Equipment Leasing

Introduction
 Alternatives for financing
Equipment
• Borrowing
• Borrow from a financial intermediary, Buy Equipment from a
vendor
• Leasing
• Transfer of right of use by the owner (Lessor) to the User
(Lessee) for an agreed period of time for rental
• Hire Purchase
• Equipment given on hire with an option to buy
• Installment Purchase
• Immediate transfer of ownership, payment in installments
 Leasing
• The owner (Lessor) of an equipment transfers the right
to use the equipment to the user (Lessee) for an agreed
period of time in return of rental
– Lessor
– Lessee
– Lease Term
• Primary – Non-cancellable
• Secondary - Renewal period
– Lease Rental
– No Transfer of ownership
 Types of Leases
• Finance Lease
– Transfer of ownership at
the end of term
– Lessee has an option to
purchase the asset at a
price<fair market value
– Lease term covers major
part of useful life
– PV of minimum lease
payments is substantially
=>Fair Market Value at the
inception
• `Hell or high water’
• Full payout lease
• Maintenance & Insurance
• Operating Lease
• Lease other than finance
lease is Operating Lease
– Wet Lease – lessor
provides maintenance,
insurance, operating know-
how
– Dry Lease – lessee bears
the insurance and
maintenance
• Right to terminate at a
short notice without
significant penalty
 Types of Leases
• Sale and Lease Back • Direct Lease
– To unlock the investment
– Operating or Finance
• Bipartite
– Supplier cum Lessor • Tripartite
– Lessee – Supplier
– Suitable for Operating – Lessor
Lease – Lessee
• Upgrade Lease
• Sale-aid Leasing
• Replacement (swap)
Lease
 Types of Leases
• Single Investor vs Leveraged Lease
(Uses a D/E Mix without recourse)
Lessor
Trustee Lessee
Loan Participant
(With recourse to the lessee)
• Big Ticket Leasing
• Domestic Vs International Lease
• Double Dip Transaction
 Advantages of Leasing
• Flexibility
• Equated
• Stepped – % Increase every year
• Ballooned – Small rental followed by large payment
• Deferred – Deferement period
• Tax benefits
• Less Paper Work
• Convenience
• Margin Money
 Rental Structure
• Cost of Equipment = Rs.50 lakhs
• Required rate of return = 16%
• Lease Period = 5 years
• Residual Value = Nil
• Equated
LR x PVIFA(16%,5) = Rs.50 lakhs
LR = Rs.50 lakhs/PVIFA(16%,5)
= Rs.50 lakhs/3.274 = Rs.15.272 L
 Rental Structure
• Stepped - 10% increase every year
Year LR PVIF(16%,y) LR x PVIF (16%,y)
1 L .862 .862 L
2 Lx 1.1 .743 .8173 L
3 L x (1.1)^2 .641 .7756 L
4 L x (1.1)^3 .552 .7347L
5 L x (1.1)^4 .476 .6969 L
3.8865 L
3.8865 L = Rs.50 lakhs
L = Rs.12.865
12.865, 14.152, 15.567, 17.123, 18.836
 Rental Structure
• Ballooned - 5 lakhs for first four years

5 x PVIFA(16%,4) + L x PVIF (16%,5) = Rs.50 lakhs

5 x 2.798 + L x .476 = Rs 50 lakhs
11.192 + .476 L = Rs. 50 lakhs
L = (50-11.192)/.476 = Rs.81.53 Lakhs
 Rental Structure
• Deferred for 2 years
L x PVIF (16%,3) + L x PVIF (16%,4) + L x PVIF
(16%,5) = Rs.50 Lakhs

L x (0.641) + L (.552) + L (.476) = Rs.50 lakhs

L (1.669) = Rs.50 lakhs
L = 50/1.669 = Rs.29.958
 Rental Structure
• Advance Installments – Equated Rental
with one advance installment ‘
LR + LR x PVIFA(16%,4) = Rs.50 lakhs
LR+LR x 2.798 = Rs.50 Lakhs
3.798 LR = Rs.50 Lakhs
LR = Rs.50 lakhs/3.798
= Rs.50 lakhs/3.798 = Rs.13.165 L
 Rental Structure-Comparison
Year Equated Stepped Ballooned Deferred Advance Loan

0 13.165
1 15.272 12.865 5.00 Nil 13.165 18.0

2 15.272 14.152 5.00 Nil 13.165 16.4

3 15.272 15.567 5.00 29.958 13.165

14.8
4 15.272 17.123 5.00 29.958 13.165
13.2
5 15.272 18.836 81.53 29.958 Nil 11.6
 Legal Aspects of Leasing
• No exclusive legislation to cover
equipment leasing
• Governed by Indian Contract Act, 1872
• Bailment – delivery of goods by one
person to another for some purpose upon
a contract that when the purpose is
accomplished they should be retuned
 Bailment
• Obligation of Bailor
• To put them in possession of the bailee
• Disclose any fault in the goods which he is aware of
• To make good any loss to bailee due to a defect in the title
• Obligation of Bailee
• Take reasonable care of goods
• Not to act in a manner inconsistent with the agreement
• Return the goods
• Not to mix with own goods
 Process of Lease Documentation
• Proposal by Lessee
• Lessor gives a Letter of Offer
• Acceptance of LOO by the Lessee –Board
Resolution
• Offer + Acceptance = Lease Agreement
• Lease Line – Master Lease Agreement
Contents of a Lease Agreement
• Description – Equipment, Location, Identification
• Period - Primary/Renewal
• Rental- Initial deposit, rental, penal
• Exemption
• Manufacturer’s warranty – tripartite
• Ownership
• Equipment Delivery
Contents of a Lease Agreement
• Repair and alteration
• Insurance
• Sub-Lease
• Surrender
• Default
• Arbitration
 Tax Aspects of Leasing
• Income Tax implications for the Lessor
• Rental Income
– If Leasing being carried out as a Business
• Income for Business & Profession
– If given on lease temporarily
• Income from Other sources
• Depreciation
 Tax aspect of leasing

