Description
Hire purchase (abbreviated HP, colloquially sometimes never-never) is the legal term for a contract, in which persons usually agree to pay for goods in parts or a percentage at a time. It was developed in the United Kingdom and can now be found in Australia, China, India, Jamaica, Japan, Malaysia, New Zealand, and South Africa. It is also called closed-end leasing.
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Leasing – concept & classification Evolution of Indian leasing Industry – Presentation Product profile Legal (regulatory aspects of leasing in India), tax & accounting aspects of leasing Funding of leasing in India. Financial evaluation of leasing
HIRE PURCHASE Concept and characteristics Legal & tax frame work, mathematics Financial evaluation of hire purchase deals-
Contractual agreement Owner of an asset grants the right Use the asset to other party Receiver of the services of asset Under lease contract
lessor
Seller, supplier, fin co, manu Claims depreciation on the asset
lessee
Individual,company,firm Periodic payment- lease rental
Lease – renting of an asset for some specified period
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Divorce of ownership from the economic use of an asset/equipment Device of financing(money lending) the cost of an asset/capital asset Fund based service Lending of funds/finance/credit
JAMES C.VAN HORNE DEFINED: Lease is a contract whereby the owner of an asset (lessor)grants to another party (lessee) the exclusive right to use the asset usually for an agreed period of time in return for the payment of rent. ? LEASING – Is a process by which a firm can obtain the use of certain fixed asset for which it must make a series of contractual periodic tax-deductible payment (lease rentals)
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Parties to the contract-lease financier, lessor, broker, lessee Asset: asset, property or equipment Ownership separated from the user Term of the lease Lease Rentals Modes of terminating lease
At the end of the lease period the asset reverts back to the lessor unless there is a provision for the renewal of contract.
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Lessee – decide asset req & supplier Lessee enters – lease agreement – lessor
? ? ? ? Basic lease period Timing and amount of periodical rental payment Option details – renew/purchase Payment details – maintenance, repairs, taxes, insurance & other expenses
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Lessor contacts manufacturer – supply – makes payment after asset delivered & accepted by lessee.
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Financial Lease & Operating Lease
Sale & Leaseback & Direct Lease Single investor Lease & Leveraged lease Domestic Lease & International Lease
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Based on risks & rewards, parties involved
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The lessor transfers to the lessee, substantially all the risks & rewards incidental to the ownership of the asset whether or not the title is eventually transferred.- IAS -17
Also known as Capital lease, long term lease, net lease and close lease, Full payout leases Approach to economic life
The salient features of a lease are: ? A financial lease is a long-term, noncancelable lease. ? The lessee has the option to purchase the asset at a price - sufficiently lower than the fair market value . ? The lease term - major part of the useful life of the asset. ? The lessee is responsible - maintenance of the asset - for insuring it against accidental damage or loss. ? The risk of Damage is shifted from the lessor to the lessee.
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According to the IAS-17, an operating lease is one which is not a finance lease. In an operating lease the lessor does not transfer all the risks & rewards incidental to the ownership of the asset. The lessor provides all the services attached to the leased asset.
Also known as Service lease, Short term lease or True lease
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The lease term is significantly less than the economic life of the equipment.
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The lease is usually cancelled at a short notice.
The lessor is responsible for the insurance & maintenance of the asset. The lessor bears the risk of economic & functional obsolescence of the asset.
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FINANCIAL
? Installment loan ? Taxes & maintenance – lessee ? Risk of obsolescence – lessee ? Contract period – medium – long term ? Contract non-cancellable ? Air crafts, land , building..
? Lessor – fulfills financial function
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OPERATING LEASE
? Rental agreement ? Taxes & maintenance – lessor ? Risk of obsolescence – Lessor ? Ranges form intermediate – short term ? Cancellable ? Computers, office equipment,Taxi,mobile cranes ? Service function
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The owner of an equipment/asset sells (Mkt value)it to a leasing company (lessor) which leases it back to the owner (lessee).
The leaseback arrangement - in the form of a „finance lease? or an „operating lease?.
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Retail stores, office buildings, multipurpose industrial building, shopping centre
TWO TYPES: ? BIPARTITE LEASE – equipment supplier cum lessor & lessee (operating lease) – upgrade lease, swap lease ? TRIPARTITE LEASE: equip supplier, lessor, lessee – sales – aid lease
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The leasing company (lessor) funds the entire investment by raising. The debt funds raised by the leasing company are without recourse to the lessee.
HUGE CAPITAL LAYOUT & ECONOMIC LIFE - 10 YRS OR MORE
borrowing a large chunk of the investment with full recourse to the lessee & without any recourse to it.
LEASING COMPANY
Lessor
Equity investor
Trustee
Leases the Equipment
Lessee
Loan participant
Aircraft, ships etc…..
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Domestic lease :All the parties to the transaction are domiciled in the same country. International lease: All parties to the lease transaction are domiciled in different countries.
