Types of leasing and

hire-purchase

Submitted to: Submitted by:

Ms :Pooja puri Maninder Singh

jasmine

MBA 3rd sem

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Financing lease

• A finance lease or capital lease is an a commercial

arrangement where:

• The lessee (customer or borrower) will select

an asset (equipment, vehicle, software);

• The lessor (finance company) will purchase that asset;

• The lessee will have use of that asset during the lease;

• The lessee will pay a series of rentals or installments

for the use of that asset;

• The lessor will recover a large part or all of the cost of

the asset plus earn interest from the rentals paid by the

lessee;

• The lessee has the option to acquire ownership of the

asset (e.g. paying the last rental, or bargain option

purchase price);

The finance company is the legal owner of the asset

during duration of the lease.

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Features It's not cancel-able.

The lessor may or may not bear the cost of insurance,

repair, maintenance etc. Usually the lessee has to bear all

cost.

The lessor may transfer ownership of the asset to the

lessee by the end of the lease term.

The lessee has an option to purchase the asset at a price

which is expected to be sufficiently lower than the value

at the end of the lease period

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Operating lease

• Definition: Operating lease is a contract wherein the

owner, called the Lessor, permits the user, called the

Lessee, to use of an asset for a particular period which

is shorter than the economic life of the asset without

any transfer of ownership rights. The Lessor gives the

right to the Lessee in return for regular payments for

an agreed period of time.

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Example of operating lease

• An example of operating lease would be when a person

is starting his or her own manufacturing business but

he or she does not have enough cash to buy machinery

then the person will take machinery on operating lease.

Operating lease is that lease which allows lessee to use

the assets for short period of time.

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Features of operating lease

• Operating lease is a short term arrangement for the use

of asset between the lessee and the owner of the asset.

• Various costs related to that asset like maintenance,

taxes etc…. are paid by the owner of the asset.

• The term of operating lease is always shorter than the

economic life of that asset.

• The lessee can cancel the operating lease prior to the

end date of the operating lease.

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• The terms related to an operating lease can vary

significantly depending upon the agreement between

the lessee and the owner of the asset.

• The rent which is paid by the lessee for the duration of

the operating lease is lower than the cost of asset.

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Forms of financial lease

1. Sales and lease back.

2. Direct leasing.

3. Leveraged leasing.

4. Straight lease and modified lease.

5. Primary lease.

6. secondary lease

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1. Sales and leaseback:

A sale and leaseback constitutes an arrangement

where the seller of an asset leases back the same asset

from the purchaser.

The lease arrangement is made immediately after the

sale of the asset with the amount of the payments and

the time period specified. Essentially, the seller of the

asset becomes the lessee and the purchaser becomes the

lessor in this arrangement.

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2. Direct leasing:

A contractual financing arrangement in which the lessor,

typically a bank, purchases the property directly from the

manufacturer and leases that property to the lessee.

3.Leveraged lease:

A lease agreement that is partially financed by the lessor

through a third-party financial institution. In a leveraged

lease, the lending company holds the title to the leased

asset, while the lessor creates the agreement with the

lessee and collects the payment. The payments are then

passed on to the lender.

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• In a leveraged lease, if the lessee stops making

payments to the lessor, then the lessor stops making

payments to the financial institution (lender). This

allows the lender to repossess the property.

• The lessor may also have the right to retain the

property upon lessee default, as long as the lessor

continues making payments to the lender.

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4. Straight lease:

A lease agreement which specifies an amount of rent that

should be paid regularly during the complete term of the

lease. Also called a flat lease.

5. Modified lease:

A lease agreement provides several options to the lessee

during the lease period.

For example: terminating the lease, purchasing asset.

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6. Primary lease: Equipment or property lease in which

the rental payments are higher in the

beginning periods, and go down as the lease

period nears its end.

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Other types of leases

1. Floating rental rate lease contracts.

2. Domestic lease

3. International lease.

4. Sale –Aid lease

5. Foreign to foreign lease.

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1. Floating rental rate lease contracts:

Under this type of lease, lease rentals are reduced or

increased according to the borrowing rates by the

lessor.

2. Domestic lease:

When all the parties of the lease agreement reside in

the same country, it is called domestic lease.

3. International lease:

When all the parties of the lease agreement reside in the

different countries, it is called international lease.

