LEASING-COURIER LC - World Bank · 2016-07-12 · LEASING-COURIER LC Information Bulletin LC January-February 1999, Issue 1 (1) Published by the Leasing Development Group of the International

LEASING-COURIER LCInformationBulletin LCLEASING-COURIER

January-February 1999, Issue 1 (1)

Published by the Leasing Development Group of the International Finance Corporation(IFC), a Member of the World Bank Group, with financial support from the British Know-How Fund and the Canadian International Development Agency

CONTENTS:

We Introduce…The InternationalFinance Corporation(IFC): LeasingDevelopment Project

p. 2

Theory and PracticeWhat is Leasing?Significance of theLeasing Sector forEconomic Development

p. 5

Leasing in RussiaAn Overview of Russia’sLeasing Market

p. 8News

p.10

EconomyEconomic Effectivenessof Leasing as Comparedto Bank Loans

p. 13

TaxationPart I of the RF Tax Codein Force: OurCommentary

LegislationOn the History of LeasingLegislation

p. 18

PPP p. 16

CONTENTS:Dear Reader!

It is our pleasure to present to you the first issue of the informationbulletin the “Leasing-Courier”.

Financial leasing understood today as an alternative to bankinvestment loans, emerged fairly recently – in the early 1950’s. Sincethen, leasing has become a high profile area of investment,particularly in the small and medium enterprise sector. In 1996 thevolume of leasing transactions over the world amounted to US$ 482.1billion, which comprises 1/8th of gross investments world-wide. Inthe EU countries leasing amounts to 1/3rd of the total volume ofinvestments.

The Russian leasing market emerged in early 1990’s and today itmakes up a little over 1 % of the overall volume of gross nationalinvestments. As compared to other countries where up to 20 or 30%of all investment is carried out by means of leasing, it is obvious thatthe market of financial leasing in Russia is still very small. Structurallimitations continue to hamper the growth of this market. However,as the economy continues its transition, the domestic market forleasing has shown a remarkable potential for growth.

The publication of the “Leasing-Courier” aims at promoting thedevelopment of financial leasing in Russia by:

· Popularizing leasing· Attracting entrepreneurs’ attention to leasing and developing

their understanding of the advantages of leasing· Attracting the attention of local authorities to leasing as a real

mechanism of investing in regional producers· Ensuring practical assistance to leasing companies in the legal,

economic and accounting aspects of their activity· Providing a forum for the discussion of issues relevant to all

the participants of leasing relations.

The Bulletin is meant for federal and regional mass media, federaland state bodies, local administrations, consulting centers workingwith small and medium enterprises, and leasing companies.

The Bulletin includes general information on how the leasingmarket is developing, more specific material concerning leasinglegislation, taxation and accounting, as well as commentary andanalysis by economists and lawyers.

We hope that you will find this publication useful in your work.We look forward to your comments, suggestions and proposals!

Moscow, 103918, Gazetny per., 5, bl.2, 3rd floor, tel.(095)956-2160, Fax (095) 956-2163, Leasing Development Group.

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LC2 LC January -February, 1999WE INTRODUCE . . .

I nternational Finance Corporation (IFC): Leasing Development Project

WHAT IS IFC?

The International Finance Corporation(IFC), a member of the World Bank Group,promotes economic development in itsmember-countries. IFC stimulates the growthof production and efficiency of privateenterprises and the development of capitalmarkets; it finances private sector venturesand projects in partnership with privateinvestors; it provides advisory work to statebodies on creating conditions favorable forboth domestic and foreign savings andinvestments. The IFC is the world’s largestsource of financing for the private sector indeveloping and emerging economies.

Since its foundation in 1956, IFC hasprovided more than US$ 23.9 billion from itsown account to support various projects, andhas arranged US$ 17 billion in syndication andunderwriting for 2,067 companies in 134developing countries. IFC’s policies andactivities are determined by its 174 membercountries, which have contributed to its sharecapital.

In FY1998 IFC approved 308 projects fora total amount of US$ 17.6 billion, providingUS$ 2.7 billion in financing from its ownaccount. IFC mobilized US$ 5.9 billion tofinance private sector projects in developingcountries and in transitional economiesthrough its loan syndication program.

IFC IN RUSSIA

IFC approved its first investments in Russiashortly after the Russian Federation becamea member of the Corporation in April 1993.Since that time IFC has approved 25investment projects, investing US$ 350 millionfrom its own account as well as US$ 60 millionin syndicated loans.

In addition to its investment activities inRussia, IFC is also involved in technicalassistance projects. These projects aim toassist the Russian Government in creating afavorable environment for private sectordevelopment and in attracting foreigninvestment. Since 1992, IFC has implemented9 technical assistance projects in a number ofindustries, including agriculture, the energysector and the financial services market.

Interview with Karim Ahmad, IFC LeasingDevelopment Project Manager, presented by «LC»Chief Editor Irina Likhachova.

I.L.: Karim, could you describe the Project andhow it started?

K.A.: The Leasing Development Project is part ofIFC’s technical assistance program in Russia aimed atdeveloping the private sector and the market for financialservices. The aim of this Project is to provide advisorysupport to the Russian Government in creatingfavorable conditions for the development of leasing andthe establishment of Russian leasing companies.

The International Finance Corporation (IFC) has 22-years of experience in leasing. In developing markets,IFC generally combines technical assistance projectswith investments in individual leasing companies. Thismodel was applied in South Korea where IFC assistedin establishing the country’s leasing sector. In 1976, IFCcarried out a technical assistance project with theGovernment of South Korea in establishing thenecessary legislative basis for creating and developingthe market of leasing services, and later participated insetting up the first leasing company in South Korea.Today, South Korea holds fifth place in the world involume of leasing operations. It is worth noting that theSouth Korean project was IFC’s first experience inleasing development. Since then IFC has implementedover 50 technical assistance projects and over 120investment projects in the leasing sector of more than40 countries.

In 1997, the Russian Government invited IFC toconduct a technical assistance project on leasingdevelopment in Russia and to submit recommendationson improving conditions for the development of theleasing sector. Today this project is sponsored by theBritish Know How Fund (BKHF) and the CanadianInternational Development Agency (CIDA). To fulfill thisproject, a leasing development team of lawyers,economists and leasing experts has been established.

IFC’s experience in international financial marketsshows that leasing is one of the most important andefficient financial instruments in developing countries.Given the lack of capital and limited choice of financialinstruments in these countries, leasing provides a realopportunity for manufacturing companies to acquire andrenovate their capital assets and to increase thecompetitiveness of their products. We hope that theestablishment of the leasing sector in Russia will havea positive impact on the development of Russianenterprises.

I.L.: When you were describing IFC’s experiencein the leasing sector, you practically answered mynext question: why is it IFC that is implementing

LCLC January-February, 1999 3WE INTRODUCE . . .

The leasing development team. From left to right: Marina Garadja, Deputy Project Manager; NinaZhuravleva, accountant-auditor; Karim Ahmad, Project Manager; Veronika Shtelmakh, economist;Irina Likhachova, PR Manager; Albert Sabitov, legal advisor; Andrei Pisarenko, Project assistant.

this project. And what are IFC’s goals in its workon the leasing development Project?

K.A.: I have already touched upon why IFC isinvolved in this project. But I would like to add a fewwords. Russia has been a member of the InternationalFinance Corporation since 1993. Having joined theIFC, Russia uses the services provided by theCorporation to its member countries. One of theseservices is assistance in developing financial markets.

Russia, in its present stage of economicdevelopment, needs support in creating a market forfinancial services, including a market for financialleasing. Thus, the leasing development project wasdesigned to respond to the existing demand.

Speaking of IFC’s goals, I have to say that thefocus of the Corporation’sactivities is investment. Inthis light the technicalassistance project onleasing development shouldbe seen as an effort tocreate a favorable climatefor attracting both foreignand domestic investmentsinto Russia’s leasing sector.In particular, one of ourgoals is to identifyinvestment opportunities inthe leasing sector for theprivate sector and IFC. So,IFC’s activities in Russia arebuilt on the principle ofmutual advantage: werespond to a current needwith our expertise andexperience, and also with aview to future investments.

The Governments ofGreat Britain and Canada,have given economic development in Russia a highpriority. To our donors, leasing is important as one ofthe most effective mechanisms of financing for smalland medium-sized enterprises, whose developmentis crucial for the development of any economy.

I.L.: Why is leasing such an attractiveinvestment mechanism world-wide?

K.A.: The point is that the leasing mechanismallows for the most favorable terms of selling andacquiring equipment. For example, a carmanufacturing plant can, on the one hand, sell itsautomobiles through leasing, and, on the other hand,that same company can use leasing in order topurchase equipment to upgrade its production andincrease the sales volume. This process can go onindefinitely, benefiting the producer as well as the end-user of the equipment and the leasing company.

