Question

A lessor and lessee are most able to maximize their financial communities of interest through a lease contract if the lessor's tax rate is very high and the lessee's very low. Explain how this would be true, and the implications for the type of firms who lease their assets and the type of companies who operate as lessors.

Answer 1

Leasing is the contract where the lessor who is the owner of the asset, grants the right to the lessee to use that particular asset for a particular time period in return for the periodic rental payment.

Lessor transfers the physical possession of asset to the lessee for use but keep on deducting the handsome amount of depreciation every year from the asset value. This reduces the tax liability of the lessor. The lease rental payments generate deductions to the payer.

Hence, leasing is beneficial to both the parties with respect to tax payments.

The firms who lease their assets benefit from the lease payments by giving access to their assets. The assets which are available for leasing are considered to be owned by the firms and not under any loan payments. This gives them benefit of tax shield by depreciation deduction from their assets.

Companies derive the tax benefit by leasing their property. If the asset is expected to become obsolete, then company gets greater tax break from the lease. It has greater benefit for the firms as compared to the companies. The companies which operate as lessor involve in buying of the assets for the basic purpose of leasing which does not give them adequate tax benefit. It increases the pre tax cash outflow as high acquiring costs of the assets are involved.