What Is Leasing?
What Is the Definition of Leasing and What Are the Basic Principles?
Leasing has been around for a while, in fact it can be traced back at least 3,000 years to the Babylonian Empire. So you might expect there to be a very clear definition of leasing. Well actually even after all these years, there’s still room for a little healthy debate!
A Brief History of Leasing
What everyone agrees is that leasing is a form of ‘bailment’ in law. Bailment derives from the French verb bailer, to deliver. In law it means there is a temporary transfer of assets such as business equipment or vehicles from one person or business to another. Under a lease contract, the lessor delivers its asset to the lessee. In return, the lessee makes regular lease payments, also called rentals or instalments.
Provided the terms of the agreement are met, the lessee enjoys ‘quiet possession’ of the assets during the agreement. That simply means the lessor can’t stop or change the terms of the agreement, unlike bank overdrafts or some loans. The lessee can be confident that it has the business equipment for however long it has agreed to lease it for.
Accountants agree with the lawyers on this basic point about a temporary transfer. They don’t actually refer to the term ‘bailment’ but instead talk about the ‘right of use’ of an asset. If one person or business provides another with the right to use its asset, this is usually a lease for accounting purposes.
So is any contract of ‘bailment’ in law, or one that provides the ‘right of use’ for accounting purposes, leasing? This is where it might take another few thousand years before everyone is in full agreement!
In day-to-day use, the term ‘leasing’ usually excludes short-term rentals. There’s actually no clear line between the rental and leasing markets, because both are bailments and both offer the right to use assets. In general, agreements of less than a year are considered to be rentals, whilst longer agreements are leases.
What is Leasing in Business Terms?
Traditionally leasing is also seen as a business-to-business product. However, personal leases are becoming more and more popular for cars and mobile phones. In today’s ‘sharing economy’ we are increasingly bailing, or making temporary use of, other peoples’ belongings, whether that’s using Airbnb, Spotify, or a bike-sharing scheme.
So let’s assume the leasing market is primarily about business agreements over one year. Where the real debate starts is around certain types of bailments that happen to be defined in law. These are Hire Purchase and Conditional Sale.
Hire purchase is a bailment where the user has an option to purchase the asset at the end of the agreement. Often, but not necessarily, that option is at a ‘bargain’ price, meaning that it is below the market value of the asset. Conditional sale is a bailment where there is an automatic transfer of ownership of the asset at the end of the agreement, without the need to exercise an option.
What Is a Lease Agreement According to UK Law?
Some say that because hire purchase and conditional sale are defined in law, they can’t also be called leases. Others say that the two products are simply examples of the many different types of lease. It’s a real quandary and explains why the debate at the leasing industry’s annual dinner goes on well into the early hours!
For what it’s worth, accountants are on the side of saying that all bailments are leases, and the UK tax rules follow the accounting.
A further twist is that in the UK’s consumer credit law (that somewhat oddly covers small businesses that aren’t limited companies) there’s an important distinction between ‘hire’ and ‘credit’. A credit agreement includes a purchase option, a hire agreement doesn’t. Congratulations if you have already spotted that hire purchase – despite its name – is actually credit and not hire.
Here at Maxxia, we believe it makes sense to keep things simple and think about all bailments as leases. Whatever the product is called, ask the basic question about what happens at the end of the lease agreement (or ‘minimum lease period’ or ‘minimum term’). For example:
- Will the lease just carry on until it is cancelled or will it automatically stop? If it carries on, will the regular lease payments reduce to a nominal ‘peppercorn’ rate, stay the same, or increase?
- Will there be an option to buy the asset? If so, what will it cost? Are there any additional administration or other fees?
- If there is an automatic transfer of ownership at the end of the lease, is there a larger final payment (‘balloon’) before this will happen?
- If there is no purchase option, or the option is not exercised, what happens then? For example, is the equipment collected by the lessor?
Whatever the leasing products are called, knowing the answers to these questions will help businesses to match the products available in the market to their needs, compare products offered by different leasing companies, and identify how the lease will work for tax and accounting purposes.
What Does Leasing Mean For Our Customers?
For our customers, the definition of leasing doesn’t have to be complex. We keep things simple so that you don’t have to worry about the complexities. Instead, we’ll do the leg work for you – finding the right lease agreement for your needs.