Theoretical Framework of Leasing

LEASING is a financing tool to acquire a property and transfer it for temporary possession and use. Leasing is carried out on the basis of a medium or long-term contract offered by a leasing company (lessor) acquiring a car, special-purpose machinery or an equipment at its own expense in order to lease it for a number of years (usually from 1 up to 5 years) toa tenant company (lessee) which periodically makes rent payments for the use of such leased property. Upon the contract expiry, the tenant either buys the property for the residual value or returns the property to the leasing company.

The application of accelerated amortization terms (specific to leased assets) combined with the deductibility of the lease payments by the lessee from its income makes Leasing as the most attractive way to acquire a property.

There are different types of leasing, namely:

Finance lease is a financing tool where the lessor undertakes to acquire a property according to specification, conditions and from a supplier specified by the lessee. Upon reception of the property and when the it is ready for use, to the lessor transfers such property to the lessee for temporary possession and use, against the payment of a leasing charge, during a particular period of time and under the terms and conditions defined in the finance lease contract. Upon the finance lease contract expiry, and provided that the lessee fulfilled all its obligations under the contract, the lessee has the right to buy the leased property from the lessor for the residual value specified in the finance lease contract. The finance lease period equals the period of the complete depreciation of the property.

Leaseback is a form of finance lease when the seller (supplier) of a leasing item is the lessee at the same time.

Operating lease is a form of Lease contract where the lessor acquires a property and transfers it to the lessee for temporary possession and use at a particular charge, for a particular period of time and under particular terms and conditions. Unlike Finance lease, Operating lease includes a number of additional services rendered by the lessor. Upon the operating lease contract expiry, property shall be returned to the lessor but it can also be let on operating lease repeatedly, usually within the complete depreciation period.

Limitations in Leasing

  • The advance payment under any lease contract cannot exceed 50%. Reason: Tax authorities may consider a leasing transaction as a hidden sale and purchase transaction and as a result cancel tax privileges;
  • The leasing period must be at least 12 months. Reason: Tax authorities may consider a leasing transaction as a hidden sale and purchase transaction and as a result cancel tax privileges;
  • When accounting leasing activities, the leasing period cannot be less than the complete depreciation period (taking into account accelerations) otherwise, the equipment will not be fully depreciated during the leasing period.

Advantages of Leasing to the Lessee

  • Lower requirements of own capital – the transaction is fully financed by the lessor;
  • Availability of funds – leasing can be the one of the only source of funds for companies not having any credit history yet, as assets are used to secure the facility;
  • Payment system flexibility – adjustment of payments to potential cash flow of the user;
  • Accelerated depreciation of a leasing item (coefficient up to 3) – enhancing the possibility of a quick update of outdated own assets, while decreasing taxable income;
  • Time factor – leasing term may be much longer than the credit term, considering irregular distribution of expenses and non certain income collection;
  • Tax privileges, governmental support – decreasing taxable income, decreasing customs duties and international leasing operations taxes;
  • Balance sheet make-up as if booked on the balance sheet of the lessor, leasing helps to not burden the debt in the lessee’s balance sheet, contributing to the investment appeal of the lessee;
  • As a rule, the leasing advance payment is less than the equipment mortgage cost discount in case of a credit;
  • Opportunity to use any payments schedule (seasonality, depending on the sale proceeds on a monthly basis, etc.) depending on customer preferences.