In many markets, leasing has flourished because of its tax appeal: leasing has been organised for high-net worth individuals to shelter against their taxes. That is, a high net worth individual may do one lease transaction, not as his principal business, and shelter his taxes. In many cases, an individual may participate in a lease syndicate organised by a leasing company.

 Restricting leasing to only leasing companies would eliminate any possibility of leasing activities being carried, on a one-off basis, by manufacturing or non-financial companies. This is a common practice in many countries. A non-leasing company, say a hotel, would carry one lease transaction and shelter against its taxes.

 As leasing markets develop, leasing by vendors or manufacturers would become common. That is, the manufacturer of a capital goods will be prepared to provide his own product on lease, instead of selling it directly. Obviously, such manufacturer cannot be treated as a "financial institution."

 Securitisation of lease receivables is a very important development in leasing markets. In strict sense, securitisation means participation in leasing transaction by the participants in the securitised portfolio. A literal ban on "financing of a leasing transaction" would inherently imply a ban on participation in a securitised portfolio as well.

1. Apparent from the definition of sec. 2 (17) is the intent that only corporate bodies should be allowed to engage in leasing business.

2. There are no restrictions in the Act in leasing companies undertaking non-leasing activities. Apparently, leasing companies can engage themselves in other financial businesses, principally hire-purchase. Most leasing companies in Bangladesh currently do not take up hire-purchase or long-term corporate lending activities, though they do have exposures in money markets such as bills discounting, short-term deposits etc.

There is a bar in sec. 15 in leasing companies taking up any non-financial business such as import, export, retail or whole sale business.

Hire-purchase, it may be noted, is clearly covered by sec. 2 (2) (c) of the Act.

3. The Act empowers the Bank to fix minimum capital for leasing companies. Opening of offices and branches is also regulated.

4. Sec. 10 prohibits a financial institution from declaring any dividends without fully writing off all direct and administrative expenses, share issue expenses, brokerage, losses, and other capitalised expenses.

5. Very important restrictions are contained in sec. 14 on exposure by leasing companies. These restrictions are:

6. Companies accepting deposits from individuals shall maintain 10% of their aggregate liabilities invested in prescribed securities.

7. Each company every year shall transfer at least 20% of its divisible profits to a reserve fund, unless the aggregate of its share premium along with such fund is equal to or more than the paid up capital of such company.

There are apparently no rules to distinguish genuine lease transactions from plain financing transactions. This is one of the most important rules to have in a developing market and an important lesson can be learnt in this regard from India.

A lease, in order to qualify for tax deduction, has to be different from a plain financial transaction. Evidently, no depreciation benefit can be claimed in case of a transaction of simple financing of an asset. In addition, one must also appreciate that if an agreement has the colour of a lease transaction but in essence is nothing but a financial transaction, the outer form of the transaction will be ignored, and based on its intrinsic substance, it would be reckoned as a financial transaction.

The meaning of the above is that if a lessor in Bangladesh writes a lease transaction which has the legal form of a lease, but is in substance nothing but a financing transaction on the security of an asset, such lease will not be regarded as a lease but as a secured financing. Obviously, it is not enough to call an agreement a lease agreement: in taxation, nomenclatures are ignored and the reality is looked into.

To guide parties as to what are the important attributes of a lease transaction that would distinguish it from a financial transaction, one would find, in advanced leasing markets, detailed rules or standards that define a true lease. In absence of such guidelines, it is quite common, particularly in nascent stages of development of an industry, for players to make mistakes which turn out to be costly both for the revenue and for the players themselves.

India, like Bangladesh, does not have true lease guidelines. As a result, around 1987-1989, when leasing grew very rapidly in the country, a number of lessors wrote leases for assets that never existed. There was obviously no intent to cheat the revenue, but such practices were founded on a premature belief that all agreements which look like lease agreements will be acceptable for tax purposes.

Even today, inspite of the fact that India today is a mature market compared to many others, a number of Indian lessors make mistakes which would only prove to be fatal over time.

