Lease Financing

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
Leasing as financial service is a contractual agreement where the owner (lessor) of equipment transfers the right to use the equipment to the user (lessee) for an agreed period of time in return for a rental. At the end of the lease period the asset reverts back to the lessor unless there is a provision for the renewal of the contract or there is a provision for the transfers of ownership to the lessee. If there is any such provision for transfer of ownership, the deal is treated as hire purchase. Therefore, a lease could be generally defined as “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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Lease Financing 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.

HISTORY AND DEVELOPMENT OF LEASING
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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Lease Financing 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.

ELEMENTS IN LEASE STRUCTURE
This is an explanation of the elements in a lease - the parties, asset, rentals, residual value, etc. This section would also elaborate the unique features of a lease as different from a regular financing transaction.

1. The transaction:
The transaction of lease of lease is generically an asset-renting transaction. What distinguishes a lease from a loan is that in the latter, what is lent out is money; in a lease, what is lent out is the asset.

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.

Ownership is no pre-condition for leasing:

Technically, in order to be a lessor, one does not have to own the asset: one has to have the right to use

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Lease Financing the asset. Thus, a lessee can be a lessor for a sub-lessee, unless the parent lessor has restricted the right to sub-lease.

3. The leased asset:
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. The concept of leasing will have the following limitations: 1. What cannot be owned cannot be leased. Thus, human resources cannot be "leased". 2. While lease of movable properties can be affected by mere delivery, immovable property is incapable of deliveries in physical sense. Most countries have specific laws relating to transactions in immovable properties: if such law provides a particular procedure for a lease of immovable or real estate, such procedure should be complied with. For example, in Anglo-Saxon legal systems (UK, Australia, India, Pakistan, etc.), transactions in real estate are not valid unless they are effected by registered conveyance. This would apply to lease of land and buildings, and permanent attachments to land. 3. A lease is structurally a rental for the lease period: with the understanding that the asset will be returned to the lessor after the period. Thus, the asset

Leasing of immovable properties may have complications:

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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.

Leased asset is a necessary precondition:

The existence of the leased asset is an essential element of a lease transaction - the asset must exist at the beginning of the lease, during the lease and at the end of the lease term. Non-existence of the asset, for

whatever reason, will be fatal to the lease.

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. In financial leases, is common to differentiate between the primary lease period and the secondary lease period. The former would be the period over which the lessor intends recovering his investment; the latter intended to allow the lessee to exhaust a substantial part of the remaining asset value. The primary period is normally non-cancelable, and the secondary period is normally cancelable.

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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Lease Financing 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. If it is an operating lease transaction, the rentals might include several elements depending upon the costs and risks borne by the Lessor, such as:
• •

Interest on the lessor's investment. If the lessor is bearing any repairs, insurance, maintenance or operation costs, them charges for such cost. Depreciation in the asset. Servicing charges or packaging charges for providing a package of the above service.

• •

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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Lease Financing 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:

Option to buy (buyout option) at a bargain price or nominal value (typical in a hire-purchase transaction), called bargain buyout option Option to buy at a fair market value or fixed, but substantial value Option to renew the lease at nominal rentals, called bargain renewal option Option to renew the lease at fair market rentals or substantial rentals Option to return the equipment

• •

• •

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.

Buyout option may characterize the lease as hire-purchase:

However, in many jurisdictions, it is the existence of such buyout option that demarcates between lease and

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Lease Financing hire-purchase transaction. If the lessor is interested to structure the lease as a lease and not hire-purchase, he would be advised not to provide any buyout option, but instead, to allow the lessee to renew the lease to continue the use of the asset. In essence, a renewal option achieves the same purpose as a purchase, but the lessor retains his ownership as also his reversionary interest in the equipment. 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:
• • • •

Initial lease rental or initial hire or down payment Advance lease rental Security deposit Initial fees The initial lease rent or initial hire (the word hire is more common in case of hire-purchase transactions) is a surrogate for a margin or borrower contribution

Margins in leases are taken as initial rental:

in case of loan transactions. Note that given the nature of a lease or hire-purchase as asset-renting transaction, it is not possible to expect a lessee's contribution to asset cost as such. Hence, the down payment or first lease rent serves the purpose of a margin.

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Lease Financing 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. The security deposit is a proper deposit to secure against the lessee's commitments under the contract - it is generally intended to be refunded at the end of the lease contract.

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Lease Financing

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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Lease Financing 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' Financial leases are "loan look-alike": However, financial leases, though being leases by structure, are financings by contrivance. To achieve the financing purpose, the leasing structure here tries to eliminate the substantive differences between leasing and plain financings 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 primary and secondary lease period :

The first 5 years are called the primary lease period and the extended period is called the secondary 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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Lease Financing

Full payout lease:

The lessor too has no significant risk/reward other than that 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. Incidentally, in the present example, the lessor gets a return

The IRR:

of 12.98% - this is equivalent to the rate of interest in case of loans. As this rate is not explicit, but implicit in the rate of rentals, the rate is implicit rate of return or IRR.

Features of financial leases: The above discussion leads to the following features of financial leases: 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 lessor takes no asset-based risks or asset-based rewards. He only takes financial risks and financial rewards, and that is why the name financial leases. 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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Lease Financing 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. Financial leases are technically different but substantively similar to secured loans. Financial leases and Hire-purchase: In some countries, distinction is made between lease and hire-purchase transactions. A hire-purchase transaction is usually defined as one where the hirer (user) has, at the end of the fixed term of hire, an option to buy the asset at a token value. In other words, financial leases with a bargain buyout option at the end of the term can be called a hire-purchase transaction.

Hire-purchase and financial leases compared

Hire-purchase is decisively a financial lease transaction, but in some cases, it is necessary to provide the cancellation option in hire-purchase transactions by statute: that is, the hirer has to be provided with the option of returning the

asset and walking out from the deal. If such an option is embedded, hire-purchase becomes significantly different from a financial lease: the risk of obsolescence

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Lease Financing 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. Hire-purchase is of British origin - the device originated much before leases became popular, and spread to countries which were then British dominions. The device is still popular in Britain, Australia, New Zealand, India, Pakistan, etc. Most of these countries have enacted, in line with United Kingdom, specific laws dealing with hire-purchase transactions.

