leasing1 aspects

7/25/2019 Leasing1 Aspects

1/19

LEASING

An Overview


2/19

Characteristics

Periodical payment of rentals

Lessor Lessee

Right to use an asset for a fixed period of time

Ownership rests with the lessor


3/19

Term

Lease Period = Lease agreement is

operational

Perpetual leasePrimary

Lease PeriodSecondary


4/19

Tests for inancial Lease

Su!stance Test" Lessee Compliance with #o$% point

ull Payment Test" Lessor Compliance with #o$& point'

Transfer of Title Test" Lessee has an option to !uy theasset

Lease Term Test" Lease term extends to the asset(slife


5/19

)yths a!out Leasing

Off*!alance sheet financing

#o evaluation for capital expenditure ' Cash flow

conse+uences,

-etter Performance ' Possi!le to enhance RO./ !ut

the transaction should yield a positive

#P0


6/19

Advantages of Leasing

Advantages to the lessor"

1$ Sta!le -usiness ' Lessee(s continued patronage

%$ Sale of spare parts2$ Second*hand mar3et

4$ Tax !enefits

5$ illip to capital mar3et

6$7asy finance


7/19

Advantages of Leasing

Advantages to the Lessee"

1$ 7fficient use of funds * #o capital investment

%$ Cheaper Source * than !uying option2$ 7nhanced !orrowing capacity * Lower 897 Ratio

4$ Off*!alance sheet !orrowing * * do *

5$ Tax !enefits

6$ :uard against o!solescence * Lessee can terminate the

lease at any timeand ta3e up another

asset under fresh

lease


8/19

Limitations

8isguised form of de!t financing

Loss of depreciation tax shield/ when depreciation

rates are high and leasing is preferred over !uying

Possi!ility of dou!le sales tax in certain states ;nfavoura!le capital gearing for the lessee

#o ownership

8efault Ris3


9/19

Tax Aspects of Leasing

Lessor" 8eduction of depreciation from taxa!le income .ncome from lease rentals is taxa!le under Profits and :ains

of -usiness and Profession>

8educti!le expenses" 8epreciation Rent/ rates/ taxes/ repairs and insuranceAmorti?ation of preliminary expenses .nterest on !orrowed capital -ad de!ts

All expenses incurred in furtherance of !usiness 7ntertainment expenses @with a cap Travel expenses @as per approved norms

@See .llustration #o$2$5 ) B han


10/19

Lessee"Allowa!ility of lease rentals ' allowed as normal

!usiness expenditure if they are not i$ of capital nature/ ii$

Personal expense and relates only to the !usiness purpose$

8educti!ility of .ncidental 7xpenses ' Repairs/)aintenance/ .nsurance/ inance Charges/[email protected]

.nstallation expense @revenue expense in the year of

incurrence


11/19

Tax Planning

Lessee" lexi!le Restructuring of Lease Rentals '

Su!stantial part of the lease rentals paya!le in the first year and avery small fraction during the remaining lease term

Lower rentals in earlier years and higher in later years dependingon cash flows Purely tax*driven structure of lease rentals not allowed !y the .T

authorities @See .llustration #o$2$6 ) B han

Transfer of .nvestment*related ;na!sor!ed Tax Shield '

Lessee firm enEoys 1FFG tax deduction @exports ' Tax shield onfresh capital investment would not have any impact on its cashflows ' Tax shields can !e transferred to the lessor who willconsider lower lease rentals

@See .llustration #o$2$H ) B han


12/19

unding Aspects of Leasing

8eposits ' )aEor source of finance

-an3 -orrowings ' )aximum Limit ' 1F times of #O including deposits/

!orrowings from !an3s9.s/ de!entures/ !onds

)aximum !an3 !orrowings would !e 2 times of #O whereH5G of the company(s assets are in e+uipment leasing andwhere H5G of its gross income is from leasing

#O = Paid up Capital I ree Reserves ' Accumulated!alance of loss/ where ree Reserves represent sharepremium account/ capital and de!enture redemption reservesand any other reserve not created for payment of any futurelia!ility or for depreciation in assets or for !ad de!ts or areserve created !y revaluation of assets

R-. has freed the restrictions w$e$f$April 1JJH


13/19

#ature of acility ' !ased on the expected flow of leaserental receiva!les

)aximum Permissi!le -an3 inance ' Calculate outstanding credit for next five years

Calculate relevant 8rawing Power against that particular

transaction

7xclude ' a$ unds raised from financial9inv$ .nstitutions

!$ 8P:s provided !y !an3s/ and c$ Assets created against

8P:s issued !y !an3s

This will imply !an3 finance will !e to an extent of % ' 2

times of #O$


14/19

Re+uirements for -an3 inance Current Ratio' )inimum 1$22 Reports* @See page no$ %F2 8r S :urusamy


15/19

Lessee(s Perspectiveof Leasing

Lease rental payments are similar to payments ofinterest on de!t

Kence/ alternative to !orrowing Choice !etween de!t financing versus lease financing 8ecision*criterion ' #et Present 0alue of Leasing9#et

Advantage of Leasing ' #P0@L9#AL 8iscount Rate used is the marginal cost of capital for

all cash flows except lease payments and tax cost of

de!t for lease payments 0alue of interest tax shield is included as a foregone

cash flow in the computation of #P0@L9#AL


16/19

#P0@L9#AL

#P0@L9#AL = .nvestment Cost* P0 of lease payment @discounted !y d

* P0 of tax shield on lease payment @discounted !yc

* )anagement eeI P0 of tax shield on management fee @disc$!y c

* P0 of 8epreciation shield @discounted !y c

* P0 of .nterest Shield @discounted !y c

* P0 of residual9salvage value @discounted !y c


17/19

#P0@L9#AL negative means leasing alternative

should !e used$

#P0@L9#AL positive means !orrowing alternative

would !e prefera!le$

Alternative approach is 8etermine the P0s of cash outflows after taxes under !oth the

alternatives

Select the alternative with the lower P0 of cash outflows

@See .llustration #o$4$1 ) B han


18/19

-rea3*7ven Lease Rental @-7LR

for lessee

The point where the #et Advantage of Leasing @#AL

is ?ero$

The rental at which the lessee is indifferent !etween

lease financing and !orrowing9!uying$

)aximum level of rental which the lessee is willing to

pay

.f the -7LR the actual rental/ the lease proposal

would !e accepta!le$

@See .llustration #o$ 4$4 ) B han


19/19

Lessor(s Perspective of Leasing

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