The trouble with a no-rule regime is that it encourages unintentional malpractices. Of course, tax avoidance and evasion can exist even where there are elaborate rules, but the trouble with absence of rules is that it breeds innocent non-compliance.

Bangladesh must notify true lease guidelines, and sooner the better. It must, most importantly, educate tax payers on what is the elementary distinction between a lease and a hire-purchase transaction, since in the latter case, depreciation cannot be claimed by the lessor.

The difference between lease and hire-purchase transactions is a crucial difference for all countries which allow depreciation based on ownership of an asset. It is a basic rule of law that "ownership" for tax purposes is not merely legal ownership - it must be backed by beneficial ownership. Beneficial ownership implies the right to attain benefits of ownership at some point of time. In a hire-purchase transaction, the legal owner (finance company) cannot be treated as beneficial owner, since, having provided the user with a right of purchase, the owner has divested himself of beneficial interest completely.

Currently in Bangladesh many of the lease transactions are in fact hire-purchase transactions, as the sale of the asset to the lessee, even if not incorporated in the contract of lease, is mostly inherent and pre-agreed.

This practice, which in opinion of the author will be a problem over time as the revenue officials get more of education on lease taxation, can be resolved either by proper training or by a proper law.

Tax incentives are surely responsible for the growth of leasing in most markets. In many markets, tax incentives has been a very strong reason for reducing the cost of lease transactions to make it viable for lessors to operate.

On an impassioned study of Bangladesh taxation statutes, one finds there are plenty of incentives that can be claimed by leasing companies in Bangladesh, inspite of major reforms in taxation in 1998-99.

Primarily, the following incentives are provided for in the Income-tax Ordinance in relation to capital assets:

 Depreciation allowance as per Third Schedule, being:

 Investment allowance for assets eligible for accelerated depreciation

 Investment allowance in respect of balancing, modernisation and replacement equipment

Though the practice among companies in Bangladesh presently is to claim only depreciation, there appears to be little reason for not claiming the investment allowance and accelerated depreciation allowance as well, in respect of eligible assets.

If normal depreciation as well as investment allowance/accelerated depreciation are claimed by leasing companies, leasing in Bangladesh is a very profitable proposition and is considerably better than loans or hire-purchase. However, if investment allowance is not claimed or allowed to leasing companies, then leasing will be considerably disadvantageous to hire-purchase in most cases, as may be seen with numerical calculations.

The first condition implies that the asset must have a natural wear and tear. This is clear from sec. 29 (1) (viii) which says: "In respect of depreciation of any building, machinery, plant.....". That is to say, the allowance as provided in the Third Schedule is to be allowed if there is a depreciation, that is, wear and tear in the property. If the asset in question be, for example, land which is not subject to wear and tear, no depreciation will be allowable. On the same logic, intangible assets which are not subject to wear and tear by usage or efflux of time are not depreciable assets.

The second condition of "ownership" implies legal as well as beneficial ownership. No doubt, the lessor is the legal owner of the asset, but if the lessor has divested all his beneficial interest in the asset for all time to come, he may be owning the chaff of legal title, which will not entitle him to claim depreciation.

The other notable issues with regard to ownership are:

The third condition is the condition of use. Both the Act and the Schedule require that the asset must have been used for business purposes. It is also provided in Para 2 (3) (b) of the Schedule. It must be understood that the "use" that qualifies a lessor to depreciation is not the physical use by the lessee, but the use by the lessor in his business of leasing. The lessor makes the use of the asset in the lessor's business of leasing the asset, and that use qualifies the lessor to stake a depreciation claim.

Having understood the condition of use in this light, it becomes clear that:

 The conditions for claiming accelerated depreciation are:

 It must be machinery or plant, not being road transport vehicle or office appliance

 It must not have been previously used in Bangladesh

 It must be used in an industrial undertaking set up in Bangladesh between 1.7.97 and 30.6.2000

 The industrial undertaking must be owned by a Bangladeshi company or state undertaking

 It must belong a class of companies as notified by the Board

 Application in prescribed form must be made within 4 months of commencement of production, with a declaration that the undertaking has not come for tax exemption under sec. 45.