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International lease of further of two types:

a) Import lease:

When lessor and lessee reside in same country and

equipment supplier stays in different country, the

lease arrangement is called import lease.

b) Cross border lease:

When the lessor and lessee are residing in two

different countries and no matter where the

equipment supplier stays, the lease is called cross

border lease.

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4. Sale –Aid leasing:

Under this type of leasing, a manufacturer directly

extends facility of leasing either by one of his own

subsidiaries or by third party.

5. Foreign to foreign lease:

under this type of lease three parties are involved:

a) The manufacturer (who is in one country).

b) Lessor ( who is in another country).

c) lessee ( in the third country).

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For example:

China is the manufacturing country and it exports

machinery to Indian based leasing company which

further lease it to Australian based firm.

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Tax aspect of leasing

• Lessor:– Deduction of depreciation from taxable income

– Income from lease rentals is taxable under “Profits and Gains of Business and Profession”

– Deductible expenses:• Depreciation

• Rent, rates, taxes, repairs and insurance

• Amortization of preliminary expenses

• Interest on borrowed capital

• Bad debts

• All expenses incurred in furtherance of business

• Entertainment expenses (with a cap)

• Travel expenses (as per approved norms)

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•Lessee:

– Deductibility of Incidental Expenses – Repairs,

Maintenance, Insurance, Finance

Charges,…(Incidental)

Installation expense (revenue expense in the year of

incurrence)

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Hire purchase

Hire purchase means a transaction where goods and

services are purchased and sold on the terms that,

1. Payment will be made in installments.

2. The possession of the goods is given to the buyer

immediately.

3. The ownership in the goods remains with the vendor

till the last installment is paid.

4. The seller can repossess the goods in case of default

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In the payment of any installment.

5. Each installment is treated as hire charges till the last

installment is paid.

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Features of Hire Purchase

The main features of hire purchase finance are:

1. The hire purchaser becomes the owner of the asset after

paying the last installment.

2. Every installment is treated as hire charge for using

the asset.

3. Hire purchaser can use the asset right after making the

agreement with the hire vendor.

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4.The hire vendor has the right to repossess the asset in

case of difficulties in obtaining the payment of

installment.

• Advantages of Hire Purchase:

• Hire purchase as a source of finance has the following

advantages:

• i. Financing of an asset through hire purchase is very

easy.

• ii. Hire purchaser becomes the owner of the asset in

future.

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• iii. Hire purchaser gets the benefit of depreciation on

asset hired by him/her.

• iv. Hire purchasers also enjoy the tax benefit on the

interest payable by them.

• Disadvantages of Hire Purchase:

• i. Ownership of asset is transferred only after the

payment of the last installment.

• ii. The magnitude of funds involved in hire purchase

are very small and only small types of assets like office

equipment’s, automobiles, etc., are purchased through

it.

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iii. The cost of financing through hire purchase is very high.

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Difference between Lease and hire-purchase

Ownership of the Asset:

• In lease, ownership lies with the lessor. The lessee has

the right to use the equipment and does not have an

option to purchase. Whereas in hire purchase, the hirer

has the option to purchase. The hirer becomes the

owner of the asset/equipment immediately after the

last installment is paid.

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Depreciation: In lease financing, the depreciation is

claimed as an expense in the books of lessor. On the

other hand, the depreciation claim is allowed to the

hirer in case of hire purchase transaction.

Rental Payments: The lease rentals cover the cost of

using an asset. Normally, it is derived with the cost of

an asset over the asset life. In case of hire purchase,

installment is inclusive of the principal amount and

the interest for the time period the asset is utilized.

•

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• Duration: Generally lease agreements are done for

longer duration and for bigger assets like land,

property etc. Hire Purchase agreements are done mostly

for shorter duration and cheaper assets like hiring a

car, machinery etc.

• Tax Impact: In lease agreement, the total lease rentals

are shown as expenditure by the lessee. In hire

purchase, the hirer claims the depreciation of asset as

an expense.

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• Repairs and Maintenance: Repairs and maintenance

of the asset in financial lease is the responsibility of

the lessee but in operating lease, it is the responsibility

of the lessor. In hire purchase, the responsibility lies

with the hirer.

• Extent of Finance: Lease financing can be called the

complete financing option in which no down payments

are required but in case of hire purchase, the normally

20 to 25 % margin money is required to be paid

upfront by the hirer. Therefore, we call it a partial

finance like loans etc.

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