DIFFERENCE BETWEEN LEASE FINANCING AND HIRE PURCHASE
BASIS LEASE FINANCING A Lease transaction is HIRE PURCHASE a Hire purchase is type of

Meaning

commercial arrangement, whereby installment credit under an equipment owner or manufacturer which the hire purchaser conveys to the equipment user the agrees to take the goods right to use the equipment in return on hire at a stated rental, for a rental. which is inclusive of the repayment of principal as well as interest, with an option to purchase.

No option is provided to the lessee Option is provided to the

Option To User

(user) to purchase the goods.

hirer(user).

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Lease Financing

Lease rentals paid by the lesee are Only

interest in

element the hire

Nature Of Expenditure

entirely lessee.

revenue

expenditure

of included

purchase, installments is revenue expenditure by nature.

Lease rentals comprise of two Hire purchase installments

Components

elements (1) finance charge and (2) comprise capital recovery. elements

of (1)

three normal

trading profit (2) finance charge (3) recovery of cost of goods/assets.

Substance of financial lease:
If financial leases are substantively so close to secured financing transactions, the categorical issue is: why should they be treated as a lease at all? Why should they not be regulated, taxed and accounted for as plain loan transactions? This question may be significant from viewpoint of :
• • • •

Regulation of financial leasing activity. Asset rights of the lessor. Taxation of the lessor/lessee. Accounting for the lease transaction.

In each case, treating the lease as a lease or, based on substance, a financing transaction, may lead to completely different implications.
o

From viewpoint of general regulation of financial leasing activity, if it is financing by another name, it should form a part of overall financial

taken as

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Lease Financing markets regulation - most countries' central banks maintain some control on financial intermediaries.
o

The asset-rights of the lessor would also be similar to those of a secured

lender, while in a plain lease contract, the lessor is the sole owner of the asset and the lessee is merely its bailee.
o

If the lease is treated as a financing transaction, the lessor should not be

allowed to claim any asset-related benefit, such as depreciation. His income should be the implicit part of rentals going towards return on investment. Likewise, the lessee, apparently a mere user of the asset, should be treated as a virtual owner and should be allowed all asset-based benefits.
o

From accounting viewpoint, if the lease is a mere financing arrangement,

the asset should feature on the Balance Sheet of the lessee rather than the lessor, along with a corresponding liability to pay fixed rentals to the lessor. Ideally, any system should be able to differentiate or integrate transactions based on their substance, and not nomenclature. So, if financial leasing is so close to lending, it should have been treated as such for every purpose, and the lessor should have been treated as a lender. 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.

In a finance lease, the lessee is responsible for repair, maintenance and insurance of the asset. The lessee also undertakes a "hell or high water" obligation to pay rental regardless of the condition or the suitability of the asset. A finance lease which operates over the entire economic life of the equipment is called a "full pay out lease".

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Lease Financing

OPERATING LEASE

The International Accounting Standards Committee defines an Operating Lease as "any lease other than a finance lease". An Operating Lease has the following characteristics: 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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Lease Financing thereon. Therefore, specializing in operating leases calls for an in-depth knowledge of the equipments per se and the secondary (resale) market for such equipments. Of course the prerequisite is the existence of a resale market. Given the fact that the resale market for most of the used capital equipments in our count~ lacks breadth, operating leases are not in popular use. But then this form of lease ideally suits the requirements of firms operating in sun rise industries which are characterized by a high degree of technological risk. Following are illustrative situations where a lease will be regarded as an operating lease:

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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Lease Financing

Differences between Finance and Operating Leases

Financial Lease
• Risks and rewards of

Operating Lease
• Economic ownership with all corresponding rights and responsibilities are borne by the lessor.The lessor buys insurance and undertake responsibility for maintenance. • The goal of the lessee is usage of the leased asset for a specific temporary need, and hence the operating lease contract covers only the short-term use of the asset. Further, the duration of an operating lease is usually much shorter than the useful life of the asset. • It is not the lessee’s intention to acquire the asset, and lease payments are determined accordingly. In addition, an asset under an operating • lease may subsequently be rented out. The present value of all lease payments is significantly less
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ownership are transferred to, and borne by, the lessee. This includes the risks of accidental ruin or damage of the asset (although these risks may be insured or otherwise assigned). Thus damage that renders an asset unusable does not exempt the • lessee from financial liabilities before the lessor. The goal of the lessee is either to acquire the asset or at least use the asset for most of its economic life. As such, the lessee will aim to cover all or most of the full cost of the asset during the lease term and therefore is likely to assume the title for the asset at the end of the lease term. The lessee may gain the title for the asset earlier, but not before the full cost of the asset has been paid

Lease Financing off. • The lessor retains legal ownership for the duration of the lease term, though the lessee may or may not buy out the leased asset at the end of the lease, with the lessor charging only a nominal fee for the transfer of asset to the lessee. • The lessee chooses the supplier of the asset and applies to the lessor for funding. This is significant because the leasing company that funds the transaction should not be liable for the asset quality, technical characteristics, and completeness, even though it retains the legal ownership of the asset. The lessee will also generally retain some rights with respect to the supplier, as if it had purchase asset directly. than the full asset price.

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Lease Financing SALE AND LEASEBACK In a sale and leaseback transaction, the owner of equipment sells it to a leasing company which in turn leases it back to the erstwhile owner (the lessee). The 'leaseback' arrangement in this transaction can be in the form of a 'finance lease' or an 'operating lease'. 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.

SELLER

SALE TRANSACTION SALE VALUE

BUYER

LESSEE

LEASE TRANSACTION LEASE RENTALS

LESSOR

Sales and Leaseback

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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Lease Financing short-term debt by medium-term finance (assuming that the leaseback arrangement is a finance lease). From the leasing company's angle a sale and leaseback transaction poses certain problems. First, it is difficult to establish a fair market value of the asset being acquired because the secondary market for the asset may not exist; even if it exists, it may lack breadth. Second, the Income Tax Authorities can disallow the claim for depreciation on the fair market value if they perceive the fair market value as not being 'fair'.

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 Financing 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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Lease Financing

Leveraged Lease

Manufacturer

Sells Asset

Lessor

Leases Assets

Lessee

Lender

Domestic Lease & International Lease
A lease transaction is classified as a domestic lease if all parties to the transaction to the equipment supplier, the lessor and the lessee are domiciled in the same country. On the other hand, if the parties are domiciled in different countries, the transaction is classified as an International Lease Transaction. The distinction between a domestic lease transaction and an international lease transaction is important for two reasons. First, packaging an international lease transaction calls for, a. An understanding of the political and economic climate; and b. Knowledge of the tax and the regularity framework governing these transactions in the countries concerned.

