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LEASING-COURIER (November - December 1999, Issue 6 (6))

Published by the Leasing Development Group of the International Finance Corporation (IFC), a Member of the World Bank Group, with financial support from the British Know-How Fund and the Canadian International Development Agency

C O N T E N T S :November - December 1999, Issue 6 (6)

THEORY AND PRACTICE Siberian Leasing Company Shares Its Experience EXPERT OPINION Some Tips for Calculating Lease Payments SMALL BUSINESS Avana Dry Cleaner, Irkutsk LEASING IN THE REGIONS Kemerovo. Sakhalin LEASING IN RUSSIA Survey of the Russian Leasing Market OUR PROJECT Events in the Group NEWS LEGISLATION Leasing in Ukraine ACCOUNTING Supplier’s Commercial Credit QUESTIONS AND ANSWERS

DEAR LC READERS!HAPPY NEW YEAR!

The International Finance Corporation (IFC) Leasing Development Group.Second row from left to right: Olga Shishlyannikova, attorney, Karim Ahmad, project manager, Gail Bowkett, deputy project manager, Aleksander Belogorodov, driver.First row from left to right: Andrei Pisarenko, training manager, Irina Likhachova, public relations manager, Nina Zhuravlyova, accountant-auditor, Veronika Shtelmakh, economist, Irina Mirolyubova, assistant.

The International Finance Corporation (IFC) Leasing Development Group wishes LC readers a

Happy New Year!

May the next year bring you good fortune and happiness in all your personal

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and professional endeavors.We would like to take this opportunity to thank you for your support and help in our work. We look forward to continuing a fruitful and productive relationship in the new year as well.

See you in the year 2000!

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THEORY AND PRACTICENovember - December 1999, Issue 6 (6)

PARTNERSHIP: THE PATH TO SUCCESS

S.A. Moroz, General Director of Siberian Leasing Company

Sofya Aronovna Moroz, general director of Siberian Leasing Company

Every leasing deal involves several agreements with various partners: equipment suppliers, investors, insurance companies and the lessee himself. It may seem as though each partner has a set of goals, which are not compatible with the other participants’ objectives. In most cases, however, this is simply not true.The equipment supplier who requires 100% pre-payment may seem to be completely independent. But even this is not always so. A supplier wanting to expand its sales volume in a competitive market must consider offering installment plans (credit against goods), trade discounts and other benefits to leasing companies (who are essentially, buyers). Siberian Leasing Company already has already formed such partnerships with its suppliers.Obviously, anyone financing a leasing transaction will be interested in how the leasing company does business and how it selects and checks its clients. After all, no matter what pledges and guarantees are given for the return of the credit, there is no better guarantee

than the successful growth of the borrower’s business.Similarly, there are many factors that unite the interests of the insurance company insuring the leased property with the success of both the lessor and the lessee. The more the insurance company can trust the leasing company to select its lessees carefully, the less it stands to lose by having to satisfy insurance claims.I would even go so far as to say that all of the parties involved in implementing a leasing deal are in the same boat.Since our company attaches a lot of importance to this, we try to develop partnerships with every party involved in a leasing deal. We try to understand their problems and concerns, expecting the same from them, and we try to find the best solutions for everyone concerned.Of course our most important partner is the lessee. When we work out the leasing deal we spend as much time as we need to learn about their business and come up with a lease payment schedule that is most appropriate for our client while still enabling us to pay back the investor on time. It has become a rule for us to meet regularly with the client throughout the term of the contract. At the slightest delay in the lease payments we try to clarify the causes of the problem and help our lessee in any way we can. In some cases, we restructure the payment schedule, giving our clients additional extensions. In others, we help clients to acquire working capital (on the basis of lease buy-back or, more rarely, promissory notes). In certain cases we make a joint decision with a client to sell all or part of the leased equipment and try to sell it together with our clients.Let me give you a few examples of how Siberian Leasing Company works with its lessees. One young entrepreneur had been selling flour from Kazakhstan for several years. He knew the market well, but came to the conclusion that he could provide for himself and his family better if he started up his own small factory. He decided to produce pasta. Our company obtained the needed equipment and leased it to the young entrepreneur for a two-year period. At the beginning of the summer, when raw materials were in shortest supply, our client found he had an opportunity to buy a large

