Ch.6-hire Purchase Finance 245a60

HIRE-PURCHASE FINANCE

Hire purchase - Definitions 1. “An agreement under which goods are let on hire and under which the hirer has an option to purchase them in accordance with the of the agreement.” 2. “Hire purchase is a peculiar kind of transaction in which the goods are let on hire with the option to the hirer to purchase them.”

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Hire Purchase Finance Meaning •Payment of Periodic installments. •Immediate possession of goods by the buyer. •Ownership of goods with vendor until full and final payment. •Vendor‟s right to repossess the goods in case of default by buyer. •Treatment of installment as a hire charge till the payment of last installment.

Hire purchase vs. Installment payment • Installment sale is a contract of sale in which the ownership is transferred to the buyer but the price is pad in specified installments over a definite period. • In Hire purchase contract the possession is delivered to the hirer at the time of entering into the contract but the ownership is transferred to the hirer on payment of the last installment. 4

Lease financing Vs Hire purchase Financing Lease Financing • Ownership lies with vendor(lessor)

• Lessor(vendor) is entitled to claim depreciation tax shield

HP Financing • Ownership transferred to the hirer on the payment of last installment. • The hirer is entitled to claim depreciation tax shield 5

Cont…… Lease Financing

HP Financing

• Capitalization of the asset is done in the books of the leasing co.

• Capitalization of the asset is done in the books of the hirer.

• Leasing used as a source of financing for high cost assets like ships, machinery, airplanes etc

• HP use as a source of finance for low cost assets as automobiles, office equipments etc.

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Cont….…. Lease Financing

HP Financing

• No Down payment required for using leased assets.

• Down payment is required to be made for acquiring the asset, and margin of 20-25% maintained.

• In Lessee’s books, leased assets shown as a note only.

• In hirer’s books ,HP assets shown as an asset, and instalments payable as a liability. 7

Process of Hire Purchase • The Dealer contracts with finance co. for financing his hire purchase deals. • The customer selects the goods for HP, and dealer arranges for the complete set of documents. • Down payment by customer on completion of proposal form. • Dealer sends documents to finance co. with request to purchase the goods, and accept the HP transaction. • The finance co. signs the agreement and sends copy along with EMI details to dealer. • Dealer delivers the goods to the customer, property es on to the finance co.. • Hirer pays EMIs, and on last payment , the ownership es on to him, with loan completion certificate by the finance co. 8

LEGAL FRAMEWORK • There is no legislation dealing with hirepurchase transaction in India. • The hire-purchase act was ed in 1972. • The provision of the act are not inconsistent with the general law and can be followed as a guideline particularly where no provision exist in general laws which, in the absence of any specific law, govern the hire-purchase transaction. 9

SALE OF GOODS ACT • In a contract of hire-purchase, the element of sale is inherent as the hirer always has the option to purchase the movable asset by making regular payment of hire charges and the property in the goods es to him on payment of the last installment. • It is in this context, and to that extent, that the provisions of the sales of goods act to hire-purchase contracts. 10

CONTRACT OF SALES OF GOODS • A contract of sales of goods is a contract whereby the seller transfer or agrees to transfer the property in goods to the buyer for a price

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ESSENTIAL INGREDIENTS OF A SALE 1. 2. 3. 4. 5.

Two parties- buyer and seller Goods Money consideration- price Transfer of ownership Essentials of valid contract under ICA

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SALES VS BAILMENT • Bailment involves a mere transfer of possession of goods on the condition that the goods will be returned after the purpose is over • In a sale, there is a conveyance of property in goods from seller to buyer for a price, and the buyer becomes the owner of goods and can deal with them in the manner he likes. 13

DOCUMENT OF TITLE TO GOODS • A DOCUMENT OF TITLE TO GOODS is one which entitles and enables its rightful holder to deal with the goods represented by it, as if he were the owner. • It is used in the ordinary course of business as proof of ownership, possession or control of goods – – – – –

e.g. cash memo, bill of lading, dock warrant, warehouse keeper‟s wharfingers certificate 14

PRICE • The price means the money consideration for transfer of property in goods from the seller to the buyer. • EARNEST MONEY or security deposit: – In certain contract the buyer pays an amount in advance as earnest money deposit or as a security deposit, for the due performance on his part of the contract. – EM is liable to be forfeited if the buyer fails to perform his part and the contract goes off. 15

CONDITIONS AND WARRANTIES • Condition is a stipulation which is essential to the main purpose of the contract. • Warranty is a stipulation which is subsidiary to the main purpose of the contract.

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TRANSFER OF PROPERTY IN GOODS •

The property in goods is said to be transferred from the seller to the buyer when the latter acquires the proprietary rights over the goods and the obligations linked thereto. The transfer of property in goods is the essence of a contract of sale.

• RULES FOR TRANSFER OF PROPERTY – – – – –

Specific goods in deliverable state Specific goods to be put in a deliverable state Specific goods to be weighed or measured Goods sent to the approval unascertain goods 17

DELIVERY OF GOODS • Delivery of goods: „Delivery‟ means „voluntary transfer of possession of goods from one person to another‟. Delivery may be – actual – symbolic – constructive.

• Delivery is said to be actual when the goods are handed over physically. • A symbolic delivery takes place where the goods are bulky and incapable of actual delivery

• A constructive delivery is a delivery by attornment which takes place when the person in possession of the goods acknowledges that he holds the goods on behalf and at the disposal of the other person. 18

RULES OF DELIVERY • PART DELIVERY – A delivery of the part of the goods, in progress of the delivery of the whole, amounts to delivery of the whole.

