Leasing: A Useful Financial Instrument in Economic Development
By Martin Serkovic
Posted: 6th December 2013 09:41As the economy keeps on growing in Peru, financial leasing has become one of the best modern financing tools to own or make use of necessary equipment in order to participate to new projects.
The leasing basically consists in a financing instrument that has become, in Peru, increasingly more common in the recent years. Typically, it can be defined as a commercial contract under which corporations and/or entrepreneurs acquire assets - movable or real estate - through a financial institution (i.e. banks and/or authorised institutions).
More particularly, the financial institution (“Lessor”) acquires and leases some assets requested by the corporation (“Lessee”), in exchange of a rental fee. During the execution of the agreement, the Lessee is in possession of the asset, being able to use it for its commercial activities. At the end of the term of the lease, the Lessee is offered an option to purchase the asset, by paying a residual value to the financial institution.
Thus, the financial leasing is basically a lease contract with the particular possibility to buy the asset after paying the monthly rentals.
Functioning and Characteristics
Being a commercial contract, financial leasing has several benefits. Firstly, it allows the Lessee to record the goods as an asset - therefore, its depreciation - and also offers tax benefits, as the VAT is included in each rental fee.
In addition, this kind of contract allows the Lessee to pay the financial lease with the revenue resulting from the exploitation of the asset. Thus, this mechanism allows the Lessee to increase its activities, as well as having capital to be invested in new possibilities.
As mentioned above, the Lessee is obliged to pay monthly rent including capital and interests that are established at the beginning of the leasing. These interests are in fact the gain from which the financial entities benefit.
In this context, the possibility of pre-payments is almost inexistent as it is not in the favourof financial entities. Indeed, such prepayment would involve a reduction of interests and limit the possibilities for the financial entity. Furthermore, the right to make pre-payments without penalties as established in the Consumer Protection Code does not apply to Lease Contracts, for not being a consumer contract.
In the sector of investments, instead of using pre-payments, refinancing of lease contracts is something used a lot. In most of the cases, after prior agreement with the financial institution (basically regarding rates and terms), Lessees refinance the leasing through a corporate loan.
Another modality of leasing is the Lease-Back, under which the Lessee and the provider of the good are the same person. Thus, the company which is the original owner, transfers the goods to the financial entity to be rented. The proposal is to obtain cash flow and keep on exploiting the rented goods commercially.
The Operating Leasing is another instrument widely use today. It allows the leasing of assets that will be used for specific operations, and will not be necessarily acquired at the end of the contract. Consequently, once the contract comes to an end the goods will be given back or replaced with more modern equipment.
It should be noted that the operating leasing is a civil contract with a purchase option, completely different from the financial leasing. Indeed, under the operating leasing, the Lessee cannot record the goods as assets or depreciate them. On the other hand, the Lessee also has a purchase option but has to buy the good at a market value, not a residual one as it is the case under a financial lease.
As a matter of fact, the Tax Authority considers that this type of contract is more a financial leasing or hire-purchase agreement than a civil contract with purchase option. As a consequence, Lessees are obliged to pay the amount of the VAT for the entire operation, from the first installment.
This argument is not valid, as even though the Lessee does not know if he will acquire the good, the Tax Authority assumes he necessarily will.
Finally, it creates a lack of balance, as the installments are calculated according to the purchase price under the financial leasing, while it is not the case under the operating leasing with purchase option.