LEASING

AND
HIRE PURCHASE
 LEASING
Leasing is a contract where by an owner of the
asset (lessor) grants to another party (lessee) the
exclusive right to use the asset in return for the
payment of the rent.
TYPES OF LEASE

 Operating lease
 Financial lease

 Leveraged lease
 Sales and lease
 Cross border lease
OPERATING LEASE Vs FINANCIAL LEASE

 Short term and  Long term and non

cancellable with proper cancellable lease contract
notice. (shorter than
useful life of the asset)

 The lessee is responsible

 The lessor is responsible for maintenance and
for maintenance and insurance
insurance
 A single operating lease  Amortise the cost of the
contract may not fully asset over the term of
amortise the original cost lease
of the asset

 Risk of obsolescence  Risk of obsolescence

remains with the lessor remains with the lessee
LEVERAGED LEASE
 Involves three parties- Lessor, Lessee and
Financer
 Lessor provides equity upto 25% of the
asset cost and Financer provides loan for
the remaining amount
SALES AND LEASE
 A user sell an existing asset owned by him
to the lessor (leasing company) and lease
it back from him. Such sale and lease
back arrangement may provide substantial
tax benefit.
CROSS BORDER LEASE
 Lessor and Lessee are in two different
countries
OTHER TYPES OF LEASE
 Close-ended lease
 Open-ended lease
 Direct lease
 Master lease
 Percentage lease
 Wet and dry lease
 Net, net, net lease
 Update lease
 Upfronted lease
 Back ended lease
 CLOSE-ENDED LEASE
 The asset gets transferred to the lessor at the end and the
risk of obsolescence remain with the lessor
 OPEN-ENDED LEASE
 The lessee has the option of purchasing the asset
 DIRECT LEASE
 Mix of operating and financial lease on a full payout basis
and provides for the purchase option to the lessee.
 MASTER LEASE
 Provides for a period longer than the asset’s life and holds
the lessor responsible for providing equipment in good
operating conditions during the lease period.
 PERCENTAGE LEASE
 Provides for a fixed rent plus some percentage of the
previous year's gross revenue to be paid to the lessor.
 WET AND DRY LEASE
 Wet lease: Involves financing as well as service and
maintenance (eg. Aviation industry)
 Dry Lease: involves only financing
 NET, NET, NET LEASE
 Lessee is obliged to take care of maintenance, taxes
and insurance of the equipment
 UPDATE LEASE
 Lessor agrees to replace obsolete asset with new one. It
protects lessee against risk of obsolescence.
 UPFRONTED LEASE
 More rentals are charged in the initial years and less in
the later years of the contract.
 BACK ENDED LEASE
 Less rentals are charged in the initial years and more in
the later years of the contract.
PROCEDURAL ASPECTS
 STEP1- Lessee selects the equipment
which also involves specification of the
equipment, supplier, price, terms of
warranties, delivery period, installation &
services.

 STEP2- Lessee approaches the lessor

submits a formal application and negotiates
the terms of lease.
CONT…
 STEP3- Lessee and lessor signs the agreement.

 STEP4- Lessee assigns the purchase rights to

the lessor and the lessor purchase the
equipment which is delivered to the lessee.

 STEP5- The lessee ensures the equipment and

endorses the insurance policy in favour of the
lessor.
LEGAL ASPECTS OF LEASING
 There is no separate status of equipment leasing
in India. The provisions relating to bailment in
Indian Contract Act 1872 governs leasing
agreement as well.

 Sec 148 of Indian Contract Act 1872 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 persons delivering them.”
 Since equipment lease transaction is engaged as a
contract of bailment, the obligations of the lessor and the
lessee are similar to those of the bailor and the bailee as
defined by the provisions of Sec 150 and 168 of the
Indian Contract Act.

 These provisions have the following implications for the

lessor and the lessee.
 The lessor has the duty to deliver the asset to the lessee to
legally authorize the lessee to use the asset and to leave the
asset in peaceful possession of the lessee during the period of
the agreement.
 The lessee 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 return the leased asset on
the expiry of the lease period.
TYPICAL CONTENTS OF LEASE AGREEMENT
 Description of the lessor, lessee and the equipment
 Amount, time and place of lease rental payment
 Time and place of equipment delivery
 Lessee’s responsibility for taking delivery and possession
of the leased equipment
 Lessee’s responsibility for maintenance, repairs etc and
the lessor’s right in case of default by the lessee
 Lessee’s right to enjoy the benefits of the warranties
provided by the equipment manufacturer / supplier
 Insurance to be taken by the lessee on behalf of the
lessor
 Variation in lease rental if there is a change in certain
external factors like bank interest rate, fiscal incentives
etc
 Option of lease renewal for the lessee
 Return of equipment on expiry of the lease period
 Arbitration procedure in the event of disputes
INCOME TAX PROVISIONS
 Lease rental paid by lessee is a tax
deductable expense.