Leasing is especially effective for small and middle-

sized enterprises, as well as for newly establishedcompanies, as an effective mechanism of acquiringand renovating capital assets. Typically, these areenterprises, which lack an established credit historyand the ability to provide sufficient collateral to receivea bank loan. You can find more information aboutthis in the article by the Team’s economist on “TheEconomic Efficiency of Leasing as Compared to BankLoans”, published in this issue of the bulletin.

I.L.: What has the leasing development teamachieved to date and what are its tasks in thecurrent year?

K.A.: The first stage of the Team’s work wascompleted in summer 1998. At that stage the project

was financed by the British Know How Fund. Themain goals of the first stage included research andanalysis of leasing market, acquaintance with Russianleasing companies and state bodies involved in thedevelopment of leasing in Russia. We analyzed thelegislative base and economic prerequisites for thedevelopment of this type of service. The results ofthe Team’s work were summed up in two Reports:“The Legislative and Regulatory Framework forFinancial Leasing in Russia (analysis andrecommendations)” and “Survey of Financial LeasingActivity in Russia”. At the same time, we determinedthe areas where change is needed in order to createthe most favorable conditions for leasing developmentin Russia.

This year we are implementing three main tasks.These are: assisting the government and legislativebodies in developing legislation necessary for leasingdevelopment, conducting a national training programon leasing and providing consultations to leasing

LC4 LC January -February, 1999WE INTRODUCE . . .

The British Know How Fund(BKHF) is the UK Government’s Fundfor technical cooperation withcountries of Central and EasternEurope and East Asia. Since the timeof its establishment in 1989, the fundhas been providing support toeconomies in transition, by providingBritish “know-how” to key industries.In all, GBP 170 million was allocatedfor the implementation of projects withover GBP 90 million allocated since1991 to finance more than 350projects. The Know How Fund hasfocused its efforts in Russia on givingtechnical assistance in the followingspheres: financial services,restructuring of enterprises,developing small and middle-sizedbusiness, increasing employment,reforms in agriculture, managementin ecology, reorganization of theenergy sector and health caremanagement.

The Canadian InternationalDevelopment Agency (CIDA) is theCanadian Government’s Agency fortechnical assistance. In partnershipwith other international organizations,Canadian non-governmentalorganizations, private companies andindividuals the Agency providesassistance to economies in transition.CIDA helps these countries toeffectively redistribute their resourcesand create basic mechanisms neededfor developing a stable marketeconomy and a modern democracyand, in the long run, to mobilizeinvestments and expand foreigntrade. In 1995 CIDA startedimplementing a program of assistanceto the countries of Central andEastern Europe including Russia.CIDA's priority lines of assistance toRussia include the transition to amarket economy and theestablishment of foreign tradelinkages, the development democraticinstitutions, the improvement of safetylevels in nuclear plants and regionaldevelopment.

companies. The funding we receive from the British Know HowFund and the Canadian International Development Agencyallows us, on the one hand, to do this work and, on the otherhand, to act as a link between Western investors and Russianleasing companies, to disseminate information about leasingand also to make concrete proposals on how to improve theenvironment for further development of the leasing sector.

I.L.: Who are the Team’s partners in reaching the setgoals?

K.A.: In our work we cooperate with the Association ofRussian Leasing companies “Rosleasing”, with the Ministriesfor Economy and Finance, the RF Federal Assembly, the RFChamber of Commerce and its regional branches, and withcenters for assistance to small and medium size enterprises.In the private sector we are working with leasing companies.

I.L.: What, do you think, are the prospects for thedevelopment of leasing in Russia?

K.A.: Our experience shows that certain preconditions areessential to the development of the leasing industry. Possiblythe most important of these is a well-developed legalenvironment, which provides for a clear definition of the rightsand responsibilities of both the lessor and the lessee, as wellas determines an effective legal mechanism for repossessionof the leased asset in case the terms of the lease agreementare violated.

A well-defined legal environment reduces the risk inherentin lease transactions. This in turn allows the lessor to reducehis margins, thus decreasing the cost of the asset to the lessee.Ultimately this also contributes to the ease with which enterprisesare able to lease equipment and hence to economicdevelopment in general.

Undoubtedly, control and regulation are necessary for thedevelopment of the leasing sector. At the same time, relativefreedom from state interference will give leasing companiesthe freedom to develop according to market principles. In orderto support this development the state needs to establishreasonable rules of the game, aimed at ensuring guaranteesboth for the creditor of leasing companies and for the lessee.

Favorable taxation and clearly defined rules of leasingaccounting are also necessary for the development of leasing.In those countries where governments try to stimulate thedevelopment of financial leasing, tax benefits are introduced.At first sight, this can appear to be a loss for the state budget,but in reality leasing development leads to the expansion ofproduction and creation of jobs, which in the long run has afavorable impact on the budget. Such benefits as the right ofthe lessor to claim accelerated depreciation and the right of thelessee to include lease payments in the cost of production, willfacilitate the development of the leasing sector and, finally, leadto the development of production.

If the Russian Government and legislative bodies manageto secure these prerequisites, leasing in Russia will activelydevelop, as the need for this already exists in the Russianmarket.

LCLC January-February, 1999 5

What is Leasing? The Importance of the Leasing Sector

for EcoBBy Irina Likhachova

It was Aristotle who said that “true wealth lies not in theownership of property but in the right to use it.» This statement

consisely defines the main idea of financial leasing. An enterpriseor entrepreneur does not have to own property to use it and tomake a profit. It is enough to have the right to use this propertyover a certain period of time. The ability to use property withoutowning it is especially important for enterprises lacking means topurchase necessary equipment. Financial leasing allows suchenterprises to acquire the right to use the necessary equipmentfor an affordable leasing fee over a certain period of time.Additionally, financial leasing schemes allow for the transfer ofproperty ownership from a leasing company to an enterprise uponthe completion of the term of leasing.

What is financial leasing? The Russian term for financial leasingis simply «leasing» or «ëèçèíã.» The term was borrowed fromEnglish. Only in the English language the term «leasing» means«rent.» To differentiate between rent and financial leasing, thereare two terms in English: «operational leasing» and «financialleasing» accordingly. The term «operational leasing» in Englishcorresponds to the notion of «rent» in Russian, while the term«financial leasing» in English corresponds to the term «leasing»in Russian. Therefore, when we refer to financial leasing in theRussian context, we will use the Russian term «leasing.»

Leasing is a complex of property relations that arise whenproperty (the asset to be leased) is acquired and is subsequentlyassigned for temporary use. Under a financial lease, one party(lessee) can use property belonging to a leasing company (lessor)purchased on the lessee’s order, in return for lease payments.The most important part of this agreement is that the propertyownership (sustained by the leasing company) is separated fromthe economic use of the asset (in the lessor’s possession). Theleasing company is concerned with the lessee’s ability to generatecash flow sufficient to cover leasing fees, and not with his creditstanding, assets or capital. This kind of agreement is especiallyconvenient for new, small or medium-sized enterprises, whichusually do not have a credit history. The leasing property servesas collateral (guarantee) in the deal.

The Civil Code of the Russian Federation (Article 665) definesleasing as follows: :

«In compliance with a financial leasing contract, the lessor mustacquire equipment as defined by the lessee and from a supplierdefined by the lessee and lease the equipment to the lessee touse for business purposes in return for lease payments. Underthese conditions, the lessor is not responsible for selecting thesubject of the financial leasing contract and the seller. The financialleasing contract can stipulate that the lessor selects the subject offinancial leasing contract.»

Parties to a Lease

The definition of leasing in the Civil Code, impliesthat any leasing transaction must have three parties. The

parties to a leasing transaction are:• the lessor – a person who acquires property specifically to

What is Leasing? The Significance of the Leasing Sector for EconomicDevelopment

THEORY AND PRACTICE

The History and Developmentof Leasing

The concept of financial leasingas a source of term finance, arose inthe 1960’s, though leasing itself hasexisted for centuries. Financialleasing, as it is defined today,developed over a significant period oftime passing through different stagesof evolution, beginning with simplerental arrangements.

The Middle East

The earliest details of leasingcan be traced as far as 5,000 yearsback to the advanced cultures of theMiddle East. Leasing was mostly usedin transactions relating to land,irrigation systems, and cattle. Recordsestablish the existence of a familyenterprise «Murashu» around 1800B.C. in the vicinity of Babylonia. Thisenterprise specialized in a form ofleasing that was connected to thePersian wage payment system.Officers and soldiers were awardedland by the monarchy. If an officer orsoldier did not want to cultivate theland, he leased it to Murashu, theleasing specialist. The firm made leasepayments to the soldier/officer inadvance and in turn leased the landto farmers.

Ancient Greece

Ancient Greece pioneered theconcept of «bank leasing» for whichthe first agreement was signed in 370B.C.The unique feature of the banklease was that the leased assets werethe name of the bank, its goodwill,deposits,office premises, staff (mainlyslaves), and in some cases, its equity.

