A LOOK AT LEASING

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A “lease” is defined as a contract between a lessor and a lessee for the hire of a specific asset for a specific period on payment of specified rentals. The maximum period of lease according to law is for 99 years. Previously land or real estate, mines and quarries were taken on lease. But now a day’s plant and equipment, modem civil aircraft and ships are taken.

Leasing is a very important financing option for an entrepreneur with no or inadequate money for financing the initial investment required in plant and machinery. In a lease, the lessor finances the asset or equipment and the lessee uses it in exchange for fixed lease rentals. In other words, lease financing is an arrangement where the lessee who requires the equipment or machinery gets the finance from the lessor for the agreed rental payments. Such kind of lease is called a finance lease. There are many such arrangements and hence, there are many types of lease. Let us have a look at the different kinds of the lease.

At present there are many leasing companies such as 1st Leasing Company, 20th Century Leasing Company which are doing quite a lot of business through leasing, It has become an important financial service and a lucrative avenue of making sizable profits by leasing companies. A certain variation in the elements of lease classifies lease into different types. Such elements are as follows:

§  The degree of ownership risk and rewards transferred to the lessee.

§  Number of parties involved

§  Location of lessor, lessee and the equipment supplier

§  The lessor and the lessee

Here, risk means the chance of technological obsolescence and reward refers to the cash flow generated by the use of equipment and the residual value of the equipment.

DEFINITION OF TERMS

(i)     Lessor:     The party who is the owner of the equipment permitting the use of the same by the other party on payment of a periodical amount.

(ii)    Lessee:    The party who acquires the right to use equipment for which he pays periodically.

 

TYPES OF LEASING

Leases are classified into different types based on the variation in the elements of a lease. Very popularly heard leases are financial and operating lease. Apart from these, there are sale and lease back and direct lease, single investor lease and leveraged lease, and domestic and international lease, conveyance type, Import, International lease etc.

1. Financial Lease

Financial leasing is a contract involving payment over a longer period. It is a long-term lease and the lessee will be paying much more than the cost of the property or equipment to the lessor in the form of lease charges. It is irrevocable. In this type of leasing the lessee has to bear all costs and the lessor does not render any service. The lessor assumes the role of a financier and hence services of repairs, maintenance etc., are not provided by him. The legal title is retained by the lessor who has no option to terminate the lease agreement.

The principal and interest of the lessor is recouped by him during the desired playback period in the form of lease rentals. The finance lease is also called capital lease is a loan in disguise. The lessor thus is typically a financial institution and does not render specialized service in connection with the asset.

2. Operating Lease

In an operating lease, the lessee uses the asset for a specific period. The lessor bears the risk of obsolescence and incidental risks. There is an option to either party to terminate the lease after giving notice. In this type of leasing

§  lessor bears all expenses

§  lessor will not be able to realize the full cost of the asset

§  specialized services are provided by the lessor.

This kind of lease is preferred where the equipment is likely to suffer obsolescence. It is where the asset is not wholly amortized during the non-cancellable period, if any, of the lease and where the lessor does not rely for is profit on the rentals in the non- cancellable period. In this type of lease, the lessor who bears the cost of insurance, machinery, maintenance, repair costs, etc. is unable to realize the full cost of equipment and other incidental charges during the initial period of lease. The lessee uses the asset for a specified time. The lessor bears the risk of obsolescence and incidental risks. Either party to the lease may termite the lease after giving due notice of the same since the asset may be leased out to other willing leases.

3. Leveraged and non-leveraged leases

In leveraged and non-leveraged leases, the value of the asset leased may be of a huge amount which may not be possible for the lessor to finance. So, the lessor involves one more financier who will have charge over the leased asset.

4. Conveyance type lease

In Conveyance type lease, the lease will be for a long-period with a clear intention of conveying the ownership of title on the lessee.

5. Sale and Lease Back Leasing

To raise funds a company may-sell an asset which belongs to the lessor with whom the ownership vests from there on. Subsequently, the lessor leases the same asset to the company (the lessee) who uses it. The asset thus remains with the lessee with the change in title to the lessor thus enabling the company to procure the much needed finance. Under this arrangement the lessor agrees with the manufacturer to market his product through his leasing operations, in return for which the manufacturer agrees to pay him a commission.

6. Cross Border Lease:

Lease across the national frontiers is called cross broker leasing. The recent development in economic liberalisation, the cross border leasing is gaining greater importance in areas like aviation, shipping and other costly assets which base likely to become absolute due to technological changes.

7. Full and non pay-out lease

A full pay-out lease is one in which the lessor recovers the full value of the leased asset by way of leasing. In case of a non pay-out lease, the lessor leases out the same asset over and over again.

8. Specialized service lease

The lessor or the owner of the asset is a specialist of the asset which he is leasing out. He not only leases out but also gives specialized personal service to the lessee. Examples are electronic goods, automobiles, air-conditioners, etc.

9. Net and non-net lease

In non-net lease, the lessor is in charge of maintenance insurance and other incidental expenses. In a net lease, the lessor is not concerned with the above maintenance expenditure. The lessor confines only to financial service.

10. Sales aid lease

In case, the lessor enters into any tie up arrangement with manufacturer for the marketing, it is called sales aid lease.

11. Tax oriented lease

Where the lease is not a loan on security but qualifies as a lease, it will be considered a tax oriented lease.

12. Import Lease

In an Import lease, the company providing equipment for lease may be located in a foreign country but the lessor and the lessee may belong to the same country. The equipment is more or less imported.

13. International lease

Here, the parties to the lease transactions may belong to different countries which is almost similar to cross border lease.

Merits of Leasing

     i.        The most important merit of leasing is flexibility. The leasing company modifies the arrangements to suit the leases requirements.

    ii.        In the leasing deal less documentation is involved, when compared to term loans from financial institutions.

  iii.        It is an alternative source to obtain loan and other facilities from financial institutions. That is the reason why banking companies and financial institutions are now entering into leasing business as this method of finance is more acceptable to manufacturing units.

  iv.        The full amount (100%) financing for the cost of equipment may be made available by a leasing company. Whereas banks and other financial institutions may not provide for the same.

   v.        The ‘Sale and Lease Bank’ arrangement enables the lessees to borrow in case of any financial crisis.

  vi.        The lessee can avail tax benefits depending upon his tax status.

Demerits of Leasing

 i.        In leasing, the cost of interest is very high.
ii.      The asset reverts back to the owner on the termination of the lease period and the lesser loses his claim on the residual value.
 iii.     Leasing is not useful in setting up new projects as the rentals become payable soon after the acquisition of assets.
  iv.       The lessor generally leases out assets which are purchased by him with the help of bank credit. In the event of a default made by the lessor in making the payment to the bank, the asset would be seized by the bank much to the disadvantage of the lessee.