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consignment of flour on very advantageous terms. He asked us if we could help him with working capital. By that time the client had already recommended himself as a competent businessman, having quickly mastered the production and sale of pasta products, and as a completely reliable partner, never allowing himself to be late with his lease payments. So we decided to help him out. We lent him the funds he needed, and he gave us a promissory note. As a result, the lessee got quickly and firmly on his feet and paid off both the lease agreement and the promissory note within just one year, rather than the agreed-upon two years. Now he’s moving ahead, making new plans.Another of our clients had a store which was robbed. Among other things, thieves stole her cash register, which belonged to the leasing company. We collected the insurance from the insurance company and immediately bought our client a new cash register. But a lot of her stock had also been stolen, and she didn’t have the funds to restock her shelves. So we as a leasing company helped her out. We signed a lease buy-back agreement with her, whereby we bought her store and leased it back to her. With the money she received, she was able to buy some goods and reopen her store.As another example, a former miner set up a bread factory, leasing some of the equipment he needed from our company. Everything was going well, our client’s business was growing, and he was making his lease payments on time. But not long before the contract was due to expire, our client had to stop production because of the senseless price policies of the regional government and the sharp increase in the price of flour. Our client turned to us and asked us to restructure the lease payment schedule. We gave him additional extensions, and within two months the problems had been solved. Our client finished paying off the lease agreement and continued making bread of outstanding quality.Another former miner decided to start his own business. He set up a small store, bought some of the equipment he needed with his own money, and leased the rest. But he didn’t have enough working capital left over to get his business off the ground. We traveled to the site, looked over the miner’s store, visited his family and came to the conclusion that we were dealing with serious business people. We bought the miner’s store equipment and immediately drew up a lease buy-back agreement. Now the store’s turnover is increasing and our client is making all of his lease payments on time.One lessee, a private entrepreneur, had a problem with an equipment supplier who wouldn’t fulfill his guarantee to repair or replace some equipment. We helped our client prepare his lawsuit and represented his interests in court.The purpose of our policy is clear: to help lessees get on their feet and get their businesses going, thereby creating reliable sources of income for ourselves. We even tell our clients about the company’s flexible approach when developing new agreements, so that they will inform us immediately if they get into difficult circumstances; that way we can look for possible solutions together.I do not mean to suggest that all of our work is rosy. That would be impossible. In some cases we have been forced to confiscate equipment through the arbitration courts. But if we did not generally take the partnership approach that I’ve described, we would have experienced a lot more conflicts.Our investors, too, can sometimes run into problems. In these cases, once again, we try to find mutually acceptable solutions and not hold strictly to the previously agreed-upon repayment schedule. After all, it is often worth sacrificing something today in order to keep a strategic partner in the future. This is exactly what we did after the August 1998 Crisis, when the insurance company that was financing our operations ran into some serious difficulties. We were working almost exclusively to return the insurance company’s investment, which meant cutting back drastically on expenses, including salaries. As a result, we made it through together, we survived the crisis, and now we’re expanding our business again. Moreover, the number of Kuzbass based insurance companies that finance our business countries to increase.Thus, Siberian Leasing Company’s three years of experience prove without a doubt the justness of this article’s title: truly, partnership is a key to success in this complicated business.

Analysis of Siberian Leasing Company’s Lease Payments

For All Contracts



1997 1998 1999(first half-year) TOTAL

Number of Contracts 36 45 50 131

Cost of Purchased Equipment 1,134,328 997,774 1,727,930 3,860,032

Lease Payments Charged 1,801,392 1,703,597 2,629,696 6,134,685

For Completed Contracts



Cost of Purchased Equipment 784,393 429,797 151,868 1,366,058

Lease Payments-charged-received

991,440957,645

484,359415,951

90,34590,345

1,566,1441,469,869

For Current Contracts



Cost of Purchased Equipment 349,935 567,977 1,576,062 2,493,974

Lease Payments-total under contracts-received

809,952412,444

1,219,238575,592

2,539,351395,807

4,568,5411,383,843



Equipment Leased by Siberian Leasing Company

You can learn about the details of Siberian Leasing Company’s business in the “Leasing in the Regions” section on page Leasing in the Regions


DEVELOPMENT GROUP







EXPERT OPINIONNovember - December 1999, Issue 6 (6)

In the «Expert Opinion» section we publish materials sent to the editorial board by participants in the leasing sector. The purpose of this section is to show the diversity of existing opinions. The opinions of the authors published in this section do not necessarily represent the official opinions of the International Finance Corporation. IFC does not guarantee the accuracy or reliability of the information presented in these articles or bear any responsibility for the consequences of its use.

