What is a lease?
A lease is a contractual arrangement where the lessor grants the lessee the right to use an asset in return for periodical rental payments. While leasing of land, buildings, and animals has been known for a long time, the leasing of industrial equipment is a relatively recent phenomenon, particularly on the Indian scene. What are the Types of Leases
Finance Lease v/s Operating Lease
The lease transfers ownership to the lessee before the lease expires The lessee can purchase the asset for a bargain price when the lease expires The lease lasts for at least 75 percent of the asset’s estimated economic life The present value of lease payments is at least 90 percent of the asset’s value
The lease term is significantly less than the economic life of the equipment The lessee enjoys the right to terminate the lease at short notice without any significant penalty The lessor usually provides the operating know-how and the related services and undertakes the responsibility of insuring and maintaining the equipment. Such an operating lease is called a ‘wet lease’. An operating lease where the lessee bears the costs of insuring and maintaining the leased equipment is called a ‘dry lease’
Operating Lease does not result in a substantial transfer of risks and rewards of ownership from the lessor to the lessee. The lessor who is structuring an Operating Lease transaction has to depend upon multiple leases or on the realisation of a substantial resale value (on the expiry of the first lease) to recover the investment cost plus a reasonable rate of return. Therefore, specializing in operating lease calls for an in-depth knowledge of the equipments per se and the existence of a secondary (resale) market for such equipments. Given the fact that the resale market for most of the used capital equipments in India lacks breadth, operating leases are not in popular use. In recent years there have been attempts to structure car lease and computer lease transactions in the operating lease format. Sale and Lease Back v/s Direct Lease
In a sale and lease back, the owner of an asset sells the asset to a leasing company, and leases it back in order to enjoy the uninterrupted use of the asset in his business. This contract can either be a finance lease or an operating lease. Manufacturing companies use this arrangement to unlock investment in fixed assets such as factory buildings. From leasing company’s point of view, a sale and lease back arrangement poses certain issues. First, It is difficult to establish a fair market value of the asset being acquired because the secondary market for the asset may not exist; even if it exists; it may lack breadth. Second, the price paid by the lessor is irrelevant for the purpose of calculating tax relevant depreciation as the depreciation claimed by the leasing company cannot exceed the depreciation that would have been claimed by the owner had he continued to own the asset. Thus, a leasing company is likely to charge a higher lease rate to make the transaction financially viable from its point of view. A direct lease can be defined as any lease transaction which is not a ‘sale and lease back’ transaction. In a other words, in a direct lease, the lessee and the owner are two different entities. A direct lease is of two types: Bipartite Lease and Tripartite Lease. Bipartite leases have two parties only, the supplier-cum-lessor and the lessee. A Tripartite lease has three parties, The supplier, the lessor and the lessee. Single Investor Lease v/s Leveraged Lease
In a Single Investor Lease transaction, the leasing company (lessor) funds the entire investment by raising an appropriate mix of debt and equity. The important point to be noted is that the debt funds raised by the leasing company are without recourse to the lessee, which means the lender cannot demand payment from the lessee in the event of the leasing company defaulting on its...
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