Ancient Greece was also thefirst to develop mine leases. All themines in Athens belonged to the Stateand were leased through a singleauthority which was the authorizedagency to lease state assets, includingmines. Mines of varying sizes anddegrees of exploitation were leased for

LC6 LC January -February, 1999

lease it;• the lessee – a person acquiring the right to use property

over a certain time peroid;• the seller – a person selling an asset which is

subsequently to be leased

Participation of 3 parties in a leasing transaction is adistinguishing feature of financial leasing wichdifferentiates it from operational lease.

There are only 2 parties required for an operational leasecontract:

• the lessor• the lesseeAdditionally, in an operational lease, the lessor purchases

equipment at his own risk, and not on the lessee’s request.With an operational lease the same equipment can be leasedseveral times.

Leased assets

According to Article 666 of the Civil Code of the RF, theassets to be leased may be “any non-consumable items,

used for business purposes, except for land and other naturalresources.”

Non-consumables are items, which do not lose their inherentproperties through use. The leased assets must be used onlyfor entrepreneurial purposes, and it can be movable andimmovable property.

Types of Leasing Transactions

Leasing transactions could have different schemes. Letus consider the two most simple ones.

Leasing Transaction Scheme (option 1)

1. A potential lessee, in need of a certain asset, defines thesupplier who has the necessary asset.

2. The lessee turns to a potential lessor with a request topurchase the required asset.

3-4. The lessor purchases the required asset from thesupplier difined by the lessee.

5. The lessor turns over the asset to the lessee on agreedterms.

3 to 7 years. The lease rental collectedon mine leases was a combination of:a) a fixed amount for the entire period; b)a fixed annual fee; c) a combination ofthe above two; and d) a fee based on theproduction of ore.

In the case of a default, the lesseewas obliged to pay a penalty of 100percent of the overdue to the State andwas also denied his rights as a citizen.Mine leasing activities provided Athenswith income of such magnitude that theState handed annual gifts to her citizenssufficient for their subsistence for twomonths. Later, funds were used to buildwarships and strengthen the naval force.This helped the Athenians to win a victoryover the Persians in 448 A.D.

EnglandOne of the first statues to refer to

leasing in the U.K. was the Statute ofWales of 1284 in which it was declaredthat the legal action of covenant derivedfrom land laws was also available forlease of immovable property. Quite often,in accordance with the Statute, leasingwas used for dishonest purposes, toconceal, for example, who was the realowner and who was the proprietor ofestate to confuse the creditors. Later, inaddition to land and estate other propertyand goods were leased.

With the mechanization of agricultureand progress on the industrial sector inthe 19th century, the types of leasedassets changed. The arrival of therailways in the mid 19th century usheredin the structural changes in the leasingindustry and led to significant advancesin the techniques of leasing. Originally theowners of coal mines started with buyingwagons for coal transportation, but soon,with stable growth in production itbecame too expensive and not profitable.Small enterprises decided to make useof the situation and to invest their capitalat a profit. They started buying coalwagons and leasing them. Companies,specializing only in this type oftransactions, began to emerge. Someleasing agreements included the right ofa lessee to purchase the equipment uponthe expiration of the term of lease. Suchtransactions were called ‘lease-purchaseagreements’ and became the prototypeof the most advanced type of leasing –financial leasing.

THEORY AND PRACTICE

LESSOR

SUPPLIER LESSEE

253-4

1


Leasing Transaction Scheme(option 2) (OPTION 2)

1. A potential lessee, in need of a certain asset, requeststhe lessor to choose a supplier of the required asset.

2-3. The lessor finds the supplier and purchases the asset.4. The lessor turns over the asset to the lessee on the agreed

terms.

The Significance of the Leasing Sector forEconomic Development

Leasing is now an important source of medium termfinance in many countries. Different projects illustrate

the role of leasing in promoting new capital investment whetherit is to provide essential tools for small businesses or to financeorbiting satellite systems.

Leasing is profitable for all parties of a lease transaction.The leasing mechanism allows the lessee to allocate scarcefinancial resources to new capital investments, as the lessor isconcerned with projected cash flow during the period ofequipment lease to be able to receive lease payments, ratherthan with the volume of assets or the lessee’s capital or credithistory. The leasing mechanism channels investment into thecapital assets which allows the enterprise to start productionand generate sufficient income to cover lease payments.

By channeling funds directly into new equipment, leasingcompanies avoid the problem faced by banks and other financialinstitutions, of funds being diverted by borrowers for non priorityuses.

From the supplier’s point of view, leasing helps to sell hisproduct. On the whole, development of the leasing sector hascontributed to economic development in a number of ways:

• Leasing creates additional competition amongstsources of finance. Leasing has lowered the cost andincreased the supply of finance, particularly fixed rate financefor investment. In developing countries, leasing has frequentlybeen able to fill a gap in the finance market place and hasenabled firms to rely less on overdraft facilities.

• Leasing increases the volume of capital investments .To a certain degree the growth of the leasing sector can beaccounted for by the fact that leasing has gradually become asubstitute for other types of financing. But mostly it can beexplained by the fact that leasing is an additional form of long-term financing.

• Leasing functions as a sales aid. In addition to

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SU PP LIER LESSE E

12-3

Leasing TodayFinancial leasing in its contemporary

form originated in the USA. The firstfinancial leasing company was foundedby Henry Shofeld in 1952 in the USA.The company was established toconclude one specific transaction in thearea of railway transportation. Thistransaction demonstrated the economiceffectiveness of financial leasing andShofeld decided to continue his businessand founded the American leasingCompany “United States Leasing Corp.”(today – “United States LeasingInternational Inc.”) In Europe, financialleasing started developing in the late1950s early 1960s.

There were several factors thatencouraged the rapid growth of financialleasing in North America and WesternEurope. Advances in technology createda need for enterprises to renovate theircapital assets. Financial leasing providedthe necessary mechanism to aquirecapital assets on more profitable termsthan purchasing equipment. At the sametime, in the 1950s, a financial servicesmarket emerged offering a greatersupply of credits, which was supportedby a low interest rate structure. Thisserved to contain inflation and the costof goods. These factors combined withfavorable taxation accompanying leasingtransactions, made financial leasingattractive for leasing companies. Thegrowth in the number of leasingcompanies stimulated furtherdevelopment of the financial leasingsector as a whole. The 1970s saw the financial leasingconcept move to the developingcountries of Asia, South America, andAfrica. The 1980s were marked by arecognition of the concept of financialleasing world-wide. Today leasing is aneffective financial tool in the acquisitionand renovation of capital assets for bothsmall and medium-sized enterprises, aswell as for financing multi-million dollartransactions in transportation (forexample, leasing of airplanes), in oilextraction (leasing of oil wells), andothers. In Russia, although financial leasingwas known in the Soviet times, it beganto develop in the early 1990s. The article«An Overview of Finanical LeasingMarket in Russia» on page 8 providesmore information on financial leasingdevelopment in Russia.

THEORY AND PRACTICE


supporting the sales campaigns of equipment suppliers, leasing encourages the domestic manufacture ofmachinery by introducing vendor leasing schemes.

• Leasing supports industrial modernization and small business. Leasing companies play animportant role in providing financing to small and medium enterprises, considering first and foremost theexpected cash flow, rather than their credit worthiness.

• Leasing helps in the implementation of industrial and fiscal policies. In addition to mobilizingliquid assets in building a company’s capital, leasing has proved to be an important stabilizing factor at thetime of economic recession, as leasing considerably increases the efficiency of privileged taxation on capitalinvestments.

Sources: K.V. Kamath, S.A. Kerkar, T. Viswanath: “The Principles and Practice of Leasing”, Lease Asia, England, 1990, p. 3-12.E.V. Kabatova, «Leasing: Legal Regulation, Practice,» INFRF-M, Moscow, 1997, p. 12-18.

LEASING IN RUSSIA

An Overview of the Financial Leasing Market in Russia By Marina Garadja

On the territory of Russia, leasing was usedduring Soviet times to purchase through

foreign trade organizations, sea and air transportation.However, the volume of these transactions was fairlysmall. Thus, the early 1990s can be considered thestarting point for the development of leasingin Russia, when the first commercial leas-ing companies began to emerge. Most ofthose were founded by commercial banks.

By the mid-1990s, the Russian Govern-ment, having recognized the potential eco-nomic and developmental benefits of leas-ing, passed a series of decrees to supportthe development of the leasing sector. As aresult, the market witnessed the emergenceof new companies, including those estab-lished by financial-industrial groups for thetechnical re-outfitting of their enterprises. In1994, 15 leasing companies formed the pro-fessional Association of Russian LeasingCompanies “Rosleasing”. In 1997“Rosleasing” represented 47 companies, andin 1998 – 56.