SOME GUIDELINES FOR CALCULATING LEASE PAYMENTS

Leonid Prilutsky

General Director of INFONALADKA, Doctor of Economicsn

The purpose of this article is to explain methods of calculating lease payments based on the theory of time value of money. I believe this will be useful not only from a theoretical point of view, but also from a practical one, since it will provide new formulas for calculating lease payments depending on the specific characteristics of any given leasing operations.Many standard software programs currently include formulas for debt settlement by equal payments. The Excel program in Microsoft Office, for example, has the “PPLAT” function for this purpose. When using this formula, users do not even stop to think which algorithm it contains or why it yields certain results. If a non-standard situation arises, they are unable to alter the function, because they do not know which formula it uses.But first we would like to focus briefly on the traditional methodology, one modification of which is the “Methodological Recommendations for Calculating Lease Payments”, ratified by the RF Ministry of the Economy on 19 April 1996. This will enable us to compare the results of lease payment calculations based on different methods. LEASE PAYMENT CALCULATIONS BASED ON CONSISTENT DEFINITIONS OF COMPENSATION FOR THE VALUE OF PROPERTY AND LEASING COMMISSIONS According to this method, the size of the lease payment is defined as the sum of compensation for the value of the property (in the simplest form of depreciation) and the interest on unpaid property value .Mathematically, the iterative procedure for calculating lease payments can be expressed in the following formulas. For the sake of convenience we shall assume that compensation for the value of the property is constant for all periods and that the value of the property is compensated in full over the term of the contract. In this case the lease payments can be determined with this formula:










where: Ri = lease payment for period i;

Ai = leasing commission for period i;

Bi = compensation for value of property for period i;

N = number of lease payments

Where: Ui = residual value of property for period i;

= lessor’s leasing commission in increments.Given the above assumptions, the amount of compensation (Bi) for the value of the property can be found by dividing

the total value of the property (C) by the number of lease payments (N):

The residual value for the following period can be found using the formula:

Let’s take a look at how this method is used in the following example. Example 1. A lease agreement has been signed. The period of the agreement equals the duration of the property’s service, which is 5 years. Over the period of the agreement, the value of the property (1,200 units) is compensated by the full amount of depreciation calculated on straight-line basis.When defining the lease payments and determining their value, one must remember that lease payments are made twice a year, and the lessor’s rate of commission is 0.2. From this it follows that the lessor’s margin for each period will be

while the number of lease payment . The results of this calculation are shown

in Table 1.

Table 1

Payment Number

Residual Value of Property (Ui)

Compensation for Value of Property (Bi)

Commission (Ai)

Lease Payments (Ri)

1 2 3 4 5

1 1200 120 120 240

2 1080 120 108 228

3 960 120 96 216



4 840 120 84 204

5 720 120 72 192

6 600 120 60 180

7 480 120 48 168

8 360 120 36 156

9 240 120 24 144

10 120 120 12 132

Total 0 1200 660 1860

It is important to note that the amount of compensation for property value given as part of the lease payment need not be constant or equal to the amount of depreciation. The constancy of Bi is assumed arbitrarily.

The method is simple and perfectly clear to the lessee. One of its main disadvantages, however, is that it does not take into account the current cost of payments (money).Now we shall look more closely at another method for calculating lease payments that can be used for payment transactions and is free from the above-mentioned disadvantage. LEASE PAYMENT CALCULATIONS BASED ON THE THEORY OF TIME VALUE OF MONEY This method for calculating lease payments is based on the theory of rents and consists in parity between the current (running) value of lease payment flow and the value of the property with all additional expenditures for its acquisition.Under the terms of payment, a single lease-payment value is defined and subsequently split into interest payments and the amount of compensation for the value of the property.Lease payments can be calculated using the following formula:

Where: C = property value including all additional expenditures;

= lessor’s leasing commission in incrementsN = number of lease payments

= installment (repayment) coefficient

This formula is based on lease payments made at the end of the period and full depreciation of the property over the term of the lease agreement.Now let’s consider this formula in more details. Formulation of the problem. The current value of lease payment flow equals the value of the leased property. Cash flow consists of N equal



payments, made at regular intervals at the end of each period. equals the leasing percentage rate. Find the value of one lease payment.Let’s portray the lease payments (R) on a timeline

and define the current value of each payment at the initial (zero) moment in time.