None of these conditions seem to be failing in case of a lease of plant or machinery by a lessor to an eligible industrial undertaking. To understand the point, let us assume the following facts: a lessor leases out a machine to be used in an industrial undertaking set up in Bangladesh by a lessee. Everything else is clearly satisfied, and the only area of doubt can be whether the lessor, who is not the owner of the industrial undertaking, can claim the depreciation.

The answer, in opinion of the author, is YES, both from a technical viewpoint, as also from the point of the view of the intent of providing the incentive measure.

Taking the second viewpoint first, as the intent of the Govt. in providing for accelerated depreciation or investment allowance is to encourage industrialisation in the country, granting such depreciation to a leasing company that finances acquisition of the machine to such an undertaking would advance the cause of the Govt. Denying it would be defeating the purpose of the law, because in case the lessor cannot claim such benefit, nor can the lessee, which means the incentive meant for use by a new industrial undertaking is completely frustrated.

Now, the technical viewpoint. The only requirement in Para 7 or 7A of Third Schedule is that the plant or machine should be used in an eligible industrial undertaking. Where such plant or machine is leased by a lessor, the owner thereof is the lessor, and the user for tax purposes is the lessor, but it no requirement of the law that the owner of the industrial undertaking can only claim the benefit. The equipment is still used in the industrial undertaking, though the lessor is its user.

On analogous provisions, investment allowance in India has been allowed by Indian courts. Though investment allowance has long back been repealed in India, this matter was still pending in courts, and it recently was ruled by the Supreme Court of India that the requirement of the law nowhere postulate that the owner of the plant or machine should be the same person who owns the industrial unit.

In view of the above, it is very logical to permit lessors to claim accelerated depreciation in Bangladesh. In fact, doing so would be an ideal situation since the lessee being a new unit would not possibly be having profits for first few years to absorb the depreciation, and the lessor may make good use of it and pass on the benefits to the lessee in form of lower cost of funding.

Investment allowance is claimed under sections 29 (1) (x) and 29 (1) (xa). The once claimed under sec. 29 (1) (x) is associated with accelerated depreciation: if the equipment is eligible for accelerated depreciation, it is also eligible for investment allowance. As in the opinion of the author above, accelerated depreciation can be claimed by the lessor, investment allowance can also be claimed by the lessor.

The second investment allowance under sec. 29 (1) (xa) is in respect of balancing, modernisation, and replacement equipment (BMRE). The condition is not linked with any eligible industrial undertaking, and simply lays down that if the assessee being a company invests in the purchase of any BMRE, to be installed in an industrial undertaking, a 25% investment allowance shall be allowed.

There should be hardly any difficulty in claiming this investment allowance in case of BMRE let out by the lessor.

These allowances arise on the sale or disposal of a capital asset, and are covered by para 10 of the Third Schedule.

An important provision here is that the "sale proceed" of an asset which is actually sold means the higher of the actual selling price or the fair market value of the asset. "Fair market value", defined in sec. 2 (30) means the price the asset may fetch in open market, or a value to be assessed by the tax authorities.

This provision, in itself, throws a significant limitation to the transfer of leased assets at pre-fixed prices. As was discussed earlier, it is a practice in nascent markets for lessors to agree to a price for transfer of leased assets at the time of entering into the lease. This price, obviously, is not the market price or estimated market price of the asset but a nominal value to complete the transfer of the asset. Let us say, a lorry, given on lease, is transferred at an agreed price of 5% of the cost after 3 years, while the actual market value is 50%. In such a case, the tax office has clear rights under the law to disregard the actual selling price, and to treat the fair market value as the selling price, and tax the lessor to capital gains or balancing charge accordingly.

Obsolescence allowance shall be granted if the sale proceeds are less than the written down value. If the sale proceeds exceed the written down value, there shall be a charge to tax upto the cost of the asset. If the sale proceeds exceed the cost of the asset, this would be taken as a capital gain.