The tax aspect of leasing can be divided into two parts – the income
tax aspect and the sales tax aspects.

The income tax aspect of leasing are primarily concerned with

d) lessee’s claim for lease rentals and the operating costs of the
leased assets being treated as tax deductible expenses.
e) tax liability on lease rental income in the hands of the lessor, and
tax shield on depreciation.

The rental income derived by the lessor is included under the head
`profit s & gains of business’ for the purpose of assessing the
income tax liability.

From the lessee’s angle, the rental expenses can be treated as tax
deductible . The costs incurred in insuring & maintaining the leased
asset are also tax deductible.
By virtue of circular issued by Central Board of Direct Taxes in 1943,
the leased agreement must not provide for a transfer of ownership
of the leased asset or a bargained purchased option to lessee.
Inclusion of these provisions will result in the leased transaction
being treated as a hire purchase transaction.

Leasing can be used as a tax planning device by

• Exploiting the flexibility in structuring the lease rentals
• Transferring the investment related tax shields from a firm which
has a low appetite for such tax shields to a lessor who can absorb
them. The firm transferring the tax shield can be benefit through a
reduction in the lease rentals.
 SALES TAX ASPECTS

Sales tax affects a lease transaction at the following stages:

• When the asset is purchased by lessor for the purpose of
leasing
• When the right to use is transferred to the lessee for a valuable
consideration
• When the asset is sold by lessor at the end of the lease period.

The lessor is at disadvantage with regards to interstate purchase

of equipment because the concessional rate of sales tax which
applies to such transactions is not made available to an
equipment supplier supplier supplying equipments to lessor.
The Constitution (46th amendment) Act, 1981 provides for sales tax on
the “transfer of the right to use any goods for any purpose for cash,
deferred payment or other valuable considerations”. After this
enactment several states have amended their sales tax laws to provide
for sales tax on lease rentals.

The validity of the provisions to levy sales tax on lease transactions

and the other related issues have been challenged by the leasing
companies and stay orders have been obtained from different state
high courts . Consequently, the lessor’s liability to pay sales tax on
rental income remains as a contingent liability.
 Income Tax implications for the
Lessor
• Depreciation
• Allowed as an expense
– The asset is owned by the asessee
– The asset is used for the purpose of business
• Finance Lease
• AS -19 Lessee to capitalise the assets in its books
of accounts
• Circular 2/2001 – Depreciation under Income Tax
would continue to be available to the Lessor
 Tax Implications
• Depreciation on Actual Cost of the asset
• Cost of acquisition
• On a Block of Assets
• At the rates given in the Income Tax Act
• Normal rate on P&M- 25%
• Higher depreciation e.g. air pollution control
equipments
 Income Tax implications for the
Lessee
• Tax Deductible Expenses
• Lease Rental
• Insurance and maintenance
 Sales Tax Aspects
• Central Sales Tax Act
– Interstate Sales of goods
• Sales Tax Acts enacted by the States
– Sales of goods within a state
• Issues involved
– Sales tax on Interstate purchase of Equipment
– Sales tax on Lease Rental
 Tax Implications
• Lease does not create tax benefits
• Depreciation Rate
• Lease Term
• Tax rate
• Upfront payment
 Sales Tax on Equipment
• Sales tax to be charged by the Vendor is 10% or the rate
applicable in the State whichever is higher
• U/S 8 of CST – if goods are sold by a registered dealer
to another registered dealer to be used by the later for
resale or in manufacturing, concessional rate of 4%.
• If bought by the Lessor – Sales Tax to be charged by
vendor is 10% of state sales tax whichever is higher
• If bought directly by the Lessee – Concessional rate of
Sales Tax @ 4%
 Sales Tax on Lease Rental
• 46th Amendment to the Constitution –
authorised the states to levy a tax on the
transfer of the right to use
• Sales Tax a payable on Annual Taxable
Turnover of the Lessor - 2% to 5%
 Sales Tax Impact
• Cost of Equipment = Rs.100 lakhs
• If Bought Directly
– CST = 4%
• If Leased
– CST = 10%
– Sales Tax on Lease Rental = 4%
– Lease rental = Rs.25 PTPM
 Sales Tax Impact
• If Bought directly
• Equipment Cost = 100 L
• Sales Tax = 4L
• Total Outflow = 104 L
• If Leased
• Cost to the Lessor = 100 L
• Sales Tax = 10 L
• Total Cost = 110 L
• Monthly Lease Rent = 30/1000 * 110 L = Rs.2.75 L
• Add : Sales Tax on Lease Rental (4%) = 0.11 L
• Total Monthly Lease Rental Rs. 2.86 L
THE END