The current value of the first lease payment equals: ,

The current value of the second lease payment equals: ,

The current value of the Nth lease payment equals: .

Thus the total value of all lease payments starting from the initial period equals

The left half of the equation is a geometric progression with the first term and denominator

.

The formula for determining the sum of a geometric progression consisting of N terms looks like this:

By substituting the values , and making some simple arithmetical changes,

we obtain the very formula for calculating lease payments (4) that was given above.



In Equation 4 for calculating lease payments made at the end of the period with full compensation for the value of the property, the main burden is borne by the so-called installment (repayment) coefficient, which is defined by the following formula:

The installment coefficient indicates the proportion of the property value paid in each period. Its values have been tabulated and can be found in any book on financial analysis. Sometimes a reduction coefficient, the inverse value of the installment coefficient, is used in the calculations:

Actual calculations generally include the numbers for annual percentage P, number of lease payments per year M, and the agreement period T.In light of these notes, the installment coefficient takes the following form:

Formula 10 clearly shows that the installment coefficient depends on the number of lease payments and the percentage rate. The installment coefficient decreases with an increase in the number of payments at any percentage rate.After the lease payment is determined, it is split into the amount of the commission and the sum of the compensation for the value of the property. First the lessor’s commission is defined as the product of the unpaid property value times the lessor’s rate of commission, and then the value of the property compensated in the given period is found by subtracting the commission from the lease payment.Mathematically, this procedure can be described using the following formulas:

The residual value of the property for the next step can be found by subtracting the amount of the property value paid at a given moment from the unpaid value of the property.

Example 2. Let’s see what we come up with for lease payments if we use the same data as we did in example 1. Remember that C = 1200; P=0.2; M=2; N=10; = 0.1The lease payments equal:



The rest of the results of the calculation are shown in Table 2.

Table 2

Payment Number



Commission (Ai)

Lease Payments (R)

1 2 3 4 5

1 1200 75.29447390 120 195.2944739

2 1124.705526 82.82392124 112.4705526 195.2944739

3 1041.881605 91.10631337 104.1881605 195.2944739

4 950.7752915 100.21694470 95.07752915 195.2944739

5 850.5583468 110.23863290 85.05583468 195.2944739

6 740.3197076 121.262.50310 74.03197076 195.2944739

7 619.0572045 133.33875340 61.90572045 195.2944739

8 485.6684511 146.72762870 48.56684511 195.2944739

9 338.9408224 161.40039160 33.89408224 195.2944739

10 177.5404308 177.54043080 17.75404308 195.2944739

Total 0 1200 752.9447386 1952.9447386

The total for the lease payments equals 1953.9447386 units, which comprises 1200 units in compensation for the value of the property and 752.9447386 units in lessor commission.Comparing the results of the two methods, using the same original data, we find that the total lease payment value obtained with the second formula is 92 units higher. We should have expected this, since the second method takes into account the current value of money. Correcting for Advance Payments In cases where the agreement stipulates advance payment in the amount of Ca, it is essential to adjust the total property value according to following formula:



and to substitute the new value for in Equation 4 for calculating lease payments.Thus, if the lessor pays an advance and starts making lease payments from the first period, then the advance payment must be deducted from the value of the property in Equation 4, i.e. the value must be corrected according to Equation 14We made our conclusion in Equation 4 on the assumption that the value of the property was fully compensated over the period of the agreement and that payments were made at the end of each period. Correcting for Residual Value Let’s see how our formulas change if residual value Co is introduced in the course of the agreement.Since we are operating on a value that takes the initial period as its starting point, the current residual value after N periods will be lower than the actual Co multiplied by a discount factor of Vn at a rate of In mathematical terms it

looks like this:

In light of this, the property value that must be returned over the term of the contract is not (C-Co), but rather

The second term in Equation 16 is the current residual value of the property after N payments.Thus the equation for calculating lease payments looks like this:

Example 3. Let’s consider the results calculated with this formula if the lease agreement is signed for a 4-year term, the residual value is 240 units, and all other parameters are the same as in Example 1:C=1200; Co=240; P=0.2; M=2; T=4; =0.1; N=8;Vn=0.1Using Equation 17, we get the following value for the lease payment:

The results of the calculations for commission, compensation for property value at each stage and total value of the lease agreement are shown in Table 3

Table 3



Payment Number



Commission (Ai)

Lease Payments (R)

1 2 3 4 5

1 1200 83.94625687 120 203.9462569

2 1116.053743 92.34088256 111.6053743 203.9462569

3 1023.712861 101.5749708 102.3712861 203.9462569

4 922.1378898 111.7324679 92.21378898 203.9462569

5 810.4054219 122.9057147 81.04054219 203.9462569

6 687.4997072 135.1962862 68.74997072 203.9462569

7 552.3034210 148.7159148 55.23034210 203.9462569

8 403.5875062 163.5875062 40.35875062 203.9462569

Total 0 1200 75.29447386 1631.570055

As you can see from Table 3, the residual value of the property is 240 units, i.e. the balance tallies. It should be noted that the balance tallies if the discounting percentage on the residual value of the property Co equals the lessor’s rate of commission, i.e. . Lease Payments Made in the Beginning of Each Period So far we have only consider cases where lease payments are made at the end of each period. Let’s see what changes occur if payments are made at the beginning of each period.From an economic perspective, the lease payments should decrease, since the debt is settled sooner. Let’s see what results the mathematical computations yield. Let’s look once again at the timeline and start all payments from the initial period.

The current value of the first payment equals R;

The current value of the second payment equals

..................................................................................................



The current value of the Nth payment equals

Thus the total value of all lease payments taking the initial period as their starting point equals:

Clearly the brackets contain the same value as we obtained for lease payments made at the end of each period. Thus the

lease payment made at the beginning of each period differs from that made at the end of each period by: ,

while the equation takes the following form:

The split in the lease payment between commission and compensation for the value of property can be described using the following formulas:

Example 4. Let’s consider what values we obtain for the lease payments if we use the data from Example 2 and assume that payments are made at the beginning of each period. Remember that C=1200; P=0.2; M=2; N=10; =0.1.According to Equation 19, the lease payments come to:

The results of the calculation confirm our hypothesis, that lease payments made at the beginning of each period are lower than those made at the end of each period.The results of the calculations for commission, compensation for property value at each stage, and the total value of the



lease agreement are shown in Table 4.

Table 4

Payment Number



Commission (Ai)

Lease Payments (R)

1 2 3 4 5

1 1200 177.5404308 0 177.5404308

2 1022.459569 75.29447386 102.2459569 177.5404308

3 947.1650954 82.82392124 94.71650954 177.5404308

4 864.3411741 91.10631337 86.43411741 177.5404308

5 773.2348607 100.2169447 77.32348607 177.5404308

6 673.017916 110.2386392 67.3017916 177.5404308

7 562.7792769 121.2625031 56.27792769 177.5404308

8 441.5167738 133.3887534 44.15167738 177.5404308

9 308.1280204 146.7276287 30.81280204 177.5404308

10 161.4003916 161.4003916 16.14003916 177.5404308

Total 0 1200 575.4043078 1775.404308

The results shown in Table 4 demonstrate that the total value of the lease agreement is lower when lease payments are made at the beginning of the period than when they are made at the end of the period. Thus, if the lessee wishes to reduce the total value of the lease agreement, he must settle his debt as quickly as possible. For example, he must make his lease payments at the beginning of the period.If we analyze all of the calculations for the given method, we can clearly see that the commission decreases from one period to the next, while the compensation of value increases.By using thoroughly considered methods one can find equations for calculating lease payments under any circumstances. In particular, you will find below an equation for calculating lease payments when the agreement stipulates an advance payment by the lessee at the beginning of the period, equal to X regular payments R, while the remaining payments are to be made starting from the beginning of the second period.



In order to reinforce your understanding of this material, we suggest you use this formula to create your own table showing the distribution of the lease payment into lessor commission and compensation for the value of the property.

Here and henceforth “property value” means all expenditures borne by the lessor when purchasing and delivering the property to the lessee, including all additional expenses. In the terminology of the Law “On Leasing” this is analo-gous to investment expenditures.


DEVELOPMENT GROUP







SMALL BUSINESSNovember - December 1999, Issue 6 (6)

AVANA DRY CLEANER, IRKUTSK Leasing at the Service of Small Businesses

Andrei Pisarenko Training Manager

IFC Leasing Development Group

Olga Viktorovna Initseevsky, general di rector of Avana.