• BUYER TO APPLY FOR DELIVERY – Unless there is a contract to the contrary, the seller is not bound to deliver the goods until the buyer applies for delivery.

• SELLER‟S DUTY TO DELIVERY – The seller is duty bound to deliver the goods in accordance with the of the contract or as and when applied for by the buyer.

• PLACE OF DELIVERY • TIME OF DELIVERY 19

Hire-purchase Agreement  A hire-purchase agreement is in many ways similar to a lease agreement, in so far as the and conditions are concerned. The important clauses in a hire-purchase agreement are:

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Cont’d 1. Nature of Agreement : Stating the nature, term and commencement of the agreement. 2. Delivery of Equipment : The place and time of delivery and the hirer’s liability to bear delivery charges. 3. Location : The place where the equipment shall be kept during the period of hire. 21

Cont’d 4 .Inspection : That the hirer has examined the equipment and is satisfied with it. 5. Hire-Charges : To be paid by the hirer, the schedule, the rate of interest/penalty for delayed payment/default. 6.Repairs : The hirer to obtain at his cost, insurance on the equipment and to hand over the insurance policies to the owner. 7.Alteration : The hirer not to make any alterations, and so on to the equipment , without prior consent of the owner. 22

Cont’d 8. Termination : The events or acts of hirer that would constitute a default eligible to terminate the agreement. 9. Risk : Of loss and damage to be borne by the hirer. 10. Registration and fees : The hirer to comply with the relevant laws, obtain registration and bear all requisite fees. 23

Taxation Aspects on Hire-Purchase Agreement • Income tax • Sales tax • Interest tax

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INCOME TAX •

Hire-purchase,as a financing alternative, offers tax benefits both to the hirevendor(hire-purchase finance company) and the hire-purchaser ( of the asset). 1) Assessment of Hire-purchaser (hirer) 2) Assessment of Owner (Hire-vendor)

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Tax planning in Hire-purchase •

It can be used as a tax planning device in two ways: 1) Net income can be inflated at the rear end of the transaction and thereby defer tax liability 2) To use hire-purchase as a bridge b/w the lessor and the lessee.

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Sales-Tax Aspects • Hire-purchase is demand to be sale • It‟s payable by the owner even if transaction does not fructify into a sale • No refund of sales tax

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Conti.. • 1) 2) 3) 4)

Delivery v/s Transfer of Property Taxable Event Taxable Quantum States Entitled to Impose Tax Rate of tax

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Interest Rate • Companies have to pay interest-tax under the Interest-tax Act,1974 • Total amount of interest earned- bad debts in the previous year @ 2%

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ing And Reporting

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What entry is made on purchase of an asset on hire purchase ? Asset on hire purchase a/c to hire purchase vendor a/c (with the cash price of assets)

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What entry is made on payment of an asset purchased on hire purchase ? Hire vendor a/c to bank Interest on hire purchase to hire vendor a/c

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What entry is made about depreciation of an asset purchased on hire purchase ?

Depreciation on asset a/c to asset & P & l a/c to depreciation

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What entry is made in the books of vendor on hire purchase sale ? Hire purchaser a/c to hire purchase sale a/c (with the cash price of goods) When Payment is received Bank a /c to hire purchaser a/c FOR INTEREST Hire purchaser To interest on hire purchase sale a/c 34

FINANCIAL EVALUATION The framework of financial evaluation of a hire-purchase both the hirer‟s as well the finance company‟s view point. 35

1. HIRE-PURCHASER (From the Point of View of the Hirer) • The lessor is entitled to claim depreciation and other deductions associated with the ownership of the equipment including interest on the amount borrowed to purchase the asset, while the lessee enjoys full deduction of lease rentals. • The evaluation of hire-purchase transaction from the hirers‟ angle, therefore, has to be done in relation to leasing alternative. 36

Decision-criterion The decision-criterion from the point of view of a hirer is the cost of hirepurchase vis-à-vis the cost of leasing.

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A) Cost of hire-purchase:

Down payment (+) service charges (+) P.v of hire purchase payments discounted by cost of debt (-) P.v of depreciation tax shield discounted by cost of capital (-) P.v of net salvage value discount by cost of capital 38

B) Cost of leasing Lease management fee (+) P.v of lease payments discounted by Kd. (-) P.v of tax shield on lease payments and lease mgmt. fees discounted by Kc. (+) P.v of interest tax shield on hire purchase discounted by Kc.

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2. HIRE-VENDOR (From the View point of Finance Company) • Decision criterion is based on a comparison of the net present values of the two alternative 1)Hire purchase plan 2)Lease financing

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Net present value of hire purchase plan The NPV(HPP) consist of Present value of hire-purchase installment (+):Documentation service fee (+):Present value of tax shield on initial direct cost (-):Loan amount (-):initial cost 41

(-):Present value of interest tax on finance income(interest) (-): Present value of interest tax on finance income(interest) meted for interest tex (-): Present value of interest tax on documentation and service fee

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Net present value of lease plan The NPV(LP) consist of Present value of lease rentals (+):Lease agreement fee (+):Present value of tax shield on intial direct costs and depreciation (+):Present value of net salvage value

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(-):Initial investment (-):Initial direct costs (-):Present value of tax liability on lease rentals and lease management fee

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• THANK YOU.

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