The development of leasing was advancedmainly by two fairly recent government de-crees. The first, Resolution 1133 (November 1995),permits lessees to record the full leasing payment asa tax-deductible business expense. Resolution 752(June 1996) allows parties to a lease to depreciateassets at an accelerated rate. However, these resolu-tions represent only the first steps towards establish-ing a clear and enabling environment for the emer-gence of a prosperous industry. In fact, the positivesteps taken to support the leasing industry may evenbe undone by certain provisions of the 1998 tax code.

The dynamics of the growth of the number of leas-ing companies is shown in Diagram 1. It must be notedthat the statistical data presented in this article comefrom different sources: the “Rosleasing” Association,the Ministry of the Economy, the Central Bank of Rus-sia, and the IFC Leasing Development Group. It isalso noteworthy that these data reflect the situation in

leasing activities. In reality, according to some esti-mations only 10% of the registered companies pro-vide financial leasing services. By far, the majorityof these companies are located in Moscow and Cen-tral Russia.

The volume of leasing activity has been also grow-ing steadily since 1993. As estimated by “Rosleasing”in 1995, leasing companies-members of the Asso-ciation signed leasing contracts worth 170 billion ru-bles (US$42 million). In 1996 this figure grew to 670billion rubles (US$130 million), and in 1997 the vol-ume of the Association’s leasing activities amountedto 2,8 trillion rubles (US$500 million).

Despite the actual tendency of growth in the vol-ume of leasing activities, the financial leasing marketin Russia is still very small. According to “Rosleasing”,

the market of leasing services prior to the crisis ofAugust 17, 1998.

Diagram 1 shows the number of registered leas-ing companies that received licenses to carry out

15 18 24

240

500

720

0

100

200

300

400

500

600

700

800

1993 1994 1995 1996 1997 1998Year

# of

com

pani

es

Diagram 1. Dynamics of growth of the number of leasing com-panies in Russia. Source: License Chamber, Ministry ofEconomy of the Russian Federation

LCLC January-February, 1999 9LEASING IN RUSSIA

the share of leasing in the total volume of investmentsis less than 1 %.

For comparison, let us conisder the data illustratingthe share of leasing operations in the investments ofother countries (Table 1).

Types of Leasing Companies

All Russian leasing companies can be classifiedinto 2 main categories according to their

source of financing - commercial or budget-based.Furthermore, commercial companies are divided intothe following 3 groups based on their founder:

1) Companies founded by banks;2) Companies founded by financial-industrial

groups;3) Companies founded by large corporations.Budget-based companies are divided into 2

groups:1) Federal (financed from the federal budget and,

as a rule, based within ministries);2) Municipal (financed from municipal budgets).Before the crisis, some of the most promising

companies were those founded by banks.Thesecompanies were able to work out leasing proceduresand contracts in a generally friendly environment asa large percentage of their first contracts involvedsupplying their parent bank and its regional brancheswith equipment and furniture. They also had accessto bank capital. These companies focus on servingtheir parent bank and its corporate clients, withminimal exposure to general clients. Examples ofsuch companies are ‘RD Leasing’, ‘Leasing-Business’,‘InkomLeasing’, ‘BaltLeasing’ and others. The futureprospects of these companies largely depends onthe stability of the bank, the company’s founder.

A considerable share of the leasing market be-longs to companies established with the participationof local administrations (business support funds, prop-erty committees, etc.) and financed from municipalbudgets at a low interest rate. These companies areset up to carry out financial projects included in mu-nicipal development plans. Examples of such compa-nies are the Moscow Leasing Company, the NizhnyNovgorod Leasing Company, and Irkutsk Business-Park.

Leasing companies that are backed by the federalbudget typically serve the interests of their industrialconglomerates or the government ministry that has

released funds for leasing equipment to enterprises,regardless of their profitability. For example, the com-pany «LeasingUgol» («leasing coal»), one of Rus-sia’s largest leasing companies, leases equipmentsolely to the financially troubled coal industry.

Types of Leased Assets

Leasing companies associated with largeindustrial concerns focus on a narrow range

of equipment produced or needed by the parent com-pany. «LeasingUgol», for example, focuses on coalextraction equipment and heavy coal trucks.

Diagram 2 shows the distribution of equipmentleased by the companies of «RosLeasing». Machineryand idustrial equipment makes up to 71 % of allequipment leased by the companies of «Rosleasing».

This large percentage occupied by this category ofequipment is accounted for by the large volume ofleasing contracts carried out by «Agrosnab» and«LeasingUgol» which are the members of«Rosleasing» and which specialize in leasing ma-chinery and industrial equipment.

Leasing companies founded by banks lease thewidest range of items including bank equipment, carsand other vehicles, computers, constructionequipment, food processing equipment, furniture,manufacturing lines, packaging lines, printing, retail,telecommunications, and wood processingequipment.

Municipal budget-backed leasing companies

Place in the world byvolume of leasingoperations

CountriesAnnual Volume ofleasing operations,US$ billion, 1996

Growth in % from1995 to 1996

Share of leasing ininvestments (%)

1 USA 168,90 5,1 30,93 Germany 33,25 5,9 185 South Korea 16,31 -11,7 26,522 Chekhia 1,74 52,1 2029 Poland 1,05 80,5 7,236 Russia 0,63 455,6 1

Table 1.The share of leasing in investments. Source: V.Gazman, “Russian Leasing In the Mirror of Statistics”, journal“Leasing Review”, N 5-6, 1998, p. 4.

Diagram 2. Equipment Leased (Companies of«Rosleasing» association, 1997)

Machines and Industrial

Equipment71%

Other Equipment (telecom., medical)

25%

Trucks1%

Ships, Planes1%

Computers and Office

Equipment1% Automobiles

1%


straddle the market. Some lease the same range ofequipment and property as the leasing companiesfounded by banks, while others concentrate on oneitem of special importance such as medical equip-

ment or construction equipment. The Moscow Leas-ing Company, for example, which leases a wide vari-ety of assets as described in Diagram 3, also has asizable real estate leasing portfolio.

Leasing Environment in Russia

Last year the IFC Leasing Development Groupconducted a survey of 20 directors of some

of the largest Russian leasing companies. Most ofthe leasing companies surveyed said they are stillgrowing despite obstacles in the legal and regulatoryframework.

The leasing company directors who were inter-viewed cited a fairly common set of challenges con-fronting them, listed below in rough order of impor-tance to the directors:

1. Need for cheaper, longer-term fundingsources.

2. Unclear tax rules.3. Need for a better way to find reliable clients. A

credit rating service was suggested.4. Need for more protection in case of default.

The court procedure for recovering property isinadequate and lengthy.

5. Time-consuming customs procedures.6. Unfamiliarity among the public regarding the

benefits of leasing as a way of financing investmentin new equipment.

7. No secondary market for equipment.8. Weak economy, political instability and the

payments crisis (macro-economic factors).

Leasing companies are also concerned with whatregulations of the newly adopted Tax Code, specifi-cally Part II, would be implemented. The companiesfear that their competitive advantage compared withbank loans will be eliminated by this Tax Code.

The environment for the leasing sector in Russiais clearly very dynamic and difficult to predict. How-ever, some of the strongest leasing companies havesurvived difficult times, such as that when the CentralBank rate was over 120 % and the August 1998 cri-sis. One hopes that leasing in Russia will continue todevelop, as it is an efficient and accessable financialmechanism for modernizing and restructuring Rus-sian producers, the cornerstone of Russia’s economicdevelopment.

References:1. Statistics of ‘RosLeasing’, “Banks, Investments,

Leasing”, N16-17 (56-57), 1998, p.8.2. V.D. Gazman “Russian Leasing in the Mirror of

Statistics”, Leasing Review, N5,6, 1998.3. «Survey of Financial Leasing Activity in Russia,»

IFC Leasing Development Group, 1998.

LEASING IN RUSSIA

In January 1999, the St. Petersburg LeasingCompany ‘Baltyisky Leasing Ltd.’ launched

a pilot project in the form of an investmentproposal to re-equip the state enterprise“Admiralteiskyie Verfi” (Admiralty Shipyards),said the Director of the Company Dmitri Korchagov.The proposal to re-equip “Admiralteiskyie Verfi” bymeans of financial leasing was developed by theCentral Technical Research Institute of Shipbuildingtechnologies together with “Admiralteiskyie Verfi” in1996. Experts from ‘Baltyisky Leasing Ltd’ alsoparticipated in the preparation of the proposal. It wasestimated that the project would take 5 years tocomplete, in the course of which it was planned to

invest US $38 million into “Admiralteiskyie Verfi” forthe renovation of capital assets through the leasingof equipment. At present this investment proposal isbeing revised in light of the current economic situationin Russia and the plan to establish a new enterprisein St. Petersburg called “Verfi of St. Petersburg”(St.Petersburg Shipyards). The first stage of theproposal is a pilot project to supply equipment usedto prepare ships’ hulls for painting. '‘BaltyiskyLeasing'’ received this equipment in December, 1998.In January 1999, the equipment will be installed andleased to SE "Admiralteiskyie Verfi".