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Lease Financing 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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Lease Financing

LEASING TO LESEE AND LESSOR

Advantages of ‘LEASING’ to ‘LESSEE’ There are several extolled advantages of acquiring capital assets on lease: (1) Saving of capital: Leasing covers the full cost of the equipment used in the business by providing 100% finance. The lessee is not to provide or pay any margin money as there is no down payment. In this way the saving in capital or financial resources can be used for other productive purposes e.g. purchase of inventories.

(2) Flexibility And Convenience: The lease agreement can be tailor- made in respect of lease period and lease rentals according to the convenience and requirements of all lessees.

(3) Planning Cash Flows: Leasing enables the lessee to plan its cash flows properly. The rentals can be paid out of the cash coming into the business from the use of the same assets.

(4) Improvement In Liquidity: Leasing enables the lessee to improve their liquidity position by adopting the sale and lease back technique.

(5) Shifting of Risk of Obsolescence: The lessee can shift the risk upon lessor by acquiring the use of asset rather than buying the asset.

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Lease Financing (6) Maintenance And Specialized Services: In case of special kind of lease arrangement, Lessee can avail specialized services of lessor for maintenance of asset leased. Although lessor charges higher rentals for providing such services, lessee’s overall administrative and service costs are reduced because of specialized services of the lessor. (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.

Disadvantages of ‘LEASING’ to ‘LESSEE’

(1) Higher Cost: The lease rental include a margin for the lessor as also the cost of risk of obsolescene, it is, thus regarded as a form of financing at higher cost. (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. (4) Penalties On Termination Of Lease: The lessee has to pay penalties in case he has to terminate the lease before expiry o lease period.

Advantages of ‘LEASING’ to ‘LESSOR’

(1) Higher profits: The lessor can get higher profits by leasing the asset.

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Lease Financing

(2) Tax Benefits: The lessor being owner of asset can claim various tax benefits such as depreciation.

(3) Quick Returns: By leasing the asset, the Lessor can get quick returns than investing in other projects of long gestation period.

Disadvantages of ‘LEASING’ to ‘LESSOR’

(1) High Risk of Obsolescence: The lessor has to bear the risk of obsolescence as there are rapid technology changes.

(2) Price Level Changes: In case of inflation, the prices of asset rises but the lease rentals remain fixed. (3) Long term Investment: Leasing requires the long term investment in purchase of an asset, and takes long time to cover the cost of that asset

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Lease Financing

LEGAL ASPECTS OF LEASING

As there is no separate statue for equipment leasing in India, the provisions relating to bailment in the Indian Contract Act govern equipment leasing agreements as well section 148 of the Indian Contract Act defines bailment as: “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’. Since an equipment lease transaction is regarded as a contract of bailment, the obligations of the lessor and the lessee are similar to those of the bailor and the bailee (other than those expressly specified in the least contract) as defined by the provisions of sections 150 and 168 of the Indian Contract Act. Essentially these provisions have the following implications for the lessor and the lessee. 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.

CONTENTS OF A LEASE AGREEMENT
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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Lease Financing

1. Description of the lessor, the lessee, and the equipment. 2. Amount, time and place of lease rentals payments. 3. Time and place of equipment delivery. 4. Lessee’s responsibility for taking delivery and possession of the leased equipment. 5. Lessee’s responsibility for maintenance, repairs, registration, etc. and the lessor’s right in case of default by the lessee. 6. Lessee’s right to enjoy the benefits of the warranties provided by the equipment manufacturer/supplier. 7. Insurance to be taken by the lessee on behalf of the lessor. 8. Variation in lease rentals if there is a change in certain external factors like bank interest rates, depreciation rates, and fiscal incentives. 9. Options of lease renewal for the lessee. 10. Return of equipment on expiry of the lease period. 11. Arbitration procedure in the event of dispute.

STRUCTURE OF LEASING INDUSTRY
The present structure of leasing industry in India consists of (1) Private Sector Leasing and (2) Public Sector Leasing. The private sector leasing consists of: i. ii. iii. Pure Leasing Companies. Hire Purchase and Finance Companies and Subsidiaries of Manufacturing Group Companies. The public sector leasing organisation are divided into: i. ii. Leasing divisions of financial institutions. Subsidiaries of public sector banks.
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Lease Financing iii. Other public sector leasing organizations.

I. Pure Leasing Companies: These companies operate independently without any link or association with any other organisation or group of organization. The First Leasing Company of India Limited. The Twentieth Century Finance Corporation Limited, and the Grover Leasing Limited, fall under this category.

II. Hire Purchase and Finance Companies:
The companies started prior to 1980 to do hire purchase and finance business especially for vehicles added leasing to their activities during 1980. Some of them do leasing as major activity and some others do leasing on a small scale as a tax planning device. Sundaram Finance Limited and Motor and General Finance Limited belong to this group.

III. Subsidiaries of Manufacturing Group Companies:
These companies consist of two categories,

(a). Vendor leasing (b). In house leasing (a). Vendor leasing: This type of companies are formed to boost and promote
the sale of its parent companies’ products through offering leasing facilities.

(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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Lease Financing

PUBLIC SECTOR LEASING (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.

(iii). Other Public Sector Organizations: A few public sector manufacturing
companies such as Bharat Electronics Limited, Hindustan Packaging Company Limited, Electronic Corporation of India Limited have started to sell their equipment through leasing.

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Lease Financing

ACCOUNTING TREATMENT OF LEASE
Presently the accounting treatment of lease transactions in India is as follows: 1. The leased asset is shown on the balance sheet of the lessor. 2. Depreciation and other tax shields associated with the leased asset are claimed by the lessor. 3. The entire lease rental is treated as income in the books of the lessor and as expense in the books of the lessee.

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.