 Lease rental received by the lessor are

taxable under the head of profits & gains
from business & profession

 Lessor can claim depreciation on the

investment made in leased asset.
ACCOUNTING TREATMENT OF LEASES

 The leased asset is shown on the Balance Sheet

of the lessor

 Depreciation and other tax shields associated

with the leased asset are claimed by the lessor

 The entire lease rental is treated as income in

the books of the lessor and as expenses in the
books of the lessee.
ADVANTAGES FOR THE LESSOR

 The lessor gets the rent for asset leased.

 He can claim depreciation for it so there is both

tax saving and it is a source of revenue.

 The lessor can slowly recover the cost of the

asset and thereafter the asset is in his
possession.

 It is a source of income for him.

DISADVANTAGES FOR THE LESSOR

 The rent received is taxable income.

 Mostly the depreciation cost is borne by

him.

 Many times the asset is of no further use

due to its wear and tear.
ADVANTAGES FOR THE LESSEE
 The lessee doesn’t have to invest in the asset and
can have his work done.

 He can enjoy the tax benefit from it.

 In many cases he is not liable for the depreciation

of the asset.

DISADVANTAGES FOR THE LESSEE

 If the use is for long period he will be in
loss.
Myths about Leasing
 Leasing provides 100% financing
 Leasing provides off Balance Sheet
financing
 Leasing improves performance
 Leasing avoids control of capital spending
Lease Finance Vs Installment Sale
1.Nature: Installment sale is a sale whereas lease financing is a type of rental contract with a purchase option between the two
parties.
2.Ownership of the Asset: In installment sale, the ownership transfers to the user at the end of the installment period. Whereas in
case of lease financing, the lessee has to transfer the asset to the lessor after the end of lease period and the lessee has an option to
purchase or not to purchase the asset.
3.Tax Benefits: The total deduction for taxation purpose is same for leasing and installment sale. However, in case of leasing, it
takes twice as long to write off the asset as compared to installment sale. The depreciation is claimed by the lessor in lease financing
whereas in installment sale, the user claims the depreciation.
4.Balance Sheet Appearance: In lease financing, the value of the asset is not included in the financial statements since the lessee is
not the owner. Whereas in case of installment sale, the installments are capitalized i.e.  the asset appears in the asset side of the
balance sheet and a corresponding liability against such asset appears on the liability side.
5.Overall Cost of the Asset: The cost of the asset in case of lease financing is the cost of using the asset over its life. In case of
installment sale, installment includes principal amount and the interest for the term till the last installment is paid.
6.Duration: Generally leasing is suitable for longer periods and for assets like land, property, heavy vehicles and huge plant and
machineries. Installment sale is done for short periods and for assets like light moving vehicles, electrical items, small machineries
etc.
7.Maintenance Support of the Asset: In case of operating lease financing, the repairs and maintenance for the asset is borne by the
lessor and in case of financial lease it is borne by the lessee. In installment sale, the responsibility lies with the user.
8.Reduced Initial Cash Outlay: Since there is no immediate purchase of asset in installment sale, the cash flow is limited up to the
margin money i.e. the down payment or the deposit as it is so called in addition to the periodic installments. In case of lease
financing, the monthly rentals are the only cash flows during the entire usage life of the asset.
It is therefore necessary to know the consequences while dealing with lease transactions and installment sales. The
person should analyze the options with different outlook. The economic viability of the transactions along with the
entries in financial statements shall be according to the specified acts and rules. Also the income tax consequences as
well as the VAT consequences should not be overlooked.
 Home-Work
 Difference between Leasing and Instalment Sales
Difference between Hire Purchase and Installment Sale                                                                                       
1. There are 3 parties in Hire Purchase trade namely the seller, the financier and the buyer. There are only
2 parties involved in Installment sale namely the seller and buyer.
2. There are 3 agreements in a hire purchase, namely between the (a) seller and financier. (b) financier
and buyer and (c) buyer and seller. But in Installment sale, there is only one agreement between the
buyer and seller.
3. Hire purchase is an agreement to hire and later to buy. Installment is an agreement to buy.
4. In hire purchase, the ownership transfers from the seller to the financier and then to the buyer on the
payment of the last installment. In Installment sale, The ownership transfers on the first installment from
the seller to buyer.
5. In hire purchase, when there is a default in payment, the financier will take back the goods from the
buyer. In installment sale, if there is a default of payment, the seller cannot take back the goods, but can
only sue the buyer.
6. In Hire purchase, any damage to the goods will only lead to claiming of insurance by the financier from
the insurance company since the ownership has not been transferred. In installment sale, any damage to
the goods will be claimed by the buyer from the insurance company.
7. Buyer cannot sell the goods to any third party until he pays the last installment to the financier in hire
purchase. In case of installment sale, the buyer can sell to any third party as he is the owner of the
goods.
8. The interest rate in hire purchase will be on a flat rate basis and is included in the installment and
recovered as equated monthly installment (EMI). Example: Car finance by Sundaram Finance. The
interest rate in installment sale is on a declining basis as every installment paid will reduce the principal
amount and hence the total interest payable is lesser than H.P scheme. Example: Bank finance for
purchase of consumer goods.
 difference between Hire-purchase system and Instalment payment system
Instalment Payment System is system of purchase and sale of goods in which
transferred to the purchaser at the time of sale of goods and the sale price of the g
the event of default in payment of any instalment, the seller has no right to take ba
of the purchaser. He can file a suit for the recovery of the outstanding balance o
followings are the differences between Hire-purchase system and Instalment paym
•In Hire-purchase system, the transfer of ownership takes place after the payment
of Instalment payment system, the ownership is transferred immediately at the time
•In Hire-purchase system, the hire-purchase agreement is like a contract of hire th
purchase
Difference after the
between payment ofsystem
Hire-purchase last instalment while payment
and Instalment in Instalment payment sys
system
contract of credit purchase.
•In case of default in payment , in Hire-purchase system the vendor has a
possession of the hire-purchaser while in case of Instalment payment system, th
back the goods from the possession of the purchaser; he can simply sue for the ba
•In Hire-purchase system, if the purchaser sells the goods to a third party before t
the third party does not get a better title on the goods purchased. But in case of In
third party gets a better title on the goods purchased.
•In Hire-purchase system the provisions of the Hire-purchase Act apply to the
Instalment payment system, the provisions of Sale of Goods Act apply to the trans
HIRE- PURCHASE
 Sells assets to
Hiree Hires asset to Hirer
Manufacturer
Features
 The hiree purchases the asset and give it on hire to the
hirer.
 The hirer pays regular hire purchase instalments over a
specific period of time which covers interest and principal
repayment.
 On payments of last instalment by the hirer, the title of the
asset transfers from the hiree to the hirer
 The hiree charges interest on a flat basis i.e. rate of
interest is charged on the initial value and not on the
diminishing value.
 The total interest collected by he hiree is allocated over
various years
 The hirer will have the option to terminate the agreement
at any time before the transfer of the ownership of the
asset.
 Leasing Hire Purchase
 The lessor is the owner  The ownership of the asset
and the lessee is entitled passes on to the hirer on
to the economic use of payment of the last
the leased asset. The instalment. Before the
ownership is never payment of the last
transferred to the lessee instalment, the ownership of
the asset vests in the hiree.