IMPORT LEASE- Lessor and lessee – domiciled in same country, supplier in different country CROSS-BORDER LEASE: Lessor and lessee are domiciled in different countries, supplier in any country - Involve Country risk & currency risk
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Default risk Residual value risk Interest rate risk Purchasing Power risk Currency & Cross-border risk
To the lessee: 1. 100% Financing of Capital Good 2. Flexibility & convenience - structuring of rentals, terminating 3. Avoids conditionality's 4. Simplicity 5. Tax Benefits – revenue expense 6. Permit alternative use of funds 7. Boon to small firm 8. Protection against obsolescence 9. Conserving borrowing capacity/Facilities additional borrowings 10. Faster and cheaper credit 11. High growth potential/return on capital employed 12. Enhanced liquidity 13. No floatation costs 14. No disposal problem 15. Lesser administrative and maintenance costs 16. Off the balance sheet transaction
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1. Full
the Lessor:
security 2. Tax Benefit – depreciation-reduce tax liabilities 3. High Profitability 4. Quick returns 5. Increased sales
Lessee: ? Higher cost ? Risk of being deprived of the use of asset ? No alteration or change in asset ? Loss of ownership incentives ? Penalties on termination of lease ? Restrictions on use of equipment ? Loss of residual/salvage value ? Cost of financing generally higher than debt financing ? Understatement of lessee's asset
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Lessor:
? High risk of obsolescence ? Competitive market price ? Price-level changes ? Management of cash flows ? Increased cost due to loss of use benefits ? Long – term investment ? Double sales – tax.
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Availability of funds Financial evaluation Possession of asset Cost of Borrowing Depreciation Taxes Salvage Value Risk Maintenance
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PRIVATE SECTOR: ? Pure leasing companies/Independent ? Hire Purchase and Finance companies: tax adv ? Subsidiaries of manufacturing group companies – Vendor leasing, in-house leasing/captive PUBLIC SECTOR: ? Leasing divisions of financial institutions: IFCI,ICICI – all – india, state level ? Subsidiaries of public sector banks: Commercial banks – 9495year onwards ? Other public sector leasing organisation: Bharat electronics ltd, Hindustan packaging company limited, ECIL – sell equipment through leasing
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First leasing company of India ltd. Sundaram finance ltd. Kotak Mahindra Finance ltd 20th century finance corporation ltd. CEAT Financial services ltd Ashok Leyland Finance Ltd. Escorts Financial services ltd Motor & General Finance Ltd Anagram Finance ltd. Rockland leasing ltd ILFS – Infrastructure leasing & financing services – 1987
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The category of „Finance Lease?. The lease agreements do not provide for transfer of ownership to the lessee. The lease rentals are structured so as to recover the entire investment cost during the primary period. The lease rentals are payable generally in EMIs at the beginning of every month. CONTD…….
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Sale & Lease back type of transactions are rare. – Most of them are direct lease Equipment leasing covers a wide range of equipments from industrial plant & machinery, office equipments, vehicles etc. standby finance.- <100 lakhs Project leasing is being attempted only on a limited scale exclusively by ILFS. Cross-border are not popular
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There is no legislation that exclusively governs equipment leasing transactions in India. CONTRACT ACT:
? Law of contract :Two provisions- specifically applicable to leasing transactions. ? General provisions: contract: legal obligation, lawful consideration, competent parties, free consent, not expressly void, discharge of contracts: performance, frustration, mutual agreement , operation of law, remission
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SPECIAL PROVISIONS: The provisions of the Indian Contract Act, 1872 – SECTION 148, relating to bailment are applicable to leasing transactions
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There are two parties to a bailment agreement, ie, bailor who delivers the goods & bailee to whom the goods are delivered for use. There is delivery of transfer of goods from the bailor(lessor) to bailee(lessee). The ownership of the goods continues with the bailor (lessor).
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The goods in bailment should be transferred for a specific purpose under a contract. – purpose – to make use of economic life of asset. When the purpose is accomplished, the goods are to be returned to the bailor or disposed off acc. to his directions
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Reasonable care Not to make unauthorized use To return the goods Not to set up an adverse title To pay the lease rental To insure and repair the goods
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Delivery of goods Peaceful possession Fitness of goods To disclose all defects
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Remedies to lessor: Forfeiture, damages, repossession Remedies to the lessee:claim damages termination
MOTOR VEHICLES ACT, 1988- SECTION 146-INSURANCE RBI NBFCs directons Other act/laws – indian stamp act Lease documentation and agreement
The objective of evaluation is: To identify
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Lessee - The source of finance & Lessor - Better investment alternative .
LEASE Evaluation
Investment decision Purchase the asset
Financing decision 1. Should the asset be funded with debt? 2. Should the asset be funded with debt & equity? 3. Should it be leased?