“Baltyisky Leasing”, January 15, 1999.

RECENT EVENTS IN THE RUSSIAN LEASING MARKET

Diagram 3. Equipment leased (Moscow Leasing Company,1997)

Real Estate 24%

Trucks15%

Woodprocessing

21%

Printing 19%

Photolabs8%

Mini-bakeries4%

Packaging9%


The leasing company “Interrosleasing”analyzed the results of its 1998 activities

in terms of supplying mining equipment for RAO“Norilsk Nickel” and AK “ALROSA”. The value ofequipment supplied to RAO “Norilsk Nickel” wasUS$37,5 million and to AK “ALROSA”, US$6,3 million.In carrying out these transactions, “Interrosleasing”used unique financing mechanisms. In supplyingequipment to RAO “Norilsk Nickel”, Interrosleasingused mechanisms which included both the guaranteeof the Swedish Export Agency (EKN), and theguarantee of equipment buyout by the supplier. Also,both mechanisms used the cessation of rights as ameans of securitization under a long-term exportcontract with “Interrosimpeks” for the supply of metal.This element of securitization was first used in thefinancing mechanisms of projects carried out by RAO“Norilsk Nickel”. Nevertheless, the mechanismmentioned above has not encountered any difficultiesdue to the effective cooperation amongst RAO“Norilsk Nickel”, TOO “Interrosleasing” and ZAO“Interrosimpeks”. In these transactions, the creditorsof “Interrosleasing” were large western banks suchas UBS (Luxemburg), WestLB (Dusseldorf), andScandinaviska Enskilda Banken (Sweden). The factsdescribed above show that these new elements ofsecuring transactions and providing comfort forcreditors, helped “Interrosleasing” attract foreigninvestment into a real sector of the Russian economyon fairly favorable terms. It is worth mentioning thatleasing projects within the framework of the FIG“Interros” provided a higher level of coordinationamong all Russian parties to the contract. Consideringadditional opportunities in financial securitization, thisincreases the competitiveness of the leasing businesswithin the framework of FIG “Interros” and createsprospects for further development.

Press-service of “Interrosleasing”, February 3,1999

Twenty two percent (22%) of funds collectedby the budget of the Irkutsk Region consist

of payments made by small enterprises. Twenty-two percent (22%) of cash paid to the budget of theIrkutsk Region comes from small enterprises andindividual entrepreneurs. The results of last year’soperations of the region’s small businesses wereanalyzed on January 18, 1999 at a meeting of theCouncil for Small Business Development under theGovernor of the Angara Region. The program“Support and Development of Small Business in theIrkutsk Region for 1997-1998” was financed quitemodestly: out of the promised 6,8 million rubles, only765 thousand was allocated. Another 3 million wasgenerated through the leasing company “IrkutskBusiness-Park”. The AO “Russian Agency ofSupporting Small Business – Irkutsk Business-Park”was established in the summer of 1994. “Business-Park” is engaged in financial leasing of equipment tosmall companies. In addition, “Business-Park” has

compiled 8 databases for small businesses. At theCouncil meeting, it was pointed out that today smallenterprises employ every tenth working person in theIrkutsk region. An additional 75 thousand people areengaged in entrepreneurial activities without havingestablished a legal entity. The Moscow trend (half ofthe Moscow budget is made up of taxes from smallbusinesses) seems to have started to take root in theIrkutsk region.

RosBusinessConsulting (RBC) January 19, 1999

The Joint-Stock Company “Orensot”(Orenburg) has completely paid for

equipment provided through leasing. Accordingto a statement made to an RBC correspondent bythe General Director of AO “Orensot”, the biggestcellular network operator in the Orenburg region (asubsidiary of OAO “Electrosvyaz, Orenburg Region”),the company has fully paid arrears to its founders forequipment supplied on lease. The overall volume ofthis leasing contract, signed at the moment of thecompany’s foundation, was about 12 billion non-denominated rubles: 6 billion was put up by “Orensot”itself, the other 6 billion – by the founders. Amongthe founders were OAO “Electrosvyaz, OrenburgRegion”, the local administration, and the Orenburgfinancial company. One of the main directions offurther development of cellular communications in theOrenburg Region, according to the leaders of“Orensot”, consists of the technical upgrading of theenterprise and the development of cellularcommunications in the town of Orsk. This will requireUS$1 billion. The leaders of the company suggestthat with the arrival in Orsk of a second cellularcommunication base station, it will become possibleto access the service from Novotroitsk, a town notfar from Orsk.

RBC, January 20, 1999

L ast year in St. Petersburg, the CivilInitiatives Center (an American non-

commercial company) established 75 smallenterprises, including those supported by loansand leasing. In 1998, special seminars on smallbusiness (marketing, finance, personnelmanagement, business planning, etc) were attendedby 250 people. Another 500 people were givenpersonal consultations at the Civil Initiatives Center.

RBC, December 28,1998

The leasing company «Avtopromleasing»will supply Chelyabinsk plant tractors to

Moscow road-building and constructioncompanies under a leasing contract.«Avtopromleasing» is going to buy equipment fromthe Chelyabinsk tractor plant for «real» cash. Duringthe 1st quarter of 1999 the plant is planning to sell noless than 200 T-170 bulldozers to «Avtopromleasing».«Avtopromleasing» will then lease the machines with

NEWS


Moscow Government guarantees.Prime-TASS,

December 15, 1998

The leasing of aircraft is the most importantway to support the aviation industry and

air carriers. About 30% of aircraft in the world aresupplied through leasing arrangements. BecauseRussian air companies do not have funds to purchasenew airplanes, they can operate only on the basis ofleasing. Thirty-one (31) foreign passenger planes arecurrently used in Russia on this basis. The annualleasing payments to Western firms and banks amountto US$150 million. The “Aeroflot” and “Transaero”companies intend to acquire another 30 Boeingairplanes.

M.Davydova, “On the Runway”,NG-Politeconomiya, N20, Dec.15, 1998

In 1998, US$128 million worth of equipmentwas imported into Russia through the

channels of “Rusleasingsvyaz” for lease toregional telecommunications companies. In 1999this figure will grow to US$ 200-250 million. In addition,“Svyazinvest” is planning to allocate US$ 230 millionof its own funds to purchase equipment for theregions. This will enable them to put 1,4 million ATCnumbers into operation.

RBC, December 11, 1998

“Svyazinvest” is planning to establish, inaddition to the existing companies “RTK-Leasing” and “Rusleasingsvyaz”, three or fournew leasing companies. “Svyazinvest” is planningto purchase equipment through these leasingcompanies, which will create new sources of incomefor the company.


On Dec.9, 1998, the committee on ForeignEconomic Ties of the Administration of

St. Petersburg hosted a round-table discussionof the leasing development program in St.Petersburg. Among the participants of the discussionwere representatives of different Committees of theAdministration of St. Petersburg, leasing companiesof the city of St. Petersburg and the Leningrad region,and the International Finance Corporation. The topicof discussion was the notion of leasing as one of themost important instruments of attracting investmentsinto the process of modernizing production in Russiaand, in particular, on the territory of St. Petersburg.The leasing development program of St. Petersburgincludes a whole series of measures aimed atsupporting St. Petersburg’s leasing companies. Forexample, these measures may include selectingenterprises interested in acquiring equipment throughleasing, compiling a list of necessary equipment,establishing a security fund or other types of providingguarantees for leasing projects, working on local

legislation which would envisage state support forinvestors and lessors, and others. The round tablediscussion resulted in the establishment of a workinggroup to further elaborate the issues of leasing in St.Petersburg.

M.Garadja, IFC, December 9, 1998

The practice of Moscow enterprises leasingequipment to small businesses in the

capital, will be expanded. Moscow enterprises willincrease the volume of equipment leased to the city’ssmall enterprises. The Moscow leasing company isto lease no less than 30 million rubles’ worth ofequipment for processing and selling agriculturalproduce. For their part, the Moscow Department ofState and Municipal Property and the MoscowInsolvency Committee, as agreed with theDepartment of Small Business Support andDevelopment, are to ensure that certain buildings andequipment acquired by the Moscow budget aspayment of arrears by debtors, will be leased to smallenterprises of the city on favourable terms.