Background and international accounting changes on lease accounting:
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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Lease Financing 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." Leasing in India would go down in history as a clear victim of legislative inaction. It is true that governments have their own way: they do not act; they react. But it is perplexing as to how could the government sleep over the fate of multi-billion dollar industry for so many years. Look at the following hard facts:

Controversy erupted regarding leasing companies' claim for depreciation in 1995 as some companies were found to have made exaggerated claims or claims that were not genuine. The Association of Leasing and Financial Services Cos. (ALFSC) has been pleading for last 5 years that the CBDT frame rules that would help the assessing officers distinguish between genuine leases and garbed financial transactions. ALFSC has also suggested model rules drawing from several other countries. Obviously enough, there was nothing that the CBDT would have lost by enacting these rules, and nothing stood to gain by not enacting them. However, nothing has been done for last 5 years. Result: as there is no rule from the CBDT, every assessing officer, and every appellate commissioner, has framed his or her own rule. Most of these officers have looked at lease transactions with a kind of inherent vengeance: therefore, the end result is common but the reasoning is different. That is, depreciation is disallowed, for reasons that differ from case to case.

Sales-tax was imposed on lease transactions some 16 years ago. No one was clear as to how would the jurisdiction and incidence of tax be determined. We allowed the controversy to linger for all these years waiting for the Supreme Court to give a ruling only in year 2000. In the

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Lease Financing meantime, some Rs 20000 crores worth lease transactions would have been signed in the country, and obviously enough, the Supreme Court ruling that operates 16 years back in history cannot be favourable to them all. At the same time, it cannot be favourable to the States as well. Any one who understands the ruling would agree that the States would not be happy with the ruling and would force the Central Govt to alter the law, possibly with retrospective effect. Again - we let things loose and unsettled for years, and wait for a crisis-like situation, and then correct our mistakes in history.

Accounting standards for lease transactions have been in the limelight for quite a while. The ICAI has expressed its resolve to adopt in India something akin to the pre-1999 version of IAS-17. This is exactly what the Institute proposed sometime in year 1983-4. For last 16 years, the framing of accounting standards has been lurching, hit by a Court-stay for some time, uncertainty for a larger time. In the meantime, IAS 17 has already been amended. There is a new thinking internationally about lease accounting, and the pre-1999 version of IAS-17 that the Institute is seeking to adopt is in the process of being discarded world-over. In other words, we would be adopting a standard, just when the rest of the world is about to reject it.

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. In the current controversy relating to accounting standards for lease transactions, some interesting issues have cropped up. Will change of accounting standard deny tax depreciation to leases? 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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Lease Financing 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? It is today almost universally agreed that the accounting distinction between financial and operating leases has not served any purpose. As the accounting difference is based on fine mathematics, lessors and lessees world-over have devised leases which in essence are financial leases but qualify for operating lease definition. This is what prompted an Australian gentleman -McGregor - to make a cothetic argument against the financial-operating lease distinction. McGregor study became the basis for what is called "the new approach" to lease accounting. It is based on this approach that IAS 17 was revised with effect from 1999. 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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Lease Financing Can the accounting distinction be used for tax laws? It would be disastrous to adopt the accounting distinction between financial and operating leases for tax purposes. As mentioned above, the accounting distinction is based on fine mathematics which is extremely complicated and subjective. The primary test used for accounting purposes is the "present value" test. Apart from being complicated, the present value test is:

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.

Should India adopt IAS-17? 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. So there should be no apprehension as to leasing meeting an untimely death due to accounting standards being revised to meet internationally accepted norms. If anything will cause the untimely death of the industry, it is lack of regulation, leading to lack of certainty. What kind of tax treatment should be applicable to leases? As discussed before, the financial lease/ operating lease distinction would be a disaster for tax laws. For tax purposes, what is more relevant is the test of a "true lease", meaning a lease that does not reflect intent of owning and letting out an

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Lease Financing 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. The Institute of Chartered Accountants of India (ICAI) recently issued a new accounting standard no AS 19 on leases, replacing the existing Guidance Note on lease accounting. The new standard is applicable for all leases entered on or after 1st April 2001: from this, it is understood that the statement will not affect past leases. However, for practical considerations, it will be advisable for companies to switch over to the new method in respect of all lease transactions, including those which are running. 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. Internationally, lease accounting continues to be in a state of flux ever since McGregor published a new approach to lease accounting under which the traditional distinction between financial and operating leases is to become irrelevant and companies are required to record as asset or liability the fair value of benefits to be derived from a leased asset and the fair value of payments to be made under the lease agreement. In other words, if during the lease period, the benefits arising from an asset exceed the lease payments, the lease is an asset even if it is an operating lease. This would, inevitably, be true in case of a financial lease anyway.

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Lease Financing To partly implement the McGregor approach, lease accounting standards in most countries, including IAS 17, have already been revised which now requires disclosure operating leases on the balance sheet of the lessee. Further changes may be on the way, as IASB as well as the UK's Accounting Standards Board have issued approach papers to implement the McGregor approach in full.

Application of Lease In Transfer of Right And Service
The new statement applies to all lease contracts - financial or operating. As an important point, the statement also applies to all hire purchase contracts, which are essentially financial leases. The standard is applicable to all lease contracts, even if such lease involves substantial services by the lessor. On the other hand, the standard does not apply to service contracts, even if the same involve provision of right to use. The distinction between a transfer of right to use, and a service contract, is relevant for several purposes and there are some very nice interpretations of this difference. There is a lease, if I transfer the right to my asset to you. There is a service, if I use my asset for your benefit. In other words, the distinction between lease and service is based on whether the use of the asset is made by the lessee, or for the lessee's benefit by the lessor. What are the main ingredients ? The main ingredients of the accounting standard are:

As for lease transactions which are currently capitalised on the books of the lessor, the accounting will be based on financial/ operating leases. For a financial lease, the lessor will not capitalise or depreciate the asset on his books: the lessor will merely record a receivable, at the outstanding principal value. The lessee will record the asset, as his fixed asset, and depreciate the same as per usual depreciation policies of the lessee. The

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Lease Financing 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.

1. Will it have tax implications ? 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. That is to say, subject to other conditions for depreciation allowance, a lessor in a lease will claim tax benefits, even though he will not be reflecting the asset as his fixed asset on balance sheet. This also means that the lessor will be subjecting his gross rentals as income, even though he takes to profit and loss a/c only the finance charges inherent in rentals.