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Since lease rentals are similar to payment of interest on debt, leasing in essence is an alternative to borrowing. PROCEDURE FOLLOWED: The decision criterion used is NPV/NAL.
If the NPV/NAL is +ve, the leasing alternative should be used, otherwise the borrowing alternative would be preferable.
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NPV/NAL PV OF CASH OUTFLOWS BERL GROSS YIELD ADD-ON YIELD IRR BASED PRICING
Initial Investment/investment cost - PV of lease rentals(kd) - Management fee + PV (tax shield on lease rentals) + PV (tax shield on Mgt. fee) - PV (tax shield on Depreciation) - PV (Net salvage value)
Lease the equipment if NAL is +ve Buy the equipment if NAL is -Ve
Kd – pre-tax cost of long term debt Kc - post – tax marginal cost of capital
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To determine the PV of the cash outflows after taxes under the leasing & the borrowing alternatives.
The decision – criterion: Select the alternative with the lower PV of cash outflows.
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The BELR is the rental at which lessee is indifferent between lease financing/borrowing & buying. BELR has NAL as zero. It reflects the maximum level of rental which the lessee would be willing to pay.
LESSEE
If the BELR exceeds the actual lease rental, the lease proposal, would be accepted, otherwise rejected.
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Accept a lease proposal /choose from alternative proposal BELR represents the minimum (floor) lease rental which he can accept. The NAL at this level is zero.
The NAL to a lessor: PV of Cash Inflows – PV of Cash Outflows
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CASH OUTFLOWS: Initial Investment Income tax on lease rentals Sales-tax on lease transactions Administration expenses CASH INFLOWS: Lease rentals Management fee Tax shield on depreciation Residual value Security deposit if any
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The BELRs of the lessor & the lessee represents the range of acceptable level of rentals. The BELR of the lessor sets the lower limit, while the BELR of the lessee sets the upper limit of the range. The actual rental has to be negotiated within the range.
A rental within the range implies a +ve NAL both for the lessor & the lessee.
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Used as the basis for pricing a lease. The gross yield of a lease can be defined as the compound rate of return that equates PV (lease rentals) + PV (Residual value) to investment cost.
If gross yield is higher than the required yield, the lessor can consider accepting the proposal
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A variant of gross yield. The add-on yield, akin to flat rate of interest assumes that the investment in the lease remains constant over the lease period. The add-on yield is not a true measure.
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IRR – internal rate of return – rate of discount at which present value of cashinflows = PV of cash outflows The IRR of a lease investment is that rate of interest at which NAL is equal to zero.
The lease investment is accepted if & only if the IRR exceeds the required rate of return.
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Income tax provisions:
? Lessee : lease rentals as tax- deductible expenses ? Lessor:
? Lease rental are taxable – “Profits & gains of business or profession” ? investment allowance/depreciation on the investment
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The lessor is not entitled – confessional rate CST – use/resale 46th amendment act (Under purview of sale ) - ST
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Lessor :
? The leased asset is shown on the balance sheet ? Depreciation and other tax shields ? Lease rental –income – lessor
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Lessee: Lease rental - expense
IAS – International accounting standard, 17- 1982
N. JOHN ? History of hire-purchasing ? Concept ? Stipulations,modus operandi,Features ? Legal framework ? Financial evaluation
PRESENTATION
SOWJANYA: ? Hire Purchase Vs Installment ? Hire Purchase Vs Leasing
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U.K, Henry moore- paino maker – 1846 U.S.A – furniture dealer – 1807 In India for more than 6 decades. The first hire-purchase company is believed to be Commercial Credit Corporation. - Madras Motor and General Finance and Instalment Supply Company were based in North India. investments supply ltd. National small industries corporation supplies machinery ssi
These companies were set up in the 1920s and 1930s.
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Development of Hire-purchase - two forms:
? Consumer durables and ? Automobiles
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Consumer durables hire-purchase was promoted by the dealers in the respective equipment. Singer Sewing Machine company, or Murphy radio dealers - instalment facilities on hire-purchase basis
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Hire-purchase of commercial vehicles developed very fast
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INCOME TAX – HIRER: ? CB of direct taxes – 1943- Entitled to the tax shield on depreciation. ? Tax shield on „consideration for hire? i.e, finance charge (hire charges). INCOME TAX – HIRE VENDOR: ? The hire charges - is liable to tax under the head profits & gains of business & profession.
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SALES-TAX: Hire-purchase transactions are liable to sales tax. The sales tax is payable once the goods are delivered by the owner to the hirer. INTEREST-TAX: The hire-purchase finance companies, have to pay interest-tax under the Interest-Tax Act, 1974. According to this Act, interest tax is payable on the total amount of interest earned.