The Samara firm “Vesna” will take secondplace for the production of soap using

imported equipment provided by “SBS-Leasing”.According to “SBS-Leasing” experts, the Samaracosmetic firm “Vesna” will shortly take second placefor the production of soap with equipment leased by“SBS-Leasing” under SBS-AGRO guarantees. TheSBS-AGRO press-service reports that “Vesna” hasalready started production of detergents on the“Balestra” production line and of ‘extra-class’ soapwith “Matzoni” equipment. This production line is thefirst in Russia to ensure quality on an internationallevel, the Press-service underlines. So far, theSamara factory has been importing raw materials,but plans have been established to graduallysubstitute them with domestic raw materials. Theequipment was leased for 4 years with obligatorymaintenance. At present “SBS-Leasing” is negotiatingthe leasing of analogous equipment to other Russiancities. The contract with “Vesna” is not the first projectcarried out by “SBS-Leasing”. Last spring thecompany supplied 100 German harvesting combines,“Dominator”, to some regions of the country. Inaddition, “SBS-Leasing” is working with a wide rangeof modern equipment for municipal services, transportnetworks, processing enterprises and smallbusinesses.


On November 27, 1998 the ’FinancialNewspaper’ (Regional Issue, N48, 49)

published the state programs of support for smallbusiness, in particular, the Package Program for theDevelopment and Support of Small Business inMoscow, 1998-2000. The Moscow Program wasdeveloped within the framework of the Federal

NEWS


program, which aims mainly at creating economic,legal and organizational conditions necessary toimprove the stability of small enterprises. This willbe accomplished by improving the existing legal andregulatory frameworks, and by introducing new formsand mechanisms of providing financial assistance tosmall businesses. In terms of exploring these newfinancial mechanisms, the Moscow programincorporates a sub-program called “InvestmentSupport for Small Enterprises through the Leasing ofEquipment”. The aim of this sub-program is todevelop and introduce a package of economic,organizational and legal measures conducive to thedevelopment of leasing in the sphere of smallbusiness. To achieve this goal, specialized leasingprograms will be launched, and the Moscow Inter-Regional Leasing Center will be established. Aprogram to promote leasing as a leading investmentmechanism will be carried out and entrepreneurs willbe trained in the basics of leasing legal relations. Also,it is planned to compile and support special inter-branch databases, containing information on leadingproducers and suppliers of equipment for smallbusinesses.

“Financial Newspaper” (regional issue, 1998,N48), “State Programs of Support for Small

Business”, A.V.Kostrov, V.V. Nikolayev

On December 16-17, 1998 a seminar on “TheBasics of Leasing Activity in Russia” was held

in Kaliningrad in cooperation with the KaliningradRegional Agency for SME support. This seminar wasprepared and organized by the Leasing DevelopmentGroup of the International Finance Corporation (IFC).

The seminar, addressed to a wide audience interestedin leasing, attracted experts from the regional andlocal administrations of the city and region, universitylecturers, officials from the state tax agency, andrepresentatives from the Regional Agency of Supportfor Small and Medium Business. The main aim ofthis seminar, like that of other similar seminars heldby the IFC Leasing Development Group, was tointroduce the participants to the basics of leasing andto provide a systematic review of economic and legalaspects of leasing activities. During the course ofthe seminar, the trainers (experts from the IFCLeasing Development Group) described theadvantages of leasing, discussed bookkeeping andtaxation of leasing operations, and reviewed thecurrent Russian legislation on leasing.

The IFC Leasing Development Group has heldsimilar seminars in Moscow, Yekaterinburg andUlyanovsk. The next seminar, with organizationalsupport of the RF Chamber of Commerce, is plannedfor February 17-18 in Nizhny Novgorod.

A. Pisarenko, IFC

ANNOUNCEMENTS

From February,10, to February,12, 1999 theFourth Annual Conference on the

“Development of Private Enterprise: Lessons fromthe Regions”, will be held in Moscow. The Conferenceis organized by the US Agency for InternationalDevelopment.

For more information contact the BussinessCollaboration Center: tel. (095) 745-5043,Fax: (095) 745-5059 (Elizaveta Shirkova)e-mail: [email protected]

ECONOMY

In this article we are going to examine theadvantages which the leasing scheme offersto companies (lessees), in comparison with a

loan purchase.

Typically, companies use three sources offinancing:

1) equity,2) bank loans,3) securities.

However, in many countries with economies intransition, the stock markets are weak and thebanks prefer to work with large enterprises that areable to put up collateral and have stable credithistories (by i.e. documented proof of creditworthiness, in terms of how accurately they madepayments and returned previous loans).

Small and medium enterprises as well as newlyestablished companies, in most cases, have no

access to bank financing. Quite often financial rent(leasing) or suppliers’ credit is the only source ofoutside financing for these enterprises.

The Economic Efficiency of Leasing as Compared to Loan Purchaseby Veronika Shtelmakh

Veronika Shtelmakh, economist, IFC LeasingDevelopment Group


Below we will list the advantages of leasingtransactions typical of developed leasing markets,which make leasing a fundamental means ofacquiring equipment for small and mediumenterprises. Unfortunately, these advantages ofleasing are not always present in the Russian market,mostly due to the lack of an effective repossessionmechanism. However, leasing in Russia does haveadvantages over bank loans. These advantages,namely the use of accelerated depreciation and thedeductibility of certain expenses from taxable income,stem from a taxation mechanism which is favourableto the parties to a leasing contract.

The parties to a leasing contract – the lessor andthe lessee – are closely interconnected. The financialstatus of the lessee, and his ability to make timelyleasing payments affects the financial status and cashflow of the leasing company. At the same time, thefavorable tax framework designed for the leasingcompany, has an impact on the lessor. As a rule, thisresults in a decrease in the total sum of the leasingpayments. Therefore, although the main purpose ofthis article is to compare the two methods ofequipment acquisition–the leasing scheme versus aloan purchase – we must also consider theadvantages that leasing offers to the leasing company,as the owner of the leased assets. The structure of the leasing transaction – analternative way of acquiring capital assets, based onseparating the ownership and the right of use, givesthe following advantages to the parties of a leasingtransaction as compared to a loan purchase scheme:

For the Leasing Company:1. The Leased equipment serves as collateral :

the leasing company retains ownership of the leasedequipment for the whole period of the leasing contract,therefore the property leased is in itself a guaranteeof the leasing transaction. In developed leasingmarkets, no other guarantees are usually required.

Unfortunately, this advantage of financial leasingdoes not always hold true in Russia, as therepossession mechanism is not sufficiently effective.

2. Dedicated use of funds :Because the lessorpurchases equipment directly from the supplier, thereis no possibility of the lessee utilizing the funds forother purposes. There is no need to constantlymonitor the use of assets (in comparison with thenecessary bank control over a loan).

3. Tax incentives:• Accelerated depreciation may be used to

depreciate movable leased assets. The depreciationcoefficient may not exceed three times straight linedepreciation.

• Any interest paid on funds used to financeleases is partially deductible*, whereas interest paidon regular bank loans to purchase equipment is non-deductible.

For the Lessee:1. Availability: the decision on making a leasing

transaction is mostly based on the lessee’s ability togenerate the necessary cash flow to cover leasepayments, and to a lesser degree it depends on thecredit history of the company. In developingcountries, leasing may be the only form of obtainingmedium or long term credit for the acquisition ofequipment, especially for new, small and mediumenterprises.

2. No additional guarantees are required : asthe lessor remains the owner of the leased asset, noadditional guarantees are required for a leasetransaction (assuming an effective repossessionmechanism is in place).

3. Small volumes of leasing transactions: banksare not interested in small transactions because ofthe high cost of processing a loan, whereas leasingcompanies are interested in such transactions.

4. A flexible schedule of lease payments inaccordance with production cycles and cash flows:when scheduling lease payments, a leasing companywould necessarily take into consideration the lessee’sfinancial situation. In case the lessee is a small ornewly formed enterprise, or if it needs a long periodof time to put the equipment into operation, the partiesto a lease are likely to accept a leasing paymentschedule according to which, the amount of individualpayments under the lease contract will be small inthe beginning, and become larger over time. Thiswill enable the lessee to meet their paymentobligations, even if cash flows are not initially verysubstantial.

5. Favorable taxation – total deductibility of theleasing payments. This results in a lower cashoutflow, as compared to a loan purchase.

IMPACT OF FAVORABLE TAXATION ONCASH FLOW

The leasing mechanism is more convenient fora lessee than purchasing an asset directly

from a vendor (supplier), as customs formalities andpayment of the corresponding taxes and dutiesbecome the responsibility of the leasing company. Inaddition, application of the leasing structure leads toa lower outflow of cash in comparison with a loanpurchase, which can be proven by calculating acompany’s cash flows in the following two cases;

1. the company acquires an asset under afinancial leasing contract,

2. the same company acquires the sameequipment under a loan purchase scheme

For convenience we will call this company in thefirst case – the “Lessee”, and in the second case –the “Buyer”, of the equipment.

To determine the difference in cash flows betweenthe financial leasing of equipment and acquiring itinto ownership, a model has been developed byspecialists, according to which the cash flows of the* Any interest above the Central Bank rate plus 3 percentage points

is not deductible for ruble loans. Any interest above LIBOR plus 3percentage points (but not exceeding 15 percent total) is notdeductible for foreign currency loans.

ECONOMY


Lessee and the Buyer of equipment can be calculated.A simplified version of this model is presented below.

