A business owner has various options for acquiring and sourcing financing for equipment from the market. Equipment leasing is an excellent business model for acquiring work machinery without undertaking the complete financial liability and maintaining the budget of the organization. This model is particularly useful for small and medium enterprises, to enable them to manage their liquidity and cash flows.
A majority of the construction and mining equipment segment is being financed by non – banking finance companies (“NBFCs”). The Reserve Bank of India (“RBI”) has classified NBFCs on the basis of activity performed, and one such classification is that of Asset Finance Companies. An Asset Finance Company is defined as any company which is a financial institution carrying on as its principal business of financing physical assets supporting productive/economic activity, such as automobiles, tractors, lathe machines, generator sets, earth moving and material handling equipment, moving on own power and general purpose industrial machines.
In leasing, the equipment is chosen by the lessee suited to its own requirements, pursuant to which it is purchased by the lessor and then let out for the specified lease rentals to the lessee. The lease rental includes the interest component payable by the lessee. At the end of the lease term, the lessee is given the option to either surrender the equipment or purchase it at the predetermined value (in case of financial lease). The asset forms the security for the financing.
The model works based on the assumption that the lessee will generate revenue through use of the asset and the payment of lease rentals will be recovered from the business of the lessee itself. The number of credit checks are also therefore lesser. Leasing is a good option to procure continually updated equipment without undergoing the cost of replacing it each time.
The key difference between equipment financing and leasing is that in financing the user gains outright ownership, while in leasing the user gets the right to use along with the option to purchase at the end of term (in case of financial lease).
Leasing could be operating or financial. Operating lease is also known as maintenance or service lease, since the lessor generally provides maintenance services for the equipment. Due to the component of service charge; the rentals are comparatively higher than in case of financial lease. Operating lease does not contemplate a full buy out as compared to a financial lease and can be for a shorter duration than the full life of the asset. Further, since the equipment is returned to the lessor after completion of the lease term, the residual value of the asset becomes critical in case of operating lease.
Financial Leasing as a concept is not very different from hire purchase. However, hire purchase agreements are often tripartite with the seller also as a party, while leasing is bipartite, between the lessor and the lessee. Depreciation is claimed by the purchaser/hirer in a hire purchase. The Institute of Chartered Accountants of India has also issued 19 “Accounting for Leases”. It inter alia provides for capitalization of finance lease assets in the books of the lessee instead of lessor. The lessor [NBFC] is required to show the assets leased only as receivables in its balance sheet instead of as fixed assets. The implication of the above AS-19 for the NBFCs is that all financial leases would now be accounted like hire-purchase transactions. On the other hand, lessors shall present assets subject to operating leases in their balance sheet according to the nature of the asset.
Revised directions for Banks for equipment leasing and hire purchase: Recently, RBI has issued orders, allowing banks to enter the leasing space directly. Under Master Direction- Reserve Bank of India (Financial Services provided by Banks) Directions, 2016, financial services undertaken by a bank, include equipment leasing and hire purchase business being undertaken through two mediums, either through a subsidiary or departmentally.
Are leasing services taxable? A landmark judgement on whether leasing services are taxable, has been provided by the Supreme Court in Association of Leasing and Financial Service Companies v. Union of India and Ors. It was opined that the activities undertaken by NBFCs of equipment leasing and hire-purchase finance are facilities extended by NBFCs to their customers; and that they fall within the meaning of the words “banking and other financial services” which is sought to be brought within the service tax net. The same is also recognized under the Goods and Services Tax regime, wherein any transfer of title is considered as supply of goods and if no transfer is contemplated, it is considered as supply of services; thereby covering both financial and operating leases.
Future prospects: Earlier the leasing option was more prevalent for certain kind of equipment, like backhoe loaders and excavators. However, with growing demand and due to the obvious advantages for business requirements, almost all kinds of equipment are now being leased out, including commercial vehicles, IT, healthcare, office, or farming equipment, both new and preowned. The equipment thus leased is used for all kinds of infrastructure projects, road construction, mining, highway development and irrigation. While more lenders have automated the process and are providing complete asset life cycle management, taking equipment on lease has become faster and more effective for consumers.
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