FINANCE LEASE |
Partnership Firms ID – 26001 (JBC-021) |
| Lease (general/operational) | Finance lease |
(a) | According to Transfer of Property Act, a lease is a transaction in which a party owning the asset (called the "lessor" or "landlord" or "owner") provides the asset for use over a certain period of time to another (called the "lessee" or the "tenant") for consideration in the form of periodic payments (called "rent") with or without a further down payment (called "premium"). In International Accounting Standard No. 17, it is said to be an agreement whereby the lessor conveys to the lessee in return for rent, right to use an asset for some time. | It is generally an arrangement for borrowing and a mode for obtaining finance. Since the lessee is interested in the lease only as a device forgetting finances, the lessor's role is limited to that of a financier. |
(b) | In an ordinary lease also called an operating lease, the lessor continues to be a owner of the asset throughout the lease period. | In finance leasing it is the lessee who becomes the owner and the lessor's title over the assets is only to have security for the asset which is given for use to the lessee on payment of periodic rent which is much less compared to the cost of the asset. |
(c) | The lessor bears the loss of obsolescence and expenses of repairs etc. if so agreed upon | The lessee invariably bears the loss of obsolescence and expenses and repairs etc. |
(d) | Risk consequent to ownership remains with the lessor. | These get passed on to the lessee on execution of lease agreement. |
(e) | The lease period is generally small and after this, the asset either reverts back to the owner or is disposed of according to his directions of the lessor--may be given to the lessee itself on realization of the same price from him. | The lease period is usually equal to the economic life of the asset. |
(f) | The lessor can cancel the lease | The lessor is interested in rentals and not in getting back the asset. Therefore, the lease is generally non-cancellable by either party. |
Supreme Court's concept of finance lease
The case of Asea Brown Boveri Ltd. v. Industrial Finance Corporation [2005] 126 Comp Cas 332 ; AIR 2005 SC 17, 21, the Supreme Court has elucidated the concept of finance leasing in para 17 as under :
". . . financial lease is a transaction current in the commercial world, the primary purpose whereof is the financing of the purchase by the financier. The purchase of assets or equipments or machinery is by the borrower. For all practical purposes, the borrower becomes the owner of the property inasmuch as it is the borrower who chooses the property to be purchased, takes delivery, enjoys the use and occupation of the property, bears the wear and tear, maintains and operates the machinery/equipment, undertakes indemnity and agrees to bear the risk of loss or damage, if any. He is the one who gets the property insured. He remains liable for payment of taxes and other charges and indemnity. He cannot recover from the lessor, any of the above mentioned expenses. The period of lease extends over and covers the entire life of the property for which it may remain useful divided either into one term or divided into two terms with clause for renewal. In either case, the lease is non-cancellable."
However, these general observations have to be understood in the background of the facts of Asea Brown Boveri because the Court itself has said (in para 20) that it has to go "by the nature of the transaction ascertaining the real intention of the concerned parties in the light of the facts and circumstances of a given case".
The basic characteristics described by the Supreme Court are :
In a finance lease the primary purpose is the financing of the purchase by the financier.
The intention of ABB was from the very beginning to enter into a transaction of financial lease.
In a financial lease the borrower becomes the owner of the assets purchased.
The borrower chooses the asset/(s), takes delivery, enjoys the use and occupation, bears the wear and tear, maintains and operates the asset, undertakes indemnity and agrees to bear the risk, loss and taxes.
Lessee pays taxes.
The period of lease extends beyond the life of the asset.
The lease is non-cancellable.
Depreciation, needs to be examined in the light of the following
(i) the depreciation can be claimed only by the owner of an asset. If by the lease transactions, the ownership remains with the lessor, then he will be entitled to depreciation on the same. (ii) The lease rent and interest received would be chargeable to tax as business income.
In the case of the lessee, since he will not be the owner he cannot claim depreciation. He will be entitled to claim deduction of interest and lease rents paid as expenditure in computing the total income.
In finance leases, the situation will be opposite if the ownership passes to the lessee. The lessee will be entitled to depreciation but no deduction for interest paid would be permissible. The interest received by the lessor would constitute his income.
In the case of sale-cum-lease-back transactions, the claims will depend on the genuineness of the arrangements which would be a matter of investigation and findings of fact will have to be recorded concerning the same.
Conclusion
Owner will also include beneficial owner, in case of finance lease the leasee is the beneficial owner and will be entitled for depreciation.