All the more significantly, India has continued to have, despite of several reportedinstances of abject misuse, a 100% depreciation rate attributable to energy-savingdevices, pollution control devices, etc. These have obviously been the centre-point of attraction for taxdeferment by leasing. T rue lease guidelines: The explosive growth in tax-triggered lease transactions over past 4-5 years has today made mostlessors wiser, albeit in a very hard way. One is the unavoidable realisation that all tax defermentsare a transient timing advantage, which, when ultimately reversed, becomes all the more painfulbeing an unprovided liability. Two, and clearly more significantly, the asset and credit quality intax-oriented lease transactions was sub-standard, in many cases, resulting into

total loss of principal for the lessors.A product which has its economic substratum purely in tax benefits is no healthy development ina system. No one, therefore, favours the current scene where a complete silence on the issuefrom the Central Board of Direct Taxes leaves every tax officer to use his own discretion inletting a transaction pass. In result, as some of the assessments made in March 1998 would show,there are as many Income-tax laws as are the assessing officers: it is rules of persons and not ruleof law that is prevailing.In November 1995 the CBDT had mooted the proposal of importing the accounting definition of a financial lease into the tax statute and qualifying an operating lease, not a financial lease, for tax benefits. As there was (and is) no operating leasing in the country, this was seen as a debaclefor the leasing industry. There was heavy opprobrium, and this approach was dumped. Inretrospect, it is worth arguing whether there was any merit in the CBDTs approach. There is nodoubt that lessors have lost crores of shareholders money in chasing tax-based transactions intodead end. So, a possible argument is that if tax benefits to leasing would have been denied, theloss of money in bad tax-motivated deals could have been saved. The fallacy of this argument is that it seeks to kill an instrument because of its possible misuse. It sounds like saying: becausethere are so many frauds in taxes, therefore, why have taxes?Any tax benefit, and the possibility of its misuse, would always co-exist, and that is why we needa clear and articulate law and a strong enforcement.India, therefore, urgently needs a standard for distinguishing a tax-true-lease from a plainfinancing transaction. Obviously, the hire-purchase-lease distinction is not enough. And such aguideline would be to every ones advantage: the tax officers would have a clear guidance for themselves, and the tax-payers can have a better idea of whether their lease will have a safeharbour Sales-tax on lease transactions: the biggest irritant: Today, the single biggest threat to the leasing industry is sales-tax on lease transactions. Whilethere is no theoretical justification for imposition of sales-tax leases, which is necessarily amulti-point levy, the singularly-revenue-sided approach of the States in taxing, and in most caseswithout Constitutional authority, lease transactions to a 4% - 15% sales-tax levy makes a leasetransaction wholly unviable.Looked at minutely, sales-tax levy is also responsible for a

lot of structural aberrations in theleasing industry, including the motivation to write underpriced tax-oriented transactions notedearlier. It goes as under: since sales-tax on a lease pushes up the cost of the lease by some 4% -10% points (say, a cost of 20% IRR becomes 24% IRR), it becomes impossible to market agenuine lease to a discerning client with good number of other funding options. Hence, all focusis diverted, either (a) to write tax-based leases where the tax benefit will allow the lessor tounderprice the lease and retain its viability inspite of sales-tax; or (b) lessors will be forced toshift to unbankable transactions such as sale and leasebacks.Under the present system of sales-tax, a lessor would necessarily buy the goods to be leased atthe least tax which the lessee would have paid on a direct purchase. Hence, there is no loss of sales-tax to any government because of leasing. So, whatever taxes are charged on lease rentalsare additional and multi-point levy.Currently, sales-tax on lease transactions has not been imposed under the Central Sales-tax Actwhich is supposed to tax transactions of inter-State nature. Many lease transactions have an inter-State nature, and are thus, outside the taxing competence of the States, and yet, the latter taxthem. The States have been taking undue advantage of the prevailing uncertainty in interpretationof what would make a lease an inter-State lease. Normally, in any uncertainty in taxes, it is thetax payer who gains, but here, for some strange reason, the entire uncertainty is operating to thebenefit of the State govts.Leasing, and sales-tax on it, cannot go together for long: they will soon be parted. Therefore, it isurgent that the following be done: a. The States need to realise that they do not lose anything that they would have gained inabsence of leasing: therefore, they should be contented with the industrial developmentthat leases result into, and not make leasing itself a target of revenue. Hence, the Statesneed to exempt leases of such goods which have already suffered tax in the State.Maharashtra, Tamil Nadu, Karnataka and Gujarat (by set-off) have done so already.Other States need to follow.b. The Central Govt. needs to define leases under the CST Act, define principles under which lease will be regarded as inter-State, and

declare leases as taxable only to a singlepoint levy, and fix the limit therefor.