The simplified model of calculating cash flows (CF)of a company (lessee). The equipment is recordedon the balance sheet of the lessor.

Lease payments paid (LP)Profit tax benefit PTBTotal: (CF)

Calculation of the cash flow of the company underloan purchase scheme .

Loan payments: Principal (Pr) Interest (IR)Profit tax benefit PTBProperty Tax (PT)Customs Duties (CD)

Total: (CF)

Results of comparing the cash flows ofthe Lessee and the Buyer of equipment

The results presentedbelow were calculated with a more complex

formula, according to which the cash flow wascalculated per year, and then the annual cash flowswere discounted. The payment and offsetting of VATwas also taken into account. The final results:

Discounted Cash Flow

As you can see from the given graph, the companyspends 450,000 c.u. less in the case where a leasingcontract is in effect, than in the case of a loanpurchase. What are the factors that make such agreat impact on the cash flows in both cases? Mainly,it is due to the profit tax benefit.

The notion of “Profit Tax Benefit”

The deductibility of expenditures lowers thecompany’s taxable base, and, as a result,

decreases the profit tax due. The notion of “profit tax

benefit” enables us to assess how much smaller thelevied tax for a company deducting certainexpenditures from taxable profit will be, than for acompany unable to deduct these expenditures.Mathematically, the profit tax benefit is calculated bymultiplying the amount of tax deductions by the profittax rate.

The following graph demonstrates that it is muchbetter for the company to deduct leasing payments

in full, in comparison with the possible deductionsavailable under a loan purchase. In the latter case,only depreciation without the acceleration coefficientand property tax are deductible.

The fact that the full amount of lease payments isdeductible from profit before tax, means that the sumof profit tax paid by the Lessee is smaller than thatpaid by the Buyer of the equipment, by 413,000 c.u.

Parameters of the Cash Flows of theLessor and the Buyer of Equipment

As the Lessor and Buyer of equipment are bothowners of equipment, the model allows us to

compare their cash flows, i.e. the difference in the

The original data for calculations:

Term of the lease contract 3yearsCost of equipment 1 blnc.u.Bank loan rate received by the Lessorfor purchasing fixed assets (hard currency) 12%

Spread of the leasing contract(difference between the interest rate of theleasing contract and interest rate on the loan,used for the purchase of leased equipment) 18%

Profit tax rate 35%Property tax rate 2%VAT (fully off-set) 20%Turnover tax rate 4%Depreciation rate 10%Accelerated depreciation coefficient 3Discount rate 10%

534,891

121,800

0

200,000

400,000

600,000

Lessee Purc haser

Profit Tax Savings

ECONOMY

(926,491)

(1,378,973)(1,500,000)

(1,000,000)

(500,000)

0

Lessee Purchaser


profit tax benefit, and the difference in the propertytax which appear as a result of accelerateddepreciation used by the Lessor.

As you can see from the given graph, the use ofaccelerated depreciation with a coefficient of 3enables the Lessor to decrease property tax.Accelerated depreciation also decreases the profittax which is 210,000 lower than that paid by theBuyer of the equipment.

The amount of property tax, paid by the Lessor inour example is 2 times smaller than that paid by theBuyer of the equipment.

Thus, the analysis of the cash flows of the partiesto a lease transaction and of the buyer of equipmentshows that financial leasing in Russia hasconsiderable advantages over a loan purchasescheme. As leasing is an effective mechanism ofacquiring capital assets, and, consequently, of

315,000

105,000

0

100,000

200,000

300,000

400,000

Lessor Purchaser

Profit Tax Savings

(24,000)

(48,000)(60,000)

(40,000)

(20,000)

0

Lessor Purchaser

Property Tax

renovating the material and technical foundation ofenterprises, it is crucial to preserve these advantagesin the future, particularily the use of accelerateddepreciation. Unfortunately, Part II of the draft TaxCode does not envisage the use of accelerateddepreciation for any category of equipment, exceptthat used in an aggressive environment and (or)having a high shift index.

If the state is really interested in developing smalland medium business and in renovating capitalassets, we believe that it is necessary to considerretaining the mechanism of accelerated depreciationfor leased assets. Our thoughts on retaining possiblemethods of charging accelerated depreciation ofleased assets will be published in the next issues ofour Bulletin.

ECONOMY

On January 1,1999, Part I of theTax Code of theR u s s i a nFederation cameinto effect. Whatare the implica-tions of thisdocument forl e a s i n gcompanies?

It was expected that the Tax Code would radicallychange the tax system of Russia, by:

1. putting all the existing legislative and regulatoryacts on taxation together in one document, which canthen be directly exercised;

2. lowering, to a certain extent, the tax burdenand reducing the number of taxes;

3. raising the level of protection and observanceof tax payers’ rights.

Part I of the RF Tax Code has Come into Effect - Our CommentaryBy Veronika Shtelmakh, and Nina Zhuravleva (photo)

So far these statements remain “declarations ofintention”, rather than effective provisions. Theproblem is that the Articles defining the various typesof taxes and dues are not currently in effect. Theywill, however, be put into effect upon the adoption ofPart II of the Tax Code. In the meantime, taxes, dues,duties and other payments to the budget or non-budget funds are levied according to Articles 19, 20,and 21, of the RF Law “On the Basic Principles ofthe Tax System”.

The lack of information about when and in whatform this part of the Tax Code will be brought intoeffect is cause for concern. It is known that thisdocument was substantially changed in comparisonwith the draft that was submitted to the State Dumaon January 31, 1998. It is difficult to say now whetherthe intentions of the authors have remainedunchanged or whether a completely new documenthas been created.

Nina Zhuravleva, accountant, IFCLeasing Development Group


Until Part II of the Tax Code is put into effect,current tax laws will remain in effect. These laws,according to Art.7 of the Federal Law of 31 July,1998N147-F3, “are in effect where not in contradiction withPart I of the Tax Code, and are subject to alignmentwith Part I of the Tax Code”.

In this article, the following provisions of Part I ofthe Tax Code which came into effect as of January1999, and to which leasing companies should payattention, will be covered:

1. the special taxation provision, which isapplicable when a company sells goods or servicesat a price not exceeding the actual cost, is abolished;

2. a new approach for determining the price ofgoods or services for taxation purposes is established;and

3. the rights of the tax payers are more protected.

The Federal Law (July 31, 1998) N147-F3 putsinto effect Part I of the Tax Code, and at the sametime abolishes the special taxation provision whichwas applicable to business entities when productswere sold at a price not exceeding the actual cost ofproduction. As it is well known, according to thisprovision, the enterprise had to recalculate its profitbefore tax and its turnover based on the market pricefor similar products. In this case, the taxable sumcould be increased by the amount of the margin ofthe market price over the actual selling price. In otherwords, the enterprise had to pay taxes on incomethey did not receive! Furthermore, the wording ofthe definition of “market price” in tax legislation wasquite ambiguous, and the application of this provisioncould lead to conflicts with local tax inspectors.Leasing companies found themselves in a similarsituation where leasing payments were paid inincreasing (or decreasing) amounts (i.e. not in equalportions), and the sum of depreciation of the leasedequipment for the period was higher than the cost ofthe equipment reimbursed by the leasing payments.Currently, in the case where leasing payments aremade in increasing or decreasing amounts, leasingcompanies do not have to recalculate profit tax andVAT due.

Article 40 of the Tax Code sets new guidelines fordetermining the contract price of goods and servicesfor taxation purposes. The price determined by theparties to the transaction (ie. the contract price) isconsidered to be the base price. Unless provenotherwise, it is assumed that the contract pricecorresponds to the market price. Tax inspectors havethe right to examine contract prices only in thefollowing cases:

a) Between interdependent persons.Interdependent persons in taxation matters are

those individuals and (or) organizations, whoserelations may have a direct impact on the conditionsor economic results of their activity (Art.20 TC). It isquite probable that tax agencies may recognizeparties to a leasing transaction as interdependent

persons. This, however, is merely an assumption.b) In barter operations.This is significant for leasing companies in the

case where leasing payments are made in acompensatory or mixed form (i.e. fully or partially bythe Lessee’s product).

c) In cases where considerable price fluctuation(over 30% either way), as determined by the taxpayer,of similar goods occurs within a short period of time.

This stipulation may also be important for leasingcompanies, where leasing contracts are concludedfor similar assets, but for different clients (for example,one client is a member of the same financial-industrialgroup as the leasing company, and the second clientis external).

If, as in the cases described above, the taxagency determines that the price of goods andservices agreed by the contracting parties deviateseither way more than 30% from the market value ofsimilar goods and services, the tax agency has theright to submit a decision on additional charges oftax and penalty. These charges are calculated onthe basis of comparable transactions valued at marketprices.

The approach described in this Articleconsiderably limits the rights of tax agencies indetermining the price of the transaction for taxationpurposes.