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Risks & rewards are transferred to the hirer at the inception of the transaction No accounting standard/guidelines note for accounting treatment in india/no law /regulation to govern HP Contracts
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Depreciation claim – based on cash purchase price - policy Cash purchase price of the asset is capitalized ---cpp - down payment – liability Total charge for credit is allocated over the hire-period – effective rate of interest method, sum-of the years-digits method/straight line method.
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HP installment as current asset (stock on hire) & unearned fin component of these installments as current liability – “ unmatched finance charges” End of each accounting period – appropriate part of Unmatured finance income – recognised as current income Direct costs – structuring of the transaction – expensed immediately/allocated against finance income over the hire-period
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Hire-purchase agreement is defined as peculiar kind of transaction in which goods are let on hire with an option to the hirer to purchase them. The purchase price is to be paid in installments – can purchase by paying all the installments.
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Payment to be made in installments over a specified period. The possession is delivered to the hirer at the time of entering into the contract. The property in the goods passes to the hirer on payment of the last instalment. If default is made in payment of any instalment, the seller becomes entitled to take away the goods. The hirer is free to return the goods without being required to pay any further installments.
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The finance (hire-purchase) company purchases the equipment from the equipment supplier and lets it on hire to the hirer. The hirer is required to make a down payment of, say 20-25% of the cost & pay balance with interest in EMIs. Alternatively, the hirer has to invest an equivalent amount on fixed deposits with the finance company.
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Ownership Depreciation Magnitude Extent of financing Maintenance Tax Benefits
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There is no exclusive legislation dealing with hire-purchase transactions in India. The Hire-Purchase Act was passed in 1972, however, the Act has not been enforced so far. In the absence of any specific law, the hire-purchase transactions are governed by the provisions of the Indian Contract Act & the Sales of Goods Act.
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The hire-purchase transaction has two aspects: An aspect of bailment of goods which is covered by the Contract Act. An element of sale when the option of purchase is exercised by the hirer which is covered by the Sales of Goods Act.
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POINT OF VIEW OF THE HIRER: The evaluation of hire-purchase transaction from the hirer?s angle, has to be done in relation to leasing alternative.
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Decision-Criterion:
The decision-criterion from the point of view of a hirer is the cost hire-purchase vis-a-vis the cost of leasing.
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Down payment + Service charges +PV hire charges - PV of depreciation payments tax shield - PV of net salvage expenses value
Lease Mgt Fee + Lease payments - PV of tax shield on lease
- PV of tax shield on
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Hire-purchase & leasing represent two alternative investment decisions of a hirevendor. The decision-criterion, is based on a comparison of the NPVs of two alternatives. The alternative with a higher NPV would be selected.
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PV of hire-purchase installments + Documentation & service fee + PV of tax shield on initial direct costs - Loan Amount - Initial Cost - PV of interest tax on interest
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PV of lease rentals + Lease Mgt Fee + PV of tax shield on depreciation + PV of net salvage value - Initial Investment - Initial Direct costs - PV of tax liability on lease rentals & lease Mgt fee
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Financial services : M Y KHAN Emerging Scenario of Financial services : GORDON AND NATARAJAN http://www.firstleasingindia.com/ourhistory. asp
EVOLUTION OF LEASING
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LEASING ACTIVITY WAS INITIATED IN INDIA IN 1973. THE FIRST LEASING COMPANY OF INDIA, NAMED “FRIST LEASING COMPANY OF INDIA LTD”. WAS SET UP IN THAT YEAR BY FAROUK IRANI, WITH INDUSTRIALIST A C MUTHIA.
Contd……
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FOR SEVERAL YEARS, THIS COMPANY REMAINED THE ONLY COMPANY IN THE COUNTRY UNTIL 20th CENTURY FINANCE CORPORATION WAS SET UP- THIS WAS AROUND 1980. FROM 1981, THE TRICLE STARTED AND SHETTY INVESTMENT ANDFINANCE, JAYABHARAT CREDIT AND INVESTMENT, MOTOR & GENARAL FINANCE, AND SUNDARAM FINANCE ETC. JOINED THE LEASING GAME.
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5. THE INDUSTRY ENTERED THE THIRD STAGE IN THE GROWTH PHASE IN LATE 1982, WHEN NUMEROUS FINANCEAL INSTITUTIONS AND COMMERCIAL BANKS EITHER STARTED LEASING OR ANNOUNCED PLAN TO DO SO. ICICI, PROMINT AMONG FINANCIAL INSTITUTIONS, ENTERED THE INDUSTRY IN 1983 GIVING A BOOST TO THE CONCEPT OF LEASING.
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INTERNATIONAL FINANCE CORPORATION ANNOUNCED ITS DECISION TO OPEN FOUR LEASING JOINT VENTURES IN INDIA. BANKS THEMSELVES WERE ALLOWED TO OFFER LEASING FACILITIES MUCH LATER – IN 1994.
