30 3 Reduction of External Funding Needs
cient to justify the lessor’s expenditure, in terms both of capital repayment and of
interest.^27 Financial leasing is thus a transaction in which:
- one party (the lessor, a financial institution),
- on the specifications of another party (the lessee, for example an airline car-
rier), - enters into an agreement (the sales contract) with a third party (the seller, for
example Airbus Industries)
under which the lessor acquires plant, capital goods or other equipment (for ex-
ample, new passenger aeroplanes)
on terms approved by the lessee so far as they concern its interests, and - enters into an agreement (the leasing agreement) with the lessee,
granting to the lessee the right to use the equipment (those aeroplanes)
in return for the payment of rentals calculated so as to take into account in par-
ticular the amortisation of the whole or a substantial part of the cost of the
equipment.^28
Reasons to use financial leasing. The firm can use financial leasing for many rea-
sons. In England, they have been summed up as follows: “First, the company may
not have the funds to purchase a large asset, or, if it does, it may have a more prof-
itable use for the cash. Second, leasing may provide tax advantages where invest-
ment allowances can be secured or where the lessor pays a higher marginal tax
rate than the lessee (less tax would be collectable than would have been the case
with a purchase). Third, leasing allows equipment to be updated flexibly and
transfers the risks associated with technologically-advanced fields to the lessor.
Similarly, where a company is ill-positioned to calculate asset depreciation rates it
can transfer risks to the lessor. Finally, if leased assets can be kept off the balance
sheet (for example, by classification as operating leases) a company can show a
higher return on assets in its accounts than would have been possible had the asset
been purchased.”^29
Financial leasing enables the lessee to protect its liquidity. The firm can try to
match lease payments with income derived from the asset (pay as you earn). At
least in some cases, the firm can deduct lease payments or part of them from its
taxable income.^30 Financial leasing can be balance sheet neutral for the lessee if
the asset is recognised as an asset belonging to the lessor (see section 3.3.2 above).
This can help the firm to signal a better return on capital invested.
(^27) See, for example, McLaney E, Business Finance. Sixth edition. Pearson Education, Har-
low (2003) pp 235–236.
(^28) For a definition, see Article 1 of the Unidroit Convention on International Financial
Leasing.
(^29) Finch V, Corporate Insolvency Law. Perspectives and Principles. Cam U P, Cambridge
(2002) p 112; referring to Samuels JM, Wilkes FM, Brayshaw RE, Management of
Company Finance. Thomson Business Press (1995) pp 586–587.
(^30) For German tax law, see § 39 Abgabenordnung.