 The cost of acquiring is

 The magnitude of fund relatively low. (eg.
involved is very large (eg. Automobile, office
Purchase of aircraft, ship, equipment, generator etc.)
machinery)
 No cash down payment is
required to be paid by the  Cash down payment is
lessee required to be paid by the
hirer
 The cost of maintenance is  The cost of maintenance is
borne by lessee in case of borne by the hirer
Financial Lease and lessor in
case of Operating lease

 Depreciation and investment

 Depreciation and investment
allowance can be claimed by
allowance can be claimed by
the hirer
the lessor

 Only the interest component of

 The entire lease rental paid by
hire purchase is a tax
the lessee is a tax deductable
deductable expenses
expenses
 The hirer, being the owner of
 The lessee, not being the
the asset, enjoys the salvage
owner of the asset, does not
value of the asset
enjoy the salvage value of the
asset
 Accounting treatment of Hire Purchase

 The hirer is required to show the hired asset on

his Balance Sheet
 The hirer is entitled to claim depreciation,
although he does not own the asset until full
payment has been made
 The payment made by the hirer is divided into
two parts: interest charges and repayment of
principal
 The hirer gets tax relief on interest and not the
entire payment
 The hire purchase agreement is like a
cancellable lease with a right to buy the asset
 Legal Position of Hire Purchase
Hire Purchase Act, 1972 defines a hire purchase
agreement as “an agreement under which goods are let
on hire and under which the hirer has an option to
purchase them in accordance with the terms of the
agreement and includes an agreement under which
 Possession of goods is delivered by the owner there of
to a person on a condition that such person pays the
agreed amount in periodic payment and
 The property in the goods is to pass to such person on
the payment of the last of such instalment and
 Such person has a right to terminate the agreement at
any time before the property so passes.”
Sec 3 of the Act provides that every hire purchase
agreement must be in writing and signed by all parties
thereto.
Taxation Aspects

Taxation aspects of hire purchase

transactions can be divided into three
parts
 Income Tax
 Sales Tax
 Interest Tax
Income Tax
The hirer is entitled to
 The tax shield on depreciation
 The tax shield on the ‘consideration for hire’.

Though the hirer is not the owner of the asset,

he is entitled to claim depreciation and
consideration for hire i.e. finance charge.
(Finance charge is the difference between the
hire purchase and the cash price)

The income received by the hire vendor is laible

to tax under the head Profits and Gain of
Business and Professions.
Sales Tax
 Sales tax is payable once the goods are
delivered by the owner to the hirer even if the
transactions does not fructify into a sales.
 There is no provision for the refund of sales tax
on the unpaid instalment.
 In other words, full tax is payable irrespective
of whether the owner gets the full price of the
goods or not.
Interest Tax
Hire Purchase Company has to pay interest
tax under the Interest Tax Act 1974. Interest
Tax is payable on the total amount of
interest earned less bad debts in the
previous year @ 2%. The tax is entitled as
a tax deductible expenses for the purpose
of computing the taxable income under the
Income Tax Act.