A lease can be defined as an arrangement between the lessor (owner of the asset) and the lessee

(user of the asset) whereby the lessor purchases an asset for the lessee and allows him to use it in
exchange for periodical payments called lease rentals or minimum lease payments (MLP).
Leasing is beneficial to both the parties for availing tax benefits or doing tax planning.

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.

 A long-term lease over the expected life of the equipment, usually three years or more, after which you pay a
nominal rent or can sell or scrap the equipment - the leasing company will not want it any more.
 The leasing company recovers the full cost of the equipment, plus charges, over the period of the lease.
 Although you don't own the equipment, you are responsible for maintaining and insuring it.
 You must show the leased asset on your balance sheet as a capital item, or an item that has been bought by the
company.
 Leases of over seven years, and in some cases over five years, are known as 'long funding leases' under which
you can claim capital allowances as if you had bought the asset outright.
 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 useful if you don't need the equipment for its entire working life
 the leasing company will take the asset back at the end of the lease
 the leasing company is responsible for maintenance and insurance
 you don't have to show the asset on your balance sheet

Sale & Lease Back: Under this kind of lease agreement, the vendor of the asset sells his asset to
the leasing company and leases it back in order to enjoy the uninterrupted use of the leased asset
in his business operations. Generally, this kind of lease agreement is used by the entrepreneurs
who want to free their money blocked on the assets or equipment and use that money for some
other purpose.

The sale & lease back arrangement could pose problems for the leasing company because it is
quite difficult to establish a fair market value of the asset being acquired. This is because, the
secondary market for the asset may not exist and also the depreciation value claimed for the tax
purposes could not be more than the value claimed earlier, by the vendor.

Direct Lease: The direct lease is a simple form of a lease agreement where the lessor and the
lessee are two separate entities and may have either the operating or a finance lease agreement.
There can be two types of direct lease: Bipartite Lease and the Tripartite Lease.

In a bipartite lease, there are two parties to the lease agreement; one is the lessor, and the other is
the lessee. Whereas in the case of a tripartite lease agreement, there are three parties to the
agreement, one is the supplier of the equipment; the other is the lessor, and the third one is the
lessee.

Single Investor Lease: In the case of a single investor lease there are two parties to the contract,
the lessor and the lessee. Here, the lessor or the leasing firm raises an optimum mix of debt and
equity to finance the entire investment.

One important thing to be noted here is, the lender cannot recover any amount from the lessee in
case the lessor defaults on his debt service obligations. Thus, the lender is only entitled to recover
money from the lessor and not from the lessee in case the lessor defaults in paying back to the
lender.

Leveraged Lease: In a leveraged lease, there are three parties to the lease agreement Viz. Lessor,
lessee and lender or loan participant. Here the investment is financed jointly by the lessor and the
lender; wherein the equity is arranged by the lessor, and the debt is financed by the financier. In
this kind of a lease agreement, the lender has the direct connection to the lessee which means in
case the lessor defaults in his debt obligations, the lender can recover his money from the lessee.
Hence, the major difference between the single investor lease and leveraged lease is that in the
case of the former lease type, the lender has no direct connection to the lessee and cannot recover
money from him in case the lessor defaults. Whereas in the case of the leveraged lease, the lender
can recover money from the lessee in case the lessor defaults and thus, has the direct connection
to the lessee.

Cross border lease

Lease across national frontiers are called cross border lease, Shipping, air service, etc., will come
under this category.

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.

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

Advantages of Leasing to the Lessee:

(i) Avoidance of Initial Cash Outlay:
Leasing enables a firm to acquire the use of an asset without making capital investment in buying
the asset. The lessee may avail 100% finance from lease financing and avoid even initial
investment in margin money as required under loan financing. However, some leasing companies
demand that first lease rent should be paid in advance.

(ii) Minimum Delay:

Usually, leasing companies take much lessor time in processing the lease proposal as compared to
the lengthy procedure involved in the term-loan financing. Thus, a firm can avoid delay in the use
of an asset by taking it on lease.

(iii) Easy Source of Finance:

Leasing provides one of the easiest sources of intermediate and long- term financing. It does not
require any mortgage of the assets because the ownership of asset leased remains with the lessor
and is not transferred to the lessee.

Moreover, various restrictive provisions imposed in term loan financing are avoided. The initial
cost of raising finance through leasing is also much lesser than that of raising long-term loans.

(iv) Shifting the Risk of Obsolescence:

In the present era of rapid changing technologies, a firm has to bear the risk of obsolescence if it
purchases the asset. The firm (lessee) can easily shift this risk upon the lessor by acquiring the use
of the asset on lease rather than buying the same.

(v) Enhanced Liquidity:

Sale and leaseback arrangement enables a firm to improve its liquidity position by realising cash
from the sale of fixed assets and retaining the economic use of the same. Thus, the lessee can
salvage its working capital crisis through lease financing.

(vi) Conserving Borrowing Capacity:

Leasing is a form of financing that does not reduce or affect the borrowing capacity of the lessee
firm. It is considered to be a hidden form of debt which does not appear as a liability in the
balance sheet of the lessee. Thus, it does not affect the debt equity ratio of the firm acquiring use
of an asset through leasing.

