CLASSIFICATION OF FINANCIAL LEASE

 Classification of Financial Lease
(i) Tax-oriented Lease: In financial lease, we have pointed out that risk and reward of ownership are substantially transferred to lessee in economic sense. Nevertheless in a financial lease if the lessor is considered as the owner of the asset for claiming tax benefit of depreciation, then the financial lease is considered as ‘tax -oriented lease’. Deduction of depreciation from lease rental reduces profit of lessor which is then subjected to tax. In other words, depreciation reduces the tax burden. Depreciation is a non-cash expenditure that results in ‘tax saving’. Putting differently we can say there is a cash inflow arising out of tax saving due to depreciation. This is a genuine benefit that arises from depreciation being a tax deductible non-cash expenditure. The lesser can pass on a part of depreciation benefit to the lessee making the arrangement attractive for the lessee. This enhances the competitive advantage of the lessor. If in place of lessor, lessee is entitled to claim depreciation for tax purpose then it is not a ‘tax oriented lease’. In that case, the tax treatment will be same as that of owning an asset through borrowing.

Depreciation benefit of tax is of paramount importance in lease versus buy decision in determining cash flow implication to the lessor and lessee and the subsequent value of the lease to the respective parties.

(ii) Leveraged Lease: A leveraged lease is tax oriented lease where the lessor borrows substantial amount from the lender to purchase the asset he leases. But an arrangement is made in such a way through tripartite agreement between the lender ( financier of the leased asset), lessor and the lessee , so that, in case of default of payment of lease rental by the lessee , the lessor is not liable to make loan repayment to the lender. Instead of lessor, the lender has to take appropriate steps to recover the loan instalments due on loan to purchase the leased asset from the lessee. Leveraged lease is a complicated arrangement and normally entered in case of very high value transactions.

(iii) Sale and Lease Back: It is arrangement under which an entity sells the asset to another party and simultaneously takes it back from the other party under a lease arrangement.

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