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Lease Financing 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. As for the lessee, though he capitalises the asset on his financial statements, he will not be able to depreciate the asset for tax purposes. Though he takes to earnings statement only the finance charges inherent in lease rentals, he will claim the whole of the rentals as expense. Thus, the new accounting standard leads to a new era of dichotomy between tax and accounting principles, and it will 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

ACCOUNTING FOR NON PERFORMING LEASES
There is no information in the guidance note on lease accounting, 1995, for nonperforming 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. The Standard provides that whereas, in general, incomes are to be recognized on the basis of accrual, in case of an uncertainty in the ultimate realization of an income, the treatment is as follows: • • 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 A lease will be regarded as a non-performing asset based on overdues for more than 12 months. That is, if dues under a lease or hire purchase transaction remain unpaid, fully or partly, for more than twelve months, the transaction will be treated as a non-performing asset. The twelve month time frame is markedly longer than the general international standard of 3 months only. If the lease transaction is a non-performing asset, there is a four-fold impact on the revenue/provisioning requirements: No income shall be recognized on an accrual basis-income recognition will shift to cash or accrual basis.

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Income already recognized, and lying unrealized, will be reversed-this, in accounting sense means the income recognized will be provided for. Notably, in case of lease transactions, the income that requires reversal is only the financial charge element inherent in the rentals, not the entire rental. 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 : ⇒ Rentals are overdue up to 12 months ⇒ Sub-standard assets : where any amounts of hire charges or rentals are overdue for more than 12 months but up to 24 months ⇒ Doubtful assets : Where any amounts of hire charges or lease rentals are overdue for more than 24 months but up to 36 months ⇒ Where any amounts of hire charges or but up to 48 months ⇒ Loss assets: Where any amounts of hire charges or lease rentals are overdue for more than 48 months 100 percent of the net book value 70 percent of the rentals 40 percent of net book value the 10 percent of the lease net book value Nil

lease are overdue for more than 36 months net book value

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TAXATION IN TERMS OF LEASING: 1. Basic tax treatment of lease and hire-purchase transactions:
The tax treatment of lease transactions in India is based on whether the lease qualifies as a lease or will be treated as a hire-purchase transaction. If the transaction is treated as a lease, the lessor shall be eligible for depreciation on the asset. The entire lease rentals will be taxed as income of the lessor. The lessee, correspondingly, will not claim any depreciation and will be entitled to expense off the rentals. If the transaction is a hire purchase or conditional sale transaction, the hirer will be allowed to claim depreciation. This is based on an old Circular of the Dept. issued in year 1943. The financing charges inherent in hire instalments will be taxed as the hire-vendor's income and allowed as the hirer's expense.

2. Depreciation in case of Leasing and hire-purchase transactions: Being the sole determinant of the tax treatment of leases, the distinction between lease and hire-purchase transactions becomes extremely important. Essentially, the distinction is based on the beneficial ownership of the asset. In order to qualify for depreciation, the lessor has to establish himself to be both the legal and beneficial owner of the asset. As in a hire-purchase transaction, the lessor allows to the lessee the right to buy the asset at a nominal price, it can be seen that the lessor has parted with the whole of his beneficial interest in the asset. The lessor will not be able to benefit from the asset during the lease period (as there is a committed right to use to the hirer), and beyond the lease period (as there is a right to buy the asset with the hirer). Having thus permanently divested himself of his beneficial rights, the lessor becomes ineligible to claim depreciation. As it is the beneficial ownership rights of the lessor that is crucial, the distinction between lease and hire-purchase goes beyond the mere existence of option to buy

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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.

3. Depreciation allowance on lease transactions:
A lease qualifying as true lease will entitle the lessor to claim depreciation. The true lease conditions and the conditions generally applicable for depreciation as such are not independent - the former are drawn essentially from the latter. 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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5. Sale and leaseback transactions:
Sale and leaseback transactions came under a lot of flak during 1995-96, when transactions in junk funding were being labeled as sale and leasebacks at phenomenal values. The Income-tax law was amended to insert a specific provision about sale and leasebacks, which now restricts the amount with reference to which depreciation can be claimed in a sale and leaseback transaction, to the written down value in the hands of the seller-lessee. That is, the actual cost of the asset to the lessor will be ignored, and instead, depreciation will be allowed on the seller's depreciated value. 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.

6. Deduction of rentals by the Lessee:
In general, in a lease, the lessee will be allowed to claim the rentals as an expense. This is subject to general rules of reasonableness and the power of the tax officer to invoke substance of a transaction ignoring its legal form. One important case where the claim by the lessee for rental was disallowed is Centre for Monitoring of Indian Economy case, where based on the fact that the lease had partaken the character of acquisition of the asset by the lessee, the lessee's claim for lease rentals was disallowed. 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 hirepurchase in the latest First Leasing Company of India case. Therefore, most likely

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Lease Financing the Centre for Monitoring of Indian Economy case will not be able to withstand at higher judicial forums

SALES TAX PROVISION PERTAINING TO LEASING:

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. a. Levy of Sales Tax: Sales Tax is leviable when goods are sold. Thus there must be " Goods and there must be a sale. "Goods” include all types of movable property. “Sale " means a transfer of property in goods from one person to another for a consideration. But Sales Tax is leviable only on a person who is a dealer. A casual transaction by a non-dealer is not subject to Sales Tax. Thus, if an individual salary earner sells off his personal car, there is no Sales Tax attracted. To summarize, Sales Tax is leviable on sale of goods by a dealer.

b. Sales Tax on financial leases:

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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.

c. Sales Tax on Lease V/s. Hire Purchase Transactions:
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 salestax difference, it is important that the sales-tax implications are analyzed before choosing the instrument or concluding the transaction.

Government Jurisdiction in levying Sales Tax :  In a sale outside India or in the course of import into or export out of India. If the sale is outside India or in the course of import into India or export out of India , India cannot tax such a sale.  Sale within a State : If the sale is within a state then that state has the power to tax it.  Sale in the course of inter state trade: If the sale takes place in the course of Inter state trade, the Central Government can tax such a sale. However, there is no administering machinery of the Central Government to administer inter state sale tax. The same is delegated to the state governments. 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.

Sales Tax Rates : Since under the sharing arrangement all the CST collections are retained by the state concerned, states have been allowed to reduce the CST rates and also give exemptions. So while as a general rule CST is 10% or such higher rate if the State charges a higher rate of tax on the local sale of the subject goods; or 4% with C Form, this could vary from state to state. But the State Government cannot increase the Central Sales Tax from 10/4 % in any case. Therefore, NBFC’s will have multiple CST assessments, one in each state from where goods move.
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Lease Financing

NBFC’s shifting jurisdiction: As explained, the jurisdiction in Inter state transaction is in the state where movement of goods commences. But NBFCs can shift the jurisdiction from all states to say Maharashtra.