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doc_366824418.ppt
Hire purchase (abbreviated HP, colloquially sometimes never-never) is the legal term for a contract, in which persons usually agree to pay for goods in parts or a percentage at a time. It was developed in the United Kingdom and can now be found in Australia, China, India, Jamaica, Japan, Malaysia, New Zealand, and South Africa. It is also called closed-end leasing.
?
? ? ? ? ? ? ? ? ? ?
Leasing – concept & classification Evolution of Indian leasing Industry – Presentation Product profile Legal (regulatory aspects of leasing in India), tax & accounting aspects of leasing Funding of leasing in India. Financial evaluation of leasing
HIRE PURCHASE Concept and characteristics Legal & tax frame work, mathematics Financial evaluation of hire purchase deals-
Contractual agreement Owner of an asset grants the right Use the asset to other party Receiver of the services of asset Under lease contract
lessor
Seller, supplier, fin co, manu Claims depreciation on the asset
lessee
Individual,company,firm Periodic payment- lease rental
Lease – renting of an asset for some specified period
?
?
? ?
Divorce of ownership from the economic use of an asset/equipment Device of financing(money lending) the cost of an asset/capital asset Fund based service Lending of funds/finance/credit
JAMES C.VAN HORNE DEFINED: Lease is a contract whereby the owner of an asset (lessor)grants to another party (lessee) the exclusive right to use the asset usually for an agreed period of time in return for the payment of rent. ? LEASING – Is a process by which a firm can obtain the use of certain fixed asset for which it must make a series of contractual periodic tax-deductible payment (lease rentals)
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Parties to the contract-lease financier, lessor, broker, lessee Asset: asset, property or equipment Ownership separated from the user Term of the lease Lease Rentals Modes of terminating lease
At the end of the lease period the asset reverts back to the lessor unless there is a provision for the renewal of contract.
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Lessee – decide asset req & supplier Lessee enters – lease agreement – lessor
? ? ? ? Basic lease period Timing and amount of periodical rental payment Option details – renew/purchase Payment details – maintenance, repairs, taxes, insurance & other expenses
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Lessor contacts manufacturer – supply – makes payment after asset delivered & accepted by lessee.
?
Financial Lease & Operating Lease
Sale & Leaseback & Direct Lease Single investor Lease & Leveraged lease Domestic Lease & International Lease
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?
?
Based on risks & rewards, parties involved
?
The lessor transfers to the lessee, substantially all the risks & rewards incidental to the ownership of the asset whether or not the title is eventually transferred.- IAS -17
Also known as Capital lease, long term lease, net lease and close lease, Full payout leases Approach to economic life
The salient features of a lease are: ? A financial lease is a long-term, noncancelable lease. ? The lessee has the option to purchase the asset at a price - sufficiently lower than the fair market value . ? The lease term - major part of the useful life of the asset. ? The lessee is responsible - maintenance of the asset - for insuring it against accidental damage or loss. ? The risk of Damage is shifted from the lessor to the lessee.
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According to the IAS-17, an operating lease is one which is not a finance lease. In an operating lease the lessor does not transfer all the risks & rewards incidental to the ownership of the asset. The lessor provides all the services attached to the leased asset.
Also known as Service lease, Short term lease or True lease
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The lease term is significantly less than the economic life of the equipment.
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The lease is usually cancelled at a short notice.
The lessor is responsible for the insurance & maintenance of the asset. The lessor bears the risk of economic & functional obsolescence of the asset.
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FINANCIAL
? Installment loan ? Taxes & maintenance – lessee ? Risk of obsolescence – lessee ? Contract period – medium – long term ? Contract non-cancellable ? Air crafts, land , building..
? Lessor – fulfills financial function
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OPERATING LEASE
? Rental agreement ? Taxes & maintenance – lessor ? Risk of obsolescence – Lessor ? Ranges form intermediate – short term ? Cancellable ? Computers, office equipment,Taxi,mobile cranes ? Service function
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The owner of an equipment/asset sells (Mkt value)it to a leasing company (lessor) which leases it back to the owner (lessee).
The leaseback arrangement - in the form of a „finance lease? or an „operating lease?.
?
Retail stores, office buildings, multipurpose industrial building, shopping centre
TWO TYPES: ? BIPARTITE LEASE – equipment supplier cum lessor & lessee (operating lease) – upgrade lease, swap lease ? TRIPARTITE LEASE: equip supplier, lessor, lessee – sales – aid lease
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The leasing company (lessor) funds the entire investment by raising. The debt funds raised by the leasing company are without recourse to the lessee.
HUGE CAPITAL LAYOUT & ECONOMIC LIFE - 10 YRS OR MORE
borrowing a large chunk of the investment with full recourse to the lessee & without any recourse to it.
LEASING COMPANY
Lessor
Equity investor
Trustee
Leases the Equipment
Lessee
Loan participant
Aircraft, ships etc…..
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?