(vii) Tax Planning and Differential Tax Advantage:

As lease rentals are considered as a revenue expense while determining taxable profits, it is
advantageous for the lessee in minimising tax liabilities. Moreover, the lessor who is usually in
the higher tax bracket passes on the benefit of depreciation advantage to the lessee in the form of
reduced lease payments.

The lessee can also arrange to adjust lease rentals in such a way that it reduces his tax liability and
thus helps him in tax planning.

(viii) Higher Return on Capital Employed:

Since the lessee acquires only the right to use the asset without owning it, such asset does not
appear on the asset side of the balance sheet. This implies higher earnings against capital
employed and higher rate of return on capital employed.

(ix) Convenience and Flexibility:

Operating or service leases are usually cancelable enabling the lessee firm to terminate the lease if
it does not require the use of the asset, any more. Hence, it is very convenient and flexible mode
of financing fixed assets.

(x) Lesser Administrative and Maintenance Costs:

Under a ‘ gross lease’ arrangement, the lessee can avail the specialised services of the lessor for
maintenance of the asset leased. Even in case of operating lease agreement there could be a
provision of maintaining the asset by the lessor.

Although, the lessor charges for such maintenance and service costs by way of higher rentals, the
lessee’s overall administrative and service costs are reduced because of specialised services of the
lessor.

Advantages of Leasing to the Lessor:

1. Higher Profits:
The lessor acting prudently can make high profits from leasing of the asset. The profits will take
care of his cost of capital as well as the risk involved.

2. Tax Benefits:
The lessor being the owner of the asset can claim various tax benefits such as depreciation,
investment allowance, etc. In fact, leasing has been successfully employed by the leasing
companies to reduce their tax liabilities.

3. Quick Returns:
The lessor gets quick returns in the form of lease rentals as compared to investment in other
projects which have a longer gestation period.

4. Increased Sales:
Lease financing through third parties has helped manufacturers to increase their sales. The
lessors are also in a position to demand certain concessions from the manufacturers.

5. Assured Regular Income:

Lessor gets lease rental by leasing an asset during the period of lease which is an assured and
regular income.
6. Preservation of Ownership:
In case of finance lease, the lessor transfers all the risk and rewards incidental to ownership to the
lessee without the transfer of ownership of asset hence the ownership lies with the lessor.

7. High Potentiality of Growth:

The demand for leasing is steadily increasing because it is one of the cost efficient forms of
financing. Economic growth can be maintained even during the period of depression. Thus, the
growth potentiality of leasing is much higher as compared to other forms of business.

8. Recovery of Investment:
In case of finance lease, the lessor can recover the total investment through lease rentals.

Disadvantages of Leasing for the Lessee:

(i) Higher Cost:
The lease rentals include a margin for the lessor as also the cost of risk of obsolescence; it is, thus,
regarded as a form of financing at higher cost.

(ii) Loss of Moratorium Period:

The lease rentals do not take care of the gestation period. It usually takes a long time before the
asset generates funds to pay it back. The term loan provides certain moratorium period in
repayments for that reason. But no such moratorium is permitted under lease’ arrangements.

(iii) Risk of Being Deprived of the Use of Asset:

The lessee may be deprived of the use of the asset due to the deterioration in the financial
position of the lessor or winding up of the leasing company.

(iv) No Alteration or Change in Asset:

As the lessee is not the owner of the asset, he cannot make any substantial changes in the asset.
Contrary to it, in case of outright purchase the buyer can modify or alter the asset to increase its
utility.

(v) Loss of Ownership Incentives:

There are certain advantages of owning the assets, such as depreciation and investment
allowance, In case of lease; the lessee is not entitled to such benefits.

(vi) Penalties on Termination of Lease:

The lessee is usually required to pay certain penalties if he terminates the lease before the expiry
of the lease period.

(vii) Loss of Salvage Value of the Asset:

An asset generally has certain salvage value at the expiry of the useful life. As the lessee does not
become the owner of the asset, he cannot realise the salvage value at the expiry of the lease rather
he has to return the asset to the lessor.

Disadvantages for the Lessor:

1. High Risk of Obsolescence:
The lessor has to bear the risk of obsolescence especially in the present era of rapid technology
developments.

2. Competitive Market:
As a number of leasing companies have emerged in recent years in India, the lessor has to face a
tough competition from Indian as well as foreign companies. Due to this competition, the lessor
may not be able to obtain sufficient lease rentals to recover the cost of the asset and his expected
profit on investment as well as taking the risk.

3. Price-Level Changes:
Inspite of the increase in prices of assets due to inflation, the lessor gets only fixed rentals based
on previous costs.

4. Management of Cashflows:
The success of a leasing business depends to a large extent upon efficient use of cashflows which
are very difficult to manage because of unexpected market fluctuations.

5. Increased Cost due to Loss of User Benefits:

The lessor is not entitled to certain benefits available to buyers who are actual users of the assets
such as concession in sales tax, duties, etc. This increases the cost of the asset and compels the
lessor to charge higher lease rentals.

6. Long-term Investment:
It usually takes a long time to recover the cost of the lessor in the capital outlays through lease
rentals. Thus, lease rentals received may not represent actual realised profits because of inherent
risks involved. Payment of dividends out of present earnings may ultimately result into payment
out of capital.