There are various types of lease on the basis of:
- The extent to which the risks and rewards are transferred
- The number and nature of parties to the transaction
- The domicile of the equipment manufacturer
Types of Lease:
On the basis of extent to which the risks and rewards are transferred there may be two types of lease:
(i) Financial Lease or Capital Lease –
A financial Lease involves payment of lease rentals over one obligatory, non-cancelable lease period sufficient in total to amortize the capital invested by the lessor and also leave some profit. It involves the transfer of all risks and rewards associated with the ownership of the asset to the lessee, but the title of ownership may or may not be transferred after the completion of lease period. Financial Lease may be of two types:
Full pay out lease – A Full Payout Lease covers the total value/cost of the asset through Lease rentals and scrap value. The lease period usually covers the entire economic life of the asset.
True lease – A true lease only involves only taxation benefits for the lessor as he bears all the risks and rewards associated with ownership of asset and the lessee only gets the right to use the asset.
Eg. Ships, air crafts, railway wagon, land, heavy machinery.
(ii) Operating Lease –
An Operating lease has the following features:
- It does not transfer all the risks and rewards associated with ownership of the asset
- The cost of asset is not fully amortized during the primary lease period
- It consists of a cancellation clause
- Responsibility of maintenance and repair, insurance lies with the lessor
- The asset is provided on lease for a short period only, usually less than the useful life of the asset
- It is a high risk lease
- The Lease can be renewed after the expiry of term period
Eg. computer operator, taxi, printers.
Difference Between Operating Lease and Financial Lease:
|Operating Lease||Financing Lease|
|The number of lease contracts||More than one lease contract is undertaken and there are several lessees||A single lessee is contracted under a single agreement|
|Amortization of cost of asset||The cost of asset is not fully amortized because the asset is leased many times with different lessees over a period of time||Fully pay out lease – The asset is amortized through a single lease as it is provided for a long term|
|Specific Use||Equipment or asset is for general purpose use||Asset is for the specific use of the lessee|
|Ownership risk||Risk associated with ownership is borne by the lessor and the lessee only gets the right to use the asset||It is transferred to the lessee and the lessor only retains the title of ownership|
|Lease period||Undertaken for a short time period hours or days||Long time, entire economic life of the asset|
|Cancellation clause||Can be canceled at any point before the expiry of the lease period by notice to the lessor||It is not revocable in the primary lease period|
|Risk of obsolesce||Lessor has to bear the risk||Lessee has to bear the risk|
|Specialized services||The lessor is specialized in services of handling the asset or equip and maintaining it||Lessor is a financial investor and does not provide any additional services|
On the basis of number and nature of parties involved in a transaction there may be the following types of lease:
(i) Sale and Lease back –
Under this type of lease the owner of the asset sells the asset to the lessor and takes it back on lease under the lease agreement i.e. the lessee is the owner of the asset. This type of lease helps in transferring the ownership from true owner to the lessor. This exchange of title helps (previous owner) the lessee in liquidating the funds tied up in a particular asset.
Hence, the seller of the asset becomes the lessee and the buyer of the asset becomes the lessor. The seller (lessee) receives the cost of asset and the right to use the asset, while the buyer enjoys the ownership of asset and lease rentals for the agreed period.
It is generally used in cases where assets are not subjected to depreciation and in industries where free finance is provided to the leasing company.
E.g. Bank Lockers
(ii) Direct Lease –
In a Direct Lease, the lessee and owner of asset are different entities. It can be of two types:
Bipartite Lease – In a Bipartite Lease, two parties are involved in a lease transaction i.e. equipment supplier or lessor and lessee. It is structured as an operating lease with inbuilt facilities like –
Upgrade lease – It provides an option to upgrade the equipment in future
Swap lease – It provides an option to replace an equipment with a similar equipment in working condition.
Tripartite Lease – In a Tripartite Lease the equipment supplier, lessor, lessee are different entities i.e. three parties are involved in a lease transaction.
It is a sales aid lease under which the equipment supplier arranges for lease finance in by –
- Providing reference about the customer to the leasing company
- Negotiating the terms with the customer
- Writing lease on his own account and discounting the lease receivables with designated leasing company
On the basis of the domicile of the equipment manufacturer there are three types of lease:
(i) Domestic lease – A lease in which all the parties under the lease contract are of the same country i.e. the equipment supplier, the lessor and lessee are domiciled in the same country, it is a domestic lease.
(ii) International or Cross border lease – In a cross border lease, the lessor and lessee are domiciled in different countries
(iii) Import Lease – In an import lease, mainly the equipment supplier is from a foreign country, the lessor and lessee may be in the same country.
Other types of Lease:
In such a lease agreement, the lessor buys an asset through borrowed funds. Since huge capital is involved in purchase of heavy machineries and equipment, therefore, borrowed funds are used to finance an asset. Generally there are three parties involved – a lessee (user), a lessor (leasing company) and a financer (Banks and Financial institutions). The lessor (leasing company) provides 20%-40% of the purchase value of the asset through equity capital and the remaining amount is borrowed from commercial bank or financial institutions (financer). Hence it is financed partly by debt and partly by equity.
Also Read: Introduction to Leasing