Avana, a small dry-cleaning company, has already been doing business in the city of Irkutsk for about five years. It started out selling clothing from Germany. Over the years it established very close contacts with German coat manufacturers. As Avana began to satisfy the market for quality clothing, a demand for dry-cleaning services arose. At that time there was not a single enterprise in the city capable of providing quality dry-cleaning services. That was when Avana’s managers decided to diversify their business to include dry cleaning. First, however, they had to acquire the necessary equipment. Avana’s specialists conducted market research among German and Italian dry-cleaning equipment suppliers. As soon as they found the equipment, the company began to consider different means of acquiring it. At that time, point in the company could not afford to use its working capital for the purchase of equipment. The time required to recover one’s investment is quite long, as it takes at least three months after the time of payment until the equipment becomes operational.When the company began to consider plans for offering dry-cleaning services, many people doubted that such a project would work. “Everybody took a skeptical view, since

they knew of the poor quality of the old dry cleaners,” says Eduard Initseevsky, one of the directors and founders of Avana. When you took your pants to the cleaner, you got them back with even more stains. So very few used dry cleaners. And all the cleaners suffered losses. Nobody could understand what we were counting on or where our profit would come from.” The leasing company Irkutsk Business Park, however, understood the project and dealt with it in a businesslike manner. After carefully reviewing Avana’s business plan, Irkutsk Business Park decided to sign a lease agreement with the company for the dry-cleaning equipment it required. The agreement was signed for a one-year period, and the equipment was valued at around US$100,000.The dry cleaner was started up in September 1997. Avana’s calculations










were correct: the business developed successfully and earned a profit. The company made its lease payments on time and in full. If there were any delays, they only lasted a few days. Dry cleaning is now the company’s primary business. Since experience has demonstrated the promising nature of the business, Avana has decided to expand its services. Recently it acquired another dry cleaner and a laundromat 300 sq. meters in size, which will both be opened as soon as they are modernized and fully equipped. The company has already begun hiring new staff. Avana’s managers are also planning to purchase some rug-cleaning equipment. This year, as winter approached, there was a noticeable demand for coat-cleaning services. This is clearly due to the fact that buying a new coat is very expensive, while having an old one cleaned is quite affordable. To clean a sheep skin coat, for example, costs between 325 and 450 rubles, depending on the length. This includes toning and oil. The demand has been so great that the store works 24 hours a day, 7 days a week, its machines running practically all the time.

The example of Avana clearly demonstrates the advantages of leasing for small business. Essentially, the company earned money through leasing equipment. Now Avana has the opportunity to invest that money in its further growth. “People have some very beautiful and promising ideas that could become quite profitable, but they often lack the start-up capital to put those ideas into practice,” notes Mr. Initseevsky. “In that kind of situation, leasing companies can be a great help.”


DEVELOPMENT GROUP






LEASING IN THE REGIONSNovember - December 1999, Issue 6 (6)

● SIBERIAN LEASING COMPANY ● SAKHALIN LEASING COMPANY

SIBERIAN LEASING COMPANY, KEMEROVO

Interview with the director of Siberian Leasing Company, Sofya Aronovna Moroz

Interview by Irina Likhachova

Sofya Aronovna, please tell us how Siberian Leasing Company was founded.Six years ago a group of my schoolmates from Novosibirsk State University started a company called the Siberian Insurance Company. In the fall of 1996 we decided to create the Siberian Leasing Company. Its goal was to invest the insurance company’s funds -- so-called insurance reserves -- effectively. We believed that leasing was the most effective mechanism and the most protected form of investing borrowed funds. Besides the Siberian Leasing Company’s own funds, have any other sources been used to finance leasing transactions?The Siberian Leasing Company is a private company. This affects how we go about looking for financing. We don’t have a big credit line or state funding like other companies affiliated with banks or large government agencies. We get only private investment. At first we worked exclusively with the Siberian Insurance Company’s insurance reserves, but within six months after we opened the leasing company -- by which time we had worked out all the leasing technology and acquired some experience working with clients -- the insurance company’s funds were no longer sufficient. Now we work with the funds of other Kuzbass based insurance companies as well. Furthermore, the fairly large volume of assets that we have acquired allows us to work with banks as well. The first bank with which we signed a credit agreement was Sberbank. That agreement was signed as part of a mini loan program of the European Bank for Reconstruction and Development. The first loan was quite small: 100,000 rubles. This is an insignificant amount, of course, but our goal was to establish a positive credit history. We accomplished that, and now the banks give our company significantly larger loans. I have to say that it was very difficult for us to find sources of financing for leasing transactions immediately following the August 1998 Crisis. But now, as financial markets are coming back to life, the lenders, banks and insurance companies are actually coming to us themselves. We have managed to give Siberian Leasing Company a reputation as a reliable partner, and one that multiplies investments. The Siberian Leasing Company must have very strict criteria for selecting clients in order to minimize the commercial risks. How else could you earn the trust of lenders in such a short time?In the beginning, Siberian Leasing Company was financed on loans from private individuals. We felt an enormous responsibility to return those funds. Minimizing risks was one of our main goals during our early days. We accomplished this not only by selecting our clients carefully and using other widespread strategies for reducing risk: we also decided to diversify risk by specializing in small and medium-sized projects.