This can be done by endorsement of the LR during transit. If endorsement is done the jurisdiction shifts to the place where endorsement was made. Thus NBFCs could instruct the Supplier to send goods physically to Customer and hand over the LR in our name at our Bombay address. NBFCs will then endorse the Consignee copy of the LR in favour of the Customer and forward it to the Customer. The Customer will claim the goods from the transporter by producing this endorsed LR.

Service Tax on Lease Transactions Service Tax on Lease Transactions with effect from 1st July, 2001: Everyone knew, though without any clue to the reasons that the Finance Ministry officials are not particularly very sympathetic to leasing and hire purchase, but no one ever thought that the Finance Minister had this provision up his sleeve. No one could have even apprehended this hearing him deliver his Budget Speech. But it is there in the fine print - a 5% service tax on the gross receivables of leasing and hire purchase companies. 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.

Constitutional validity to be questioned: Surprisingly enough, leasing as well as hire purchase are not a part of services under the Constitution - as they are defined as "sales" in the Constitution and are liable to sales-tax. Service tax cannot be imposed on leasing and hire purchase activities as they are defined as sales under the Constitution and the Constitution places restrictions on tax on sale or purchase of goods - leasing and hire purchase being defined as sale and purchase of goods. The Central Govt's right to tax such sales is only limited to inter-state transactions with the States having the right to tax intra-state transactions. The receivables from lease and hire purchase transactions are therefore, sale revenues under the Constitution, and they cannot be taxed as value for services.

Gross value of services Does this mean, in case of a bank, even the repayment of the loan is to be charged to service tax? Not really. First of all, because bank loans are not even included in the definition of financial services. And two, because the splitting of interest and principal is defined in the bank's loan agreement. In case of hire purchase, the splitting of interest and principal is an accounting adjustment, and is not recognized in law as interest or principal. In case of lease transactions, the lease rental is surely the gross value for the leasing service. So as it seems, leasing and hire purchase companies better pack up - since they have to shell out a 5% of their own principal, and 5% of their income, to the Government before they can take up anything to their revenue account.

INCOME TAX PROVISIONS RELATING TO LEASING:

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Lease Financing

The principal income-tax provisions relating to leasing are as follows: 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’ depreciation on the investment made in leased assets. 3. The lessor can claim investment allowance (this may be doubtful) and

LEASING IN RELATION TO BANK FINANCE

With both leasing and bank financing involving credit decisions and financial risks, the key differences are that two additional factors apply to leasing companies:

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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.

The Difference between Financial Leasing and Loans
From the lessee’s perspective, there is only one substantive difference between a loan and a lease: with a loan, the asset belongs to the borrower, whereas with a lease, the asset belongs to the lessor. The many similarities between a loan and a financial lease include: ■ The lessee and borrower have the choice over the acquisition of the asset. The borrower and lessee (providing the terms of the lease are met) would be able to retain the asset once payments are complete. ■ Over the period of both a loan and a lease, interest and capital (equipment cost) are repaid. ■ Should there be default on either a loan or a lease, as long as the loan is secured,

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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
Leasing has great potential in India. However, leasing in India faces serious handicaps which may mar its growth in future. The following are some of the problems.

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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.

2. Lack of Qualified Personnel:
Leasing requires qualified and experienced people at the helm of its affairs. Leasing is a specialized business and persons constituting its top management should have expertise in accounting, finance, legal and decision areas. In India, the concept of leasing business is of recent one and hence it is difficult to get right man to deal with leasing business. On account of this, operations of leasing business are bound to suffer.

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 treated as a pure lease transaction. Accordingly a heavy stamp duty is levied on lease documents. This adds to the burden of leasing industry.

5. Delayed Payment and Bad Debts:
The problem of delayed payment of rents and bad debts add to the costs of lease. The lessor does not take into consideration this aspect while fixing the rentals at the time of lease agreement. These problems would disturb prospects of leasing business.

The current problems of Indian leasing could be listed as follows, again without any order of listing:
Asset-liability mismatch: Most non-banking finance companies in India had relied extensively on public deposits -this was not a new development, as the RBI itself was constantly encouraging and supporting the deposit-raising activities of NBFCs. If the resulting asset-liability mismatch, to everybody's agreement, is the surest culprit of all NBFC woes today, it must have been a sudden realization, because over all these years, each Governor of the RBI has passed laudatory remarks on the deposit-mobilization by NBFCs knowing fully well that most of these deposits were 1-year deposits while the deployment of funds was mostly for longer tenures. It is only the contagion created by the CRB-effect that most NBFCs have realized that they were sitting on gun-powder all these years. The sudden brakes put by the RBI have only worsened the mismatch.

Generally-bad economic environment:

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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.

Poor and premature credit decisions in the past: 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

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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!

Extraneous problems - frauds, closures and regulation: 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

.

PLAYERYS IN THE INDIAN LEASING INDUSTRY

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Lease Financing There is a shake out in the market at the moment-90% of which is complete. Today there are close to 800 leasing companies in the market of these, about 5060 companies operate on a national level. This figure once stood at 4000. This is an indicator of the enormity of the shakeout in the market. The top ten players in the market account for about 65% of the market.

Company Name

Volume Of Business (Rs. In Crores

Asset Leased

Categories Average

Nature

Of

Lease Tenor Leases

TATA FINANCE

approx) 500

Aircrafts 100% Depreciable Assets Infrastructural Equipment Equipment Computers Commercial Vehicles

8-10 Years

Financial Operating

L

&

T 30 20

5 Years 3-4 Years

Financial Operating Financial

FINANCE KOTAK MAHINDRA ICICI

1500

Capital Equipment Ships Aircrafts Railway Wagons Vehicles Equipment Computers
62

5-10 Years

Financial

FIRST LEASING

150

3-5 Years

Financial

Lease Financing

IL & FS

500

Plant & Machinery 5-7 Years Ships Aircrafts Power Equipment Vehicles Plant & Machinery

Financial Operating

ASHOK LEYLAND FINANCE CHOLAMUNDULUM FINANCE SREI INTERNATI ONAL

50

5-7 Years

Financial

50

Vehicles Computers Equipment Construction Equipment 100% Depreciable Assets

5 Years

Financial Operating

30

5 Years

Financial

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Lease Financing

LEASING: TOUCHING THE PEAK
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. Though it is currently passing through a testing time, leasing has had an undeniable role in Indian economy. From consumer finance to small industry, heavy industry to automobiles, from railways to electricity boards, almost every sector of the economy has utilized leasing as its source capital. Having attained an average over-30% growth rate over past 7 years, Indian leasing has reached the 14th largest place in the World, a fact which is least realized by most.

