USN
PESIT Bangalore South Campus
Hosur road, 1km before Electronic City, Bengaluru -100
Department of MBA
INTERNAL ASSESSMENT TEST – 2
Date
Subject & Code
: 30-9-15
Max Marks: 50
: INVESTMENT BANKING AND FINANCIAL SERVICES -14MBAFM302
Section: A
Name of faculty : Divya Mathur
Time: 8:30-10:00 am
Note: Answer all questions
1 (a)
What is leveraged lease?
(3 marks)
Ans-Form of finance lease.
A lease in which most of the funds needed to purchase the leased asset are borrowed
by the lessor.
Involves at least three parties instead of the normal two. The additional party is a
lender, normally referred to as a ‘debt participant’.
Typically involves a non-recourse loan, whereby the lessor is not responsible for its
repayment.
(b)
Explain the different types of leasing?
(7 marks)
Ans-Finance Leases
Operating Leases
Sale and Lease-Back Agreements
Leveraged Leasing
Cross-Border Leasing
(c)
Explain the concepts and features of leasing and hire purchase agreements with
depreciation and tax implications relevant to those agreements.
Ans-If a leased asset is used to generate taxable income, the lease rentals paid by the
lessee are an allowable tax deduction, provided that the lease is classified as a ‘genuine
lease’ rather than an ‘instalment purchase arrangement’.
MBA III SEMESTER -FINANCE
(10 marks)
USN
PESIT Bangalore South Campus
Hosur road, 1km before Electronic City, Bengaluru -100
Department of MBA
While lease rentals are deductible, the lessee cannot deduct, for tax purposes,
depreciation on the leased asset.
A lease can affect the present value of the government’s tax receipts in two ways:
The government gains, in that it can tax the lease rentals received by the lessor.
The government loses, in that the lessor is able to claim deductions for depreciation on
the leased asset.
Tax Treatment of Lessor-In accordance with IT 2594, the "asset method" must be used
by the lessor in returning rental income.Under this method, the lessor includes the full
amount of the lease rentals in assessable income and claims relevant deductions
relating to ownership of the leased asset. For example, the lessor may claim
depreciation and any interest expense incurred in financing the acquisition of the asset.
The "asset method" was confirmed as appropriate by the Full Federal Court in the
Citibank case. The Full Federal Court held that the gross rentals received by the lessor
(in respect of a luxury car finance leases) would be assessable and a deduction could be
claimed by the lessor for depreciation (subject to the depreciation cost limit).
Tax Treatment of Lessee-Broadly, the lessee may claim a deduction for lease payments
under section 8-1 of the 1997 Act to the extent that the losses or outgoings are :
incurred in producing assessable income; or necessarily incurred in carrying on a
business for the purpose of producing assessable income.Therefore, this requires a
consideration of the use of the leased property.The lease payments will be deductible
when they are "incurred", which is generally when they are paid or become due and
payable. If the lease payment is prepaid, it will be deductible in the year it is paid,
provided the period to which it relates does not exceed 13 months.
In lease agreement, the total lease rentals are shown as expenditure by the lessee. In
hire purchase, the hirer claims the depreciation of asset as an expense.
The taxation aspects of hire purchase transaction can be divided into three parts (a)
Income Tax, (b) Sales Tax and (c) Interest Tax.
Income Tax Aspect-Hire purchase, as a financing alternative, offers tax benefits both to
the hire-vendor (hire purchase finance company) and the hirer. on the finance charges.
Even though the hirer is not the owner
MBA III SEMESTER -FINANCE
USN
PESIT Bangalore South Campus
Hosur road, 1km before Electronic City, Bengaluru -100
Department of MBA
he gets the benefit of depreciation on the cash price of the asset/equipment. Also he
can claim finance charges (difference of hire purchase price and cash price) as
expenses. If the agreement provides for the option of purchasing the goods as any time
or of returning the same before the total amount is paid, no deduction of tax at source
is to be made from the consideration of hire paid to the owner. Income tax assessment
of the Hire purchase or hirer: The hirer is entitled to (i) The tax shield on depreciation
calculated with reference to the cash purchase price and (ii) the tax shield Income tax
assessment of the Owner or financer: The consideration for hire/hire charges / income
received by the hire vendor / financer is liable to tax under the head profits and gains of
business and profession where hire purchase constitute the business (mainstream
activity) of the assessee, otherwise as income from other sources. The hire income from
house property is generally taxed as income from house property. Normal deduction
(except depreciation) are allowed while computing the taxable income.
Sales Tax Aspect
The salient features of sales tax pertaining to hire purchase transactions after the
Constitution (Forty Sixth Amendment) Act, 1982, are as discussed in following points: a.
Hire purchase as Sale: Hire purchase, though not sale in the true sense, is deemed to be
sale. Such transactions as per se are liable to sales tax. Full tax is payable irrespective of
whether the owner gets the full price of the goods or not. b. Delivery v/s Transfer of
property: A hire purchase deal is regarded as a sale immediately the goods are
delivered and not on the transfer of the title to the goods. The quantum of sales tax is
the sales price, thus the sales tax is charged on the whole amount payable by the hirer
to the owner. The sales tax on a hire purchase sale is levied in the state where the hire
purchase agreement is executed c. Rate of tax: The rate of sales tax on hire purchase
deals vary from state to state. There is, as a matter of fact, no uniformity even
regarding the goods to be taxed. If the rates undergo a change during the currency of a
hire purchase agreement, the rate in force on the date of the delivery of the goods to
the hirer is applicable.