Another very important point: the Tax Codeprovides for a higher level of protection andobservance of taxpayers’ rights.

- From now on, new taxes cannot be introducedbefore the start of the following fiscal year, and anychanges introduced into existing tax laws will comeinto effect no earlier than one month after their officialpublication (Cl.1 , Art.5 TC).

- The size of sanctions for tax violations hasbeen considerably decreased, and the sanctionsthemselves have been almalgamated.

- If the taxpayer disagrees with the results of taxinspection, collection of tax sanctions can be claimedonly by court order. (Art.104 TC)

- As an additional mechanism of protecting thetaxpayer’s economic interests, the sum of anyovercharged tax is reimbursed with interest accordingto the RF Central Bank refunding rate effective atthat time (Cl.4 Art.79 TC)

Although the Tax Code has become a reality, someof its provisions have not yet come into effect.Unfortunately, it is impossible to say with certaintywhether the adoption of Part I of the Tax Code hasmade life any easier. Furthermore, as reported bythe press, a law is currently being prepared on theintroduction of changes and amendments to Part I ofthe Tax Code “in order to eliminate inaccuracies andtechnical errors”.

Subsequent issues of our Bulletin will provide moredetailed commentary on the effect that the operatingprovisions of Part I of the Tax Code will have on theactivities of leasing companies.

TAXATION


Albert Sabitov, lawyer, IFC Leasing DevelopmentGroup

As the Russian economy began its transitionto a market-oriented system in the early

1990s, financial leasing underwent a transformationfrom a financial instrument available only to largestate-owned export agencies, to a means ofinvestment intended for wide application. In thefollowing pages we review the development oflegislation, which characterizes the legal environmentfor financial leasing.

We can identify three broad stages in thedevelopment of Russian legislation on leasing.

STAGE 1 – PRIOR TO 1990This period can be characterized by a lack of

special legislation regulating leasing. The businessenvironment for leasing was also undeveloped andthere was no clear definition of the legal status ofparties to a lease agreement. During this periodleasing was mostly conducted by large foreign tradeassociations. This, in particular, was predeterminedby the fact that economic activity in the USSR wasdominated by the state.

STAGE 2 –1990-1996With the beginning of market reforms and the

transition to a market economy, business contractsthat contained elements of leasing transactions beganto appear. However, there was still no specificlegislation in place.

This period is characterized by the followingfeatures:

• the lack of a special regulatory framework inthe sphere of leasing. However, leasing was beginningto develop on the basis of legislation which regulatedrental activities;

• the high level of risk for participants in leasingactivities, which restricted the development of leasing.

Until 1996, leasing transactions fell into the

A Brief History of Russian Legislation on LeasingBy Albert Sabitov

category of transactions which were “not stipulatedby law, but not in contradiction to the law” (Article 4,Civil Code RSFSR 1964). During this period it wastypical for leasing contracts to incorporate someelements of a purchase and sale contract andproperty hire.

STAGE 3 – 1996- OCTOBER 1998The beginning of this stage is marked by the

emergence of Presidential Decree No. 1929, “On thedevelopment of financial leasing in investment activity”(September 17, 1994) and a number of otherregulatory acts issued by the Government.

Decree N1929 of the RF President was the firstregulatory document that actually designated leasingas an independent type of transaction, definedleasing, and declared the importance of leasing “forthe support and development of small and mediumbusiness”.

This decree was followed by Resolution No. 633of the Government of the Russian Federation “Onthe development of leasing in investment activity"(June 29, 1995). Among other things, this resolutionenacted the Interim Regulation on Leasing.

The Interim Leasing Regulation designated:• the general principles of leasing operations,• the rights and obligations of parties to a leasing

contract, and• the composition and order of leasing payments.The Interim Regulation is still in effect now, but

only to the extent to which it conforms with the RFCivil Code and the Federal Law “On Leasing”.

Another important step towards the strengtheningof the legal framework for leasing in Russia was theadoption of Part II of the Civil Code of the RussianFederation, which came into effect in March 1996.Since then all regulatory acts on financial leasing mustbe viewed through the “prism” of the Civil Code.Lease relations are regulated by Chapter 34 of thecivil code and paragraph six of this chapter is devotedspecifically to financial leasing.

In order to understand the nuances of leasinglegislation in Russia, it is necessary to analyze thedifferences in the notions of leasing and rent. Theterm ‘leasing’, translated from English, equates to theterm ‘rent’ in Russian. In international practice thereare two main types of leasing - operational andfinancial. In Russia, the term ‘leasing’ became widelyknown only in the early 90’s, with the beginning of thesecond stage in the development of leasinglegislation. In regulatory acts, this term first appearedwith the adoption of the Presidential Decree.Considering that the notion of operational leasing is

LEGISLATION


identical to what is understood in Russian as rent,we may conclude that when the term “leasing” is usedin Russian, the authors of regulatory acts are referringto financial leasing. This is confirmed by the definitiongiven in the Civil Code:

Under a financial leasing contract, thelessor shall undertake to acquire intoownership the asset specified by thelessee from the vendor defined by thelatter, and grant the lessee temporarypossession and use of the asset forentrepreneurial purposes, in return forpayment.

Selection of the vendor and the asset may be alsomade by the lessor, if this is stipulated by the contract.

Under a financial leasing contract, in contrast to arent contract (operational lease):

• a new party to the transaction appears, namelythe vendor (supplier);

• the lessor must acquire an asset only for thepurpose of leasing it;

• the active role of the lessee presupposes filingan application and specifying the property and thevendor, unless the contract states otherwise.However, it should be noted that if the leasing contractdefinition, given in the RF Civil Code is interpretedliterally, it is the request of the lessee to the lessorwhich is primary.

• the leased asset may be used forentrepreneurial purposes only.

Thus, we see that the Civil Code’s Chapter 34,section 6, encompasses the following:

• a relationship amongst three parties: a lessor,lessee and vendor (supplier),

• their rights and responsibilities,• their obligations in case of default or improper

fulfillment of responsibilities.Practically all the provisions of section 6 in Chapter

34 of the RF Civil Code bear a dispositional characterand parties to a lease agreement can solve manyquestions at their own discretion, provided theiractions do not contradict the law.

Furthermore, the manner in which financial leasingis conceptualized in the Civil Code corresponds inmany ways to the UNIDROIT Convention onInternational Financial Leasing of 1988, which alsoemphasizes the three-party relationship. Russiaratified this Convention in 1998.

Along with legislation, the regulatory frameworkcontinued to develop. Resolution N 752 of theGovernment of the Russian Federation introducedchanges and amendments in the Interim Regulationon Leasing. The Resolution was adopted on June27, 1996 and added the following rules to the InterimRegulation:

• If parties to a lease contract came to anagreement, they could use accelerated depreciationwith an accelerator of not more than 3, provided theleased asset was moveable property classifiable asan ‘active’ fixed asset.

• Parties to a lease contract were given thefreedom to decide on whose balance sheet a leasedasset would be recorded.

On November 20, 1995, the Government adoptedResolution number 1133 entitled “On MakingAmendments in Provision N552 on the Costs ofProduction and Sale of Products (Goods andServices), Included in the Unit Cost of Products(Goods and Services) and the Procedure forAccounting Earnings Before Taxes”. Following theadoption of this resolution, parties to leasingtransactions can include in the cost of products (goodsand services):

• interest on financing for the purchase of theasset (by the lessor);

• lease payments, and expenses covering loaninterest (by the lessee).

In summary, one can say that at the time of theadoption of the federal law on leasing in October 1998,legislation in the Russian Federation regulatingleasing was relatively well developed. In the next issueof this newsletter we will complete this description oflegislation concerning leasing with a detailedcommentary to the federal law on leasing.

LEGISLATION

IN THE NEXT ISSUES:

LEASING IN THEREGIONS

Saint Petersburg: experience inusing leasing to establish smallbusinesses

Leasing in Ulyanovsk: interviewwith Mr. Ryabov, executivedirector of «INTER-Leasing»,city of Ulyanovsk

Moscow: Leasing as means ofinvesting in small businesses

NEWS

Press review of events in theleasing market

TAXATION

Part I of the RF Tax Code hascome into effect: ourcommentary (continuation)

LEGISLATIONFederal law «On Leasing»: ourcommentary

QUESTIONS AND ANSWERS

Answers to «LC» readers’questions

and much more . . .

LCLC

DEAR READER!

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The articles for this issue were preparedand written by:

Marina GaradjaNina ZhuravlevaIrina LikhachovaAndrei PisarenkoAlbert SabitovVeronika Shtelmakh

Editor in Chief: Irina Likhachova

English language editors: Karim Ahmad,Gail Bowkett

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Documents

LEASING-COURIER LC - World Bank · 2016-07-12 · LEASING-COURIER LC Information Bulletin LC January-February 1999, Issue 1 (1) Published by the Leasing Development Group of the International