Characteristics of Finance Lease
Business model of Finance Lease
Finance leases are mainly prevalent in Japan. The procedure to enter into a finance lease contract is as follows.
- Select equipment to be leased (leased asset).
- Make an application for a lease contract.
- Agree to the lease contract.
- Agree to the sale and purchase contract for the leased equipment.
- Deliver the leased equipment.
- Issue a certificate (commencement of lease, obligation to make lease payments).
- Pay the acquisition cost of the leased equipment.
- Agree to the maintenance contract for the leased equipment.
Diffrences between Finance lease and Rental Transaction
- Select equipment to be leased
When it comes to a rental transaction, a lessee selects a piece of equipment or properties that the lessor originally has owned such as lands, buildings, or goods. On the other hand, a lessor in finance lease purchases the equipment or property designated by the lessee from the supplier designated by the lessee, and then the lessor leases it out to the lessee.
- Transaction between Third Parties
For finance lease, three parties (i.e. a lessee, a lessor and a supplier) have something to do with the finance lease. The sale and purchase contract between the lessor and the supplier is separate from the finance lease contract. However, covenants are interrelated in the finance lease contract and the sale and purchase contract (e.g. covenants for delivery of the leased asset and warranty etc.).
A lessor pays all the cost of the leased equipment or property to the supplier in a lump at the commencement of the lease. The lessor intends to collect all the cost arising from acquiring the equipment or property by receiving lease payments from the lessee. Consequently, the lease contract is not able to be terminated during the lease term. If the contract is prematurely terminated, it is stipulated in the contract that the lessee is to pay all the remaining payments (or the equivalent to the remaining payments) to the lessor in a lump.
The differences between finance lease and rental transaction are listed below.
|Finance Lease||Rental Transaction|
|Equipment to be leased||A lessor newly purchases equipment to be leased from a supplier designated by a lessee. The leased equipment is also designated by the lessee.
Almost all kinds of equipment or software could be leased.
|A lessee selects a good to be leased among the ones a lessor originally owns. Those goods are typically able to be leased out to multiple lessees.
(e.g. construction equipment, measuring instrument, paintings, and foliage plant for corporate use; automobiles, personal computers, CDs, furniture, bedclothes, goods for caring, and travel outfit for private use).
|Contract Term||The lease term is comparatively long. Under the lease taxation, the lease term should be more than 70 of the legal life of the equipment (e.g. personal computers: for two years or more).||When it comes to a rental transaction of land, the term could be pretty long. That of office space or residence is generally for two years. That of equipment is for a comparatively short term. However, the length of the term varies from a daily basis to a yearly basis, depending on the purpose of using the equipment.|
|Lease payments||The amount of lease payments is priced in order for the lessor to collect all the costs arising from acquiring the leased equipment over the lease term, because the lessor newly purchases the equipment to lease out.||A lessor intends to lease out a good to multiple lessees over and over, by which the lessor collects the amount invested in the equipment and the other costs.|
|Delivery of Leased
|A supplier directly delivers the equipment to a lessee, and then the lessee inspects the equipment. Subsequently, the lessee issues to the lessor a certificate for the leased equipment. The delivery from the lessor to lessee is regarded as being completed on the date of the certificate being issued.||A lessor directly delivers to a lessee the equipment to be leased.|
|Termination||A lease contract is not be able to be prematurely terminated. If a lease contract is terminated, the lessee is required to pay to the lessor the remaining lease payments or the equivalent.||A lessee is generally granted a right to terminate the contract.
There are some contracts where the lessee has no right to prematurely terminate the contract (e.g. in long-term rental transactions of land or buildings, the lessee is not able to immediately terminate the contract until a certain period passes. In other cases, the lessee needs to make a notice to terminate the contract in advance.).
|Repair of Equipment||A lessee has an obligation to repair the leased equipment and make a maintenance contract with the supplier.||A lessor has an obligation to repair the leased equipment.|
|Warranty||A lessor does not take any responsibility for the warranty related to the leased equipment. However, a lessee is able to directly make a claim against the supplier of the equipment for defects as long as the lessor lets the lessee to do so.||A lessor takes responsibility for the warranty related to the equipment.|
|Risk of Loss||A lessee is required to incur any costs arising from the leased equipment being damaged.
However, almost all the costs the lessee would have incurred are covered by insurance the lessor buys on the equipment.
|A lessor takes responsibility for the risk of loss related to the leased equipment.
A lessee is able to make a claim that the rent should be reduced or the contract should be terminated if the equipment is damaged.
|Renewal of Contract||When a lease term expires, the lease contract may be renewed. The amount of lease payments over the renewed lease term would be lower than over the initial term.||When a contract term expires, the lessee may continuously use the equipment on the same or new conditions.|
Conditions in Finance Lease Contracts
- Lease Term (Finance lease only)
Under the lease taxation, the lease term should be for more than 70% of the legal useful life. For example, if a lessee leases personal computers, the lease term should be more than 2years
※ Minimal lease term: 4 (Year) × 70% = 2.8 (Year) →2 Year (rounded down)
- Lease payments
Lease payments include the acquisition cost of the equipment, personal property tax, funding cost, insurance, administration cost and the lessor's profit. The amount of monthly lease payment is calculated as follows:
Monthly Lease Payment
＝(acquisition cost of equipment + personal property tax + funding cost + insurance + administration cost + lessor's profit)/lease term (the number of months)
- Delivery/Use of Leased Equipment and Lease Payment
A supplier (seller of the leased equipment) directly delivers it to the lessee. Then the lessee inspects it and issues a "certificate" of the leased equipment if there is no defect on the equipment. The certificate means that delivering the leased equipment from the lessor to lessee is completed. The date of the certificate being issued is usually the commencement date of the lease, from which the lessee is obligated to make lease payments and is allowed to use the leased equipment.
- Points to be Acknowledged during the Lease Term
A lease contract is non-cancelable during the lease term. If the parties mutually agree to terminating that contract, the lessee is to pay to the lessor the remaining lease payments or the equivalent in a lump. The lessee is responsible for repairing the leased equipment and incurs the cost arising from doing so. If the leased equipment has a defect, the lessor cooperates with the lessee when the lessee makes a claim against the supplier for the defect. If the equipment is damaged and both the lessee and the lessor are not responsible for that damage, the lessee incurs any cost arising from that damage. However, the cost the lessee would have incurred is covered by insurance the lessor buys on the equipment. If the lessee breaches the lease contract (e.g. the lessee's failing to make lease payments), the contract would be also terminated (Refer to "Studies & Proposals, Lease Contract".).
- Options at the End of Lease Contract
A lease contract expires when its term does. A lessor informs a lessee of it a few months before the lease term expires. If the lessee intends to continuously use the same equipment, the lessee would renew the lease term (what is called re-lease). Otherwise, the lessee would return the equipment to the lessor (the place designated by the lessor), incurring the cost arising from doing so.