Interest Tax
The hire purchase finance companies, like other credit / 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 less bad debts in the previous year at a
rate of 2 percent. The tax is treated as a tax deductible expense for the purpose of
computing the taxable income under the Income Tax.
2 (a)
What is a hire purchase contract? Brief its characteristics.
MBA III SEMESTER -FINANCE
(3 marks)
USN
PESIT Bangalore South Campus
Hosur road, 1km before Electronic City, Bengaluru -100
Department of MBA
Ans- Hire purchase is a mode of financing the price of the goods to be sold on a future
date. In a hire purchase transaction, the goods are let on hire, the purchase price is to
be paid in installments and hirer is allowed an option to purchase the goods by paying
all the installments. Hire purchase is a method of selling goods. In a hire purchase
transaction the goods are letnout on hire by a finance company (creditor) to the hire
purchasencustomer (hirer). The buyer is required to pay an agreed amount in periodical
installments during a given period. The ownership of the property remains with creditor
and passes on to hirer on the payment of the last installment.
Features of Hire Purchase Agreement
Under hire purchase system, the buyer takes possession of goods immediately and
agrees to pay the total hire purchase price in installments.
· Each installment is treated as hire charges.· The ownership of the goods passes from
the seller to thebuyer on the payment of the last installment.
· In case the buyer makes any default in the payment of any installment the seller has
right to repossess the goods from the buyer and forfeit the amount already received
treating it as hire charges.
· The hirer has the right to terminate the agreement any time before the property
passes. That is, he has the option to return the goods in which case he need not pay
installments falling due thereafter. However, he cannot recover the sums already paid
as such sums legally represent hire charges on the goods in question.
(b)
What is the distinction between bills discounting and factoring?
All though both factoring and bill discounting provides short term finance, however in
bill discounting the drawer undertakes the responsibility of collecting the bills and pay
the proceeds while in factoring it is the factor that usually undertakes the responsibility
of collecting the bills. Given below are some more differences between the two –
1. Bill discounting is always of recourse type while factoring can be either with or
without recourse. In case of recourse the factor does not assume the credit risk and it is
the company which assumes the credit risk.
2. Factoring is an off balance sheet entry in the sense that both amount of receivables
and bank credit are not shown in the balance sheet which is not the case with the bill
discounting which is shown in the balance sheet.
MBA III SEMESTER -FINANCE
(7 marks)
USN
PESIT Bangalore South Campus
Hosur road, 1km before Electronic City, Bengaluru -100
Department of MBA
3. In bill discounting there is only provision of finance while in factoring factor provides
in addition to finance facility other facilities like sales ledger maintenance, collection
etc..
4. Discounted bills may be re-discounted several times before they mature for payment
which is not the case with factoring.
(c)
Explain the Steps in Leasing Transactions.
Ans- Step 1
Business owner determines equipment and negotiates cost with the equipment dealer.
Step 2
Submit an equipment lease application by fax, e-mail, or telephone.
Step 3
Accord Leasing processes the credit application pulling personal credit and business
reports.
Step 4
When the lease is approved, Accord Leasing will notify the business owner and the
equipment dealer of the terms and conditions of the approval. The average decision
time for application only is one business day . When tax returns and/or financial
statements are required add additional 24 hours after receipt of all the requested
financial information .
Step 5
The equipment dealer will provide Accord Leasing with an invoice or quote providing
make model and serial number if available. After we receive this information, we will
generate the lease documents and overnight or email them to the business owner or
vendor if desired .
Step 6
When Accord Leasing receives back lease documents we carefully review for proper
signatures and receipt of advance payment from business checking account. We then
issue a purchaseorder to the equipment dealer or provide pre-funding if required .
MBA III SEMESTER -FINANCE
(10marks)
USN
PESIT Bangalore South Campus
Hosur road, 1km before Electronic City, Bengaluru -100
Department of MBA
Step 7
After the equipment is delivered and installed the business owner will be contacted by
phone and asked to verbally verify the delivery and acceptance of the equipment. We
verbally review the lease terms, and authorize payment to the equipment dealer.
Payment to vendor is then made by overnight courier or bank wire .
3
XYZ LTD is in the business of manufacturing steel utensils. The firm is planning to diversify (10 marks)
and add a new product line. The firm either can buy the required machinery or get it on
lease. The machinery can be purchased for Rs.1500000. It is expected to have a useful
life of 5 years with a salvage value of Rs.100000 after the expiry of 5 years. The purchase
can be financed by 20% loan repayable in 5 equal annual installments (inclusive of
interest) becoming due at the end of each year. Alternatively, the machine can be taken
on year-end lease rentals of Rs.450000 for 5 years. Advice the company on the option it
should choose. For your exercise, you may assume the following.
i.
ii.
iii.
The machine will constitute a separate block for depreciation purposes. The
company follows written down value method of depreciation, the rate of
depreciation being 25%.
Tax rate is 35% and the cost of capital is 20%.Lease rentals are to be paid at
the end of the year.
Maintenance expenses estimated at Rs.30000 per year are to be borne by
the lessee.
Ans-XYZ should go with buying option as its PV of Cash outflow is less in
comparison to Leasing Option.
********
MBA III SEMESTER -FINANCE