Domestic lease :All the parties to the transaction are domiciled in the same country. International lease: All parties to the lease transaction are domiciled in different countries.
IMPORT LEASE- Lessor and lessee – domiciled in same country, supplier in different country CROSS-BORDER LEASE: Lessor and lessee are domiciled in different countries, supplier in any country - Involve Country risk & currency risk
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Default risk Residual value risk Interest rate risk Purchasing Power risk Currency & Cross-border risk
To the lessee: 1. 100% Financing of Capital Good 2. Flexibility & convenience - structuring of rentals, terminating 3. Avoids conditionality's 4. Simplicity 5. Tax Benefits – revenue expense 6. Permit alternative use of funds 7. Boon to small firm 8. Protection against obsolescence 9. Conserving borrowing capacity/Facilities additional borrowings 10. Faster and cheaper credit 11. High growth potential/return on capital employed 12. Enhanced liquidity 13. No floatation costs 14. No disposal problem 15. Lesser administrative and maintenance costs 16. Off the balance sheet transaction
? To
1. Full
the Lessor:
security 2. Tax Benefit – depreciation-reduce tax liabilities 3. High Profitability 4. Quick returns 5. Increased sales
Lessee: ? Higher cost ? Risk of being deprived of the use of asset ? No alteration or change in asset ? Loss of ownership incentives ? Penalties on termination of lease ? Restrictions on use of equipment ? Loss of residual/salvage value ? Cost of financing generally higher than debt financing ? Understatement of lessee's asset
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Lessor:
? High risk of obsolescence ? Competitive market price ? Price-level changes ? Management of cash flows ? Increased cost due to loss of use benefits ? Long – term investment ? Double sales – tax.
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Availability of funds Financial evaluation Possession of asset Cost of Borrowing Depreciation Taxes Salvage Value Risk Maintenance
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PRIVATE SECTOR: ? Pure leasing companies/Independent ? Hire Purchase and Finance companies: tax adv ? Subsidiaries of manufacturing group companies – Vendor leasing, in-house leasing/captive PUBLIC SECTOR: ? Leasing divisions of financial institutions: IFCI,ICICI – all – india, state level ? Subsidiaries of public sector banks: Commercial banks – 9495year onwards ? Other public sector leasing organisation: Bharat electronics ltd, Hindustan packaging company limited, ECIL – sell equipment through leasing
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First leasing company of India ltd. Sundaram finance ltd. Kotak Mahindra Finance ltd 20th century finance corporation ltd. CEAT Financial services ltd Ashok Leyland Finance Ltd. Escorts Financial services ltd Motor & General Finance Ltd Anagram Finance ltd. Rockland leasing ltd ILFS – Infrastructure leasing & financing services – 1987
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The category of „Finance Lease?. The lease agreements do not provide for transfer of ownership to the lessee. The lease rentals are structured so as to recover the entire investment cost during the primary period. The lease rentals are payable generally in EMIs at the beginning of every month. CONTD…….
?
?
? ?
Sale & Lease back type of transactions are rare. – Most of them are direct lease Equipment leasing covers a wide range of equipments from industrial plant & machinery, office equipments, vehicles etc. standby finance.- <100 lakhs Project leasing is being attempted only on a limited scale exclusively by ILFS. Cross-border are not popular
?
?
There is no legislation that exclusively governs equipment leasing transactions in India. CONTRACT ACT:
? Law of contract :Two provisions- specifically applicable to leasing transactions. ? General provisions: contract: legal obligation, lawful consideration, competent parties, free consent, not expressly void, discharge of contracts: performance, frustration, mutual agreement , operation of law, remission
?
SPECIAL PROVISIONS: The provisions of the Indian Contract Act, 1872 – SECTION 148, relating to bailment are applicable to leasing transactions
?
?
There are two parties to a bailment agreement, ie, bailor who delivers the goods & bailee to whom the goods are delivered for use. There is delivery of transfer of goods from the bailor(lessor) to bailee(lessee). The ownership of the goods continues with the bailor (lessor).
?
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The goods in bailment should be transferred for a specific purpose under a contract. – purpose – to make use of economic life of asset. When the purpose is accomplished, the goods are to be returned to the bailor or disposed off acc. to his directions
?
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Reasonable care Not to make unauthorized use To return the goods Not to set up an adverse title To pay the lease rental To insure and repair the goods
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Delivery of goods Peaceful possession Fitness of goods To disclose all defects
?
?
Remedies to lessor: Forfeiture, damages, repossession Remedies to the lessee:claim damages termination
MOTOR VEHICLES ACT, 1988- SECTION 146-INSURANCE RBI NBFCs directons Other act/laws – indian stamp act Lease documentation and agreement
The objective of evaluation is: To identify
? ?
Lessee - The source of finance & Lessor - Better investment alternative .
LEASE Evaluation
Investment decision Purchase the asset
Financing decision 1. Should the asset be funded with debt? 2. Should the asset be funded with debt & equity? 3. Should it be leased?