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.

Factors that contributed to growth of Indian leasing:
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.

Buoyant growth in capital expenditure by companies :

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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.

Fast growth in car market:
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:
India continues to have unclear distinction between a lease that will qualify for tax purposes, and one which would not. In retrospect, this is being realized as an unfortunate legislative mistake, but the absence of any clear rules to distinguish between true leases and financing transactions, and no bars placed on deduction of lease tax breaks against non-leasing income, propelled tax-motivated lease transactions. There was a growing market in sale and leaseback transactions, which, if tested on principles of technical perfection or financial prudence, would appear to be a shame on everyone's face.

Optimistic capital markets:
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

Access to public deposits:

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).

A generally go-go business environment:
At the backdrop of all this was a general euphoria created by liberalization and the economic policies of Dr. Manmohan Singh.

Leasing in Emerging Economies:
Emerging economies face several challenges, including the need for investment. This is compounded by an under-capitalized banking system that is only able to offer its potential clients a limited range of products. In turn, small and medium-size companies possess insufficient collateral or credit history to access more traditional bank finance. This results in a shortage of credit available to domestic entrepreneurs. Developing the leasing sector as a means of delivering finance increases the range of financial products in the marketplace and provides a route for accessing finance to businesses that would otherwise not have it, thus promoting domestic production, economic growth, and job creation. In addition, many developed countries suffer from underdeveloped or imperfect legal institutions. Although in principle secured lending and leasing should be roughly equivalent in terms of risk, in many jurisdictions experience has shown that legal ownership is recognized by all participants, especially courts, more readily and consistently than secured lending. This can reduce the risk to lenders (lessors) considerably. The value of this advantage of leasing should not be underestimated, particularly in more challenging environments.

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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

LEASING COMPANIES- CASE STUDY

IL&FS- Infrastructure Leasing & Financial Services Ltd. Overview A financial giant, IL&FS’s mandate is to ensure an atmosphere with financial backing including funding to create a world-class infrastructure. The management concluded that an important aspect of infrastructure is education and created a company IL&FS ETS to look after this important aspect. 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. Challenges and Requirements 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. Web Access Role

Web Access decided to test its baseline, “If you can dream it, we can do it”. It accepted the challenge with a broad outline target. It also agreed to something unthinkable in the IT industry. An evolving requirement with a locked in time and cost estimation. We managed to successfully create 3 different software with multiple modules by working closely with the KDC team in developing the evolving framework and creating requirement specifications in a iterative and

70

Lease Financing

evolving manner. Benefits and Outcome

K-Creator, K-Class and K-Content together constitute a learning environment that is unique. It uses the latest technologies, but is customised to be used even by teachers in rural India with zero knowledge of computers. It supports the many languages that India has, whilst allowing the students to seamlessly use and enjoy the system, without formal computer training. It is a good example of unity in diversity that makes India unique.

CSI LEASING COMPANY
Leasing IT Doesn't Have to be Difficult CSI Leasing Customer:
• •

Leading supplier to the automotive industry 2,500 employees in 50 locations worldwide

The Problems By using several technology lessors, this IT department found itself in asset management chaos. By choosing to lease its PC’s and laptops directly from the captive finance arm of the manufacturer, this $600 million company believed it had found the most convenient solution for its IT leasing needs. It quickly learned, however, that its organization was not quite big enough to garner much attention from the captive leasing company. Equipment orders were delayed. Shipment locations were consistently incorrect. Invoices were confusing and often late. Since no single dedicated account manager was assigned to the business, it took multiple calls to multiple departments at the captive finance company to correct ongoing errors.

71

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. How CSI did it: 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

PROLOGIS-Leasing & Property Management
Honda Honda’s Easy Transition to New ProLogis Distribution Facility: In September 2005, Honda Logistics UK was based in an old converted factory in Swindon and planning to move to new premises in the town. ProLogis learned of Honda’s requirement while in the process of buying 42 acres of land at South Marston, an established commercial location to the North West of Swindon. Only five miles from Junction 15 of the M4 – and next door to Honda’s own giant manufacturing plant producing the new Honda Civic –South Marston would be Honda’s ideal location. Armed with a detailed understanding of Honda’s needs, ProLogis explained its way of working and ability to deliver before the crucial lease break of April 2006. The ProLogis team demonstrated how it could incorporate fit-out into the package and still provide substantial savings to Honda. Crucial lease break: 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. The warehouse incorporates 21,000 sq ft (1951 sq m) of offices on three stories. Amenity areas include a canteen, a fully-equipped kitchen, showers, lockers and administrative accommodation. In addition, Honda required a mezzanine space of 23,400 sq ft (2,175 sq m) inside the warehouse, along with dispatch offices and extensive plant areas. ProLogis arranged all the fit-out, including gas-fired ambient heaters and racking along with an area of strengthened slab to accommodate future racking. The building is fully sprinklered. 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

Cherokee Carpet Industries
Company Background: Cherokee Carpet Industries of Dalton, Georgia is a manufacturer of residential and commercial carpeting. With 315 employees, Cherokee Carpet Industries boasts $50 million a year in revenues. In its five years in business, Cherokee Carpet has grown rapidly. 1999 was the first year that Cherokee Carpet will have audited financial statements. As a closely held and highly leveraged S-corporation, to grow its company, Cherokee was looking for strategic financing methods that would position the company for the next level. Since its inception, Cherokee has leveraged the benefits of leasing as a strategy to grow the company. At present, the company leases $150,000 annually in equipment. What was the Need? 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. Cherokee recognized equipment leasing would provide tax benefits as well as preserve operating capital. The primary reason Cherokee Carpet chose to lease versus purchase the industrial piece of equipment was because as the company was rapidly expanding, leasing offered Cherokee Carpet the ability to maximize cash flow. Therefore Cherokee Carpet had more capital

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Lease Financing available for the operation of the company and for business growth investments. What were the Terms of the Lease:
CIT Group, the equipment leasing company, structured the lease to help Cherokee Carpet Industries minimize its capital requirements. The lease was negotiated to the terms of a seven year capital lease with an early buy out (EBO) option at three and five years and limits on fair market value.