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Since lease rentals are similar to payment of interest on debt, leasing in essence is an alternative to borrowing. PROCEDURE FOLLOWED: The decision criterion used is NPV/NAL.
If the NPV/NAL is +ve, the leasing alternative should be used, otherwise the borrowing alternative would be preferable.
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NPV/NAL PV OF CASH OUTFLOWS BERL GROSS YIELD ADD-ON YIELD IRR BASED PRICING
Initial Investment/investment cost - PV of lease rentals(kd) - Management fee + PV (tax shield on lease rentals) + PV (tax shield on Mgt. fee) - PV (tax shield on Depreciation) - PV (Net salvage value)
Lease the equipment if NAL is +ve Buy the equipment if NAL is -Ve
Kd – pre-tax cost of long term debt Kc - post – tax marginal cost of capital
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To determine the PV of the cash outflows after taxes under the leasing & the borrowing alternatives.
The decision – criterion: Select the alternative with the lower PV of cash outflows.
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The BELR is the rental at which lessee is indifferent between lease financing/borrowing & buying. BELR has NAL as zero. It reflects the maximum level of rental which the lessee would be willing to pay.
LESSEE
If the BELR exceeds the actual lease rental, the lease proposal, would be accepted, otherwise rejected.
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Accept a lease proposal /choose from alternative proposal BELR represents the minimum (floor) lease rental which he can accept. The NAL at this level is zero.
The NAL to a lessor: PV of Cash Inflows – PV of Cash Outflows
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CASH OUTFLOWS: Initial Investment Income tax on lease rentals Sales-tax on lease transactions Administration expenses CASH INFLOWS: Lease rentals Management fee Tax shield on depreciation Residual value Security deposit if any
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The BELRs of the lessor & the lessee represents the range of acceptable level of rentals. The BELR of the lessor sets the lower limit, while the BELR of the lessee sets the upper limit of the range. The actual rental has to be negotiated within the range.
A rental within the range implies a +ve NAL both for the lessor & the lessee.
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Used as the basis for pricing a lease. The gross yield of a lease can be defined as the compound rate of return that equates PV (lease rentals) + PV (Residual value) to investment cost.
If gross yield is higher than the required yield, the lessor can consider accepting the proposal
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A variant of gross yield. The add-on yield, akin to flat rate of interest assumes that the investment in the lease remains constant over the lease period. The add-on yield is not a true measure.
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IRR – internal rate of return – rate of discount at which present value of cashinflows = PV of cash outflows The IRR of a lease investment is that rate of interest at which NAL is equal to zero.
The lease investment is accepted if & only if the IRR exceeds the required rate of return.
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Income tax provisions:
? Lessee : lease rentals as tax- deductible expenses ? Lessor:
? Lease rental are taxable – “Profits & gains of business or profession” ? investment allowance/depreciation on the investment
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The lessor is not entitled – confessional rate CST – use/resale 46th amendment act (Under purview of sale ) - ST
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Lessor :
? The leased asset is shown on the balance sheet ? Depreciation and other tax shields ? Lease rental –income – lessor
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Lessee: Lease rental - expense
IAS – International accounting standard, 17- 1982
N. JOHN ? History of hire-purchasing ? Concept ? Stipulations,modus operandi,Features ? Legal framework ? Financial evaluation
PRESENTATION
SOWJANYA: ? Hire Purchase Vs Installment ? Hire Purchase Vs Leasing
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U.K, Henry moore- paino maker – 1846 U.S.A – furniture dealer – 1807 In India for more than 6 decades. The first hire-purchase company is believed to be Commercial Credit Corporation. - Madras Motor and General Finance and Instalment Supply Company were based in North India. investments supply ltd. National small industries corporation supplies machinery ssi
These companies were set up in the 1920s and 1930s.
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Development of Hire-purchase - two forms:
? Consumer durables and ? Automobiles
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Consumer durables hire-purchase was promoted by the dealers in the respective equipment. Singer Sewing Machine company, or Murphy radio dealers - instalment facilities on hire-purchase basis
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Hire-purchase of commercial vehicles developed very fast
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INCOME TAX – HIRER: ? CB of direct taxes – 1943- Entitled to the tax shield on depreciation. ? Tax shield on „consideration for hire? i.e, finance charge (hire charges). INCOME TAX – HIRE VENDOR: ? The hire charges - is liable to tax under the head profits & gains of business & profession.
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SALES-TAX: Hire-purchase transactions are liable to sales tax. The sales tax is payable once the goods are delivered by the owner to the hirer. INTEREST-TAX: The hire-purchase finance companies, have to pay interest-tax under the Interest-Tax Act, 1974. According to this Act, interest tax is payable on the total amount of interest earned.
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Risks & rewards are transferred to the hirer at the inception of the transaction No accounting standard/guidelines note for accounting treatment in india/no law /regulation to govern HP Contracts
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Depreciation claim – based on cash purchase price - policy Cash purchase price of the asset is capitalized ---cpp - down payment – liability Total charge for credit is allocated over the hire-period – effective rate of interest method, sum-of the years-digits method/straight line method.
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HP installment as current asset (stock on hire) & unearned fin component of these installments as current liability – “ unmatched finance charges” End of each accounting period – appropriate part of Unmatured finance income – recognised as current income Direct costs – structuring of the transaction – expensed immediately/allocated against finance income over the hire-period
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Hire-purchase agreement is defined as peculiar kind of transaction in which goods are let on hire with an option to the hirer to purchase them. The purchase price is to be paid in installments – can purchase by paying all the installments.
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Payment to be made in installments over a specified period. The possession is delivered to the hirer at the time of entering into the contract. The property in the goods passes to the hirer on payment of the last instalment. If default is made in payment of any instalment, the seller becomes entitled to take away the goods. The hirer is free to return the goods without being required to pay any further installments.
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The finance (hire-purchase) company purchases the equipment from the equipment supplier and lets it on hire to the hirer. The hirer is required to make a down payment of, say 20-25% of the cost & pay balance with interest in EMIs. Alternatively, the hirer has to invest an equivalent amount on fixed deposits with the finance company.
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Ownership Depreciation Magnitude Extent of financing Maintenance Tax Benefits
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There is no exclusive legislation dealing with hire-purchase transactions in India. The Hire-Purchase Act was passed in 1972, however, the Act has not been enforced so far. In the absence of any specific law, the hire-purchase transactions are governed by the provisions of the Indian Contract Act & the Sales of Goods Act.
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The hire-purchase transaction has two aspects: An aspect of bailment of goods which is covered by the Contract Act. An element of sale when the option of purchase is exercised by the hirer which is covered by the Sales of Goods Act.
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POINT OF VIEW OF THE HIRER: The evaluation of hire-purchase transaction from the hirer?s angle, has to be done in relation to leasing alternative.
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Decision-Criterion:
The decision-criterion from the point of view of a hirer is the cost hire-purchase vis-a-vis the cost of leasing.
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Down payment + Service charges +PV hire charges - PV of depreciation payments tax shield - PV of net salvage expenses value
Lease Mgt Fee + Lease payments - PV of tax shield on lease
- PV of tax shield on
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Hire-purchase & leasing represent two alternative investment decisions of a hirevendor. The decision-criterion, is based on a comparison of the NPVs of two alternatives. The alternative with a higher NPV would be selected.
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PV of hire-purchase installments + Documentation & service fee + PV of tax shield on initial direct costs - Loan Amount - Initial Cost - PV of interest tax on interest
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PV of lease rentals + Lease Mgt Fee + PV of tax shield on depreciation + PV of net salvage value - Initial Investment - Initial Direct costs - PV of tax liability on lease rentals & lease Mgt fee
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Financial services : M Y KHAN Emerging Scenario of Financial services : GORDON AND NATARAJAN http://www.firstleasingindia.com/ourhistory. asp
EVOLUTION OF LEASING
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LEASING ACTIVITY WAS INITIATED IN INDIA IN 1973. THE FIRST LEASING COMPANY OF INDIA, NAMED “FRIST LEASING COMPANY OF INDIA LTD”. WAS SET UP IN THAT YEAR BY FAROUK IRANI, WITH INDUSTRIALIST A C MUTHIA.
Contd……
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FOR SEVERAL YEARS, THIS COMPANY REMAINED THE ONLY COMPANY IN THE COUNTRY UNTIL 20th CENTURY FINANCE CORPORATION WAS SET UP- THIS WAS AROUND 1980. FROM 1981, THE TRICLE STARTED AND SHETTY INVESTMENT ANDFINANCE, JAYABHARAT CREDIT AND INVESTMENT, MOTOR & GENARAL FINANCE, AND SUNDARAM FINANCE ETC. JOINED THE LEASING GAME.
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5. THE INDUSTRY ENTERED THE THIRD STAGE IN THE GROWTH PHASE IN LATE 1982, WHEN NUMEROUS FINANCEAL INSTITUTIONS AND COMMERCIAL BANKS EITHER STARTED LEASING OR ANNOUNCED PLAN TO DO SO. ICICI, PROMINT AMONG FINANCIAL INSTITUTIONS, ENTERED THE INDUSTRY IN 1983 GIVING A BOOST TO THE CONCEPT OF LEASING.
Contd…..
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INTERNATIONAL FINANCE CORPORATION ANNOUNCED ITS DECISION TO OPEN FOUR LEASING JOINT VENTURES IN INDIA. BANKS THEMSELVES WERE ALLOWED TO OFFER LEASING FACILITIES MUCH LATER – IN 1994.
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