Results: Leasing equipment as a financing option afforded Cherokee Carpets the ability to leverage their capital, increase cash flow and maintain more funds for business expenditures. CIT, was able to customize a program to meet Cherokee Carpet's financial and equipment needs.

East Texas Copy Systems (ETCS) and Canon Financial Services, Inc. (CFS)
Company Background: East Texas Copy Systems (ETCS) of Tyler, Texas is an authorized Canon Dealer of digital networked office equipment. With 15 employees, ETCS services large quantity accounts, such as hospitals, school districts, city and county governments and major industries. One of ETCS' largest customers, a non-profit health system, was looking to take advantage of leasing equipment as a means to minimize cash outlay and acquire 400 copiers and facsimile machines, as well as to structure a deal

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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. What was the Need? 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. ETCS needed a flexible, all-cost included leasing program in order to meet its customer's requirements. When considering financing options, the health system also looked at acquiring the copiers using a bank line of credit; however, leasing the equipment from Canon Financial proved to be a more flexible and process efficient solution. What were the Terms of the Lease: The challenge of meeting the customers billing needs was to integrate an aggregate cost-per-copy billing cycle with individual cost center reporting. Canon Financial structured the lease to meet the billing needs defined by the health system. Each copier was billed with individual reporting to its own cost center. Aggregate pricing was based on lease volume within a 60-day period; thus, lowering the lease price as the hospital continued to order copiers. Canon Financial Services' flexible invoicing accommodated the hospital's payment terms, thus avoiding administrative delinquency, which had been a problem with the hospitals previous financing source.

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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."

Hardware Leasing Company
The Leveraged Lease Spacemakers of Kuwait is the largest independent owner-operator of large-scale automated self-storage complexes in the greater Kuwait City area. The company opened its first self-storage complex in Kuwait in 1994 and now has facilities throughout downtown Kuwait City and nearby residential areas. The business is based on a franchise management company based in Cincinnati, USA.
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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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CONCLUSION: FUTURE OF LEASING
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. Cross-border competition will come in two forms: direct cross-border transactions, and cross-border investments in lease transactions. A number of global leasing giants have already occupied their positions in India. Capital account convertibility measures will precipitate the process. The impact of foreign investments will be greater consolidation activity at home. 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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Lease Financing equipment leasing market and line up with suppliers of equipment. Vendor leasing in time to come will be a very significant part of the leasing market. 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. The intensity of price-based competition will be split between the corporate finance market and the consumer finance market. The latter has always placed emphasis on service, accessibility, and nonquantifiables of that sort, but the corporate finance market consists of a professional treasury manager who will have to justify the cost of money to his boss. So far, leasing has continued to sell itself on several intangibles as speed, smile, and simplicity, but corporate finance quickly moves to a dilemma where every one is fast, everyone smiles and every one is simple enough for the sophisticated audience. It is there the price becomes decisive. Leasing, with all its cost additives as sales tax and stamp duties, will have to sustain as a cost-competitive financing option. 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

This project is the mixture of theoretical as well as practical knowledge. Also it contains ideas and information imparted by the guide. The secondary data required for the project was collected from various web sites and the book of reputed author. The project started with sorting all the raw data and arranging them in perfect order. To add value to the project and to understand the practicality of LEASE FINANCING

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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. LEASE RATE (Rental Payment) 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 The user of the equipment being leased. 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 In this type of lease, the lessor provides an equity portion (usually 20 to 40 percent) of the equipment cost and lenders provide the balance on a nonrecourse debt basis. The lessor receives the tax benefits of ownership. 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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Lease Financing 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 The value of an asset at the conclusion of a lease. SALE-LEASEBACK An arrangement whereby equipment is purchased by a lessor from the company owning and using it. The lessor then becomes the owner and leases it back to the original owner, who continues to use the equipment. SALES-TYPE LEASE A lease by a lessor who is the manufacturer or dealer, in which the lease meets the definitional criteria of a capital lease or direct financing 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 A working relationship between a financing source and a vendor to provide financing to stimulate the vendor's sales. The financing source offers leases or conditional sales contracts to the vendor's customers. The vendor leasing firm substitutes as the captive finance company of a manufacturer or distributor through the extension of leasing to customers, provisions of credit checking, and performance of collections and operational administration. Also known as lease asset servicing or vendor program.

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Lease Financing . CAPITAL LEASE Type of lease classified and accounted for by a lessee as a purchase and by the lessor as a sale or financing, if it meets any one of the following criteria: (a) the lessor transfers ownership to the lessee at the end of the lease term; (b) the lease contains an option to purchase the asset at a bargain price; (c) the lease term is equal to 75 percent or more of the estimated economic life of the property (exceptions for used property leased toward the end of its useful life); or (d) the present value of minimum lease rental payments is equal to 90 percent or more of the fair market value of the leased asset less related investment tax credits retained by the lessor. (Also see finance lease.) CERTIFICATE OF ACCEPTANCE (Delivery and Acceptance) A document whereby the lessee acknowledges that the equipment to be leased has been delivered, is acceptable, and has been manufactured or constructed according to specifications DIRECT FINANCING LEASE (Direct Lease) A non-leveraged lease by a lessor (not a manufacturer or dealer) in which the lease meets any of the definitional criteria of a capital lease, plus certain additional criteria. ECONOMIC LIFE (Useful Life) The period of time during which an asset will have economic value and be usable.

EFFECTIVE LEASE RATE 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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Lease Financing include in the cash flows any effect the transactions have on federal tax liabilities.

FIRST AMENDMENT LEASE 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. If the purchase option is not exercised, then the lease is automatically renewed for a fixed term (typically 12 or 24 months) at a fixed rental intended to approximate fair rental value, which will further reduce the lessor's end-of-term residual position. The lessee is not permitted to return the equipment on the option exercise date. If the lease is automatically renewed, then at the expiration of that initial renewal term, the lessee typically has the right either to return the equipment without penalty or to renew or purchase at fair market value.

FINANCE LEASE

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Lease Financing Typically, a finance lease is a full-payout, noncancellable agreement, in which the lessee is responsible for maintenance, taxes, and insurance.

FULL PAYOUT LEASE 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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