Today, 80% of our clients are small businesses. These are people who have nothing to offer in the way of additional guarantees on the lease agreements, except for the leased equipment itself. This is why during the client selection process we pay close attention to the lessee’s own personality, his ability to work and his business approach, as well as the liquidity of the leased equipment. The vast majority of our projects are signed without additional guarantees. The leased equipment itself serves as the guarantee. That’s why it’s important for us to insure the equipment with a reliable insurance company. Do you require a minimum amount for transactions?No, there’s no minimum. Our company has clients who need only a cash register worth 2-4 thousand rubles. Others need scales, for example. Even for deals like these we sign lease agreements. How many contracts has your company signed since it was founded?We have already signed about 200 contracts. In the second quarter of this year alone we signed 50 new ones. The average term of our contracts is one year, but we’ve signed some for 1 ½ to 2 years. We offer a wide range of equipment. We’ve leased refrigerating equipment, mini printing presses, beauty salon equipment, and production equipment for mayonnaise, pelmeni (dumplings), pies, pasta, etc. Now we’re considering a deal for textile equipment. What would you consider a large deal? That is, what’s the biggest contract your company would be willing to sign right now?The biggest one we’ve signed so far was for 300,000 rubles. At the time the contract was signed, that translated into $5,000. At the moment we’re considering projects worth $25,000 and $30,000. Going back to our conversation about the company’s credit history, do you often have problems with lessees failing to make their lease payments, and if so, how do you handle it?Even though we’re very careful about selecting our clients, we do still have problems sometimes with receiving lease payments. If a lessee runs into some temporary difficulties, Siberian Leasing Company always tries to meet them half way. We are willing to restructure the payment schedule and wait until the lessee can pay his arrears. But there are some hopeless contracts where the lessee doesn’t make his payment, even with deferments. These contracts make up about 2-3% of our portfolio. In effect this means we’ve seen default on two contracts. But in one of these cases we managed to get back part of the equipment. In the other we haven’t managed to get anything back yet, but we are still working on it. But since the volume of our transactions is constantly growing, the percentage we lose through default is constantly decreasing. We hope that trend will continue. In which regions does Siberian Leasing Company do business?The company operates throughout the Kuzbass region. A few months ago we also opened a subsidiary in Omsk. We also have a representative office in Novosibirsk. Does your company work closely with any large equipment manufacturers in the Kuzbass?There aren’t any large equipment manufacturers in the Kuzbass, but there are some equipment dealers. After doing business in this market for several years, our company has developed partnerships with many equipment suppliers. We try to keep working with the same suppliers in order to get discounts and open lines of credit with them. Are suppliers willing to share the commercial risks with Siberian Leasing Company?One manufacturer and supplier of computer equipment signed an agreement with us guaranteeing resale of the equipment. That is, if we decide for some reason to repossess our equipment from the lessee, the supplier is obliged to help us sell it on the secondary market. This is very important for the leasing company since, according to the law, equipment cannot be leased more than once. Are suppliers willing to share risks in any other ways?



Yes, sometimes suppliers themselves guarantee the lessee. One supplier, for example, regularly brings clients to us. These are generally regular customers that the supplier knows well and trusts, but who don’t have enough resources at that given moment to purchase new equipment, while the supplier, for his part, is not able or willing to offer him any installment plans. In such cases we lease the equipment to the client, while the supplier provides us with a guarantee. Then there are some suppliers who take certain risks not so much in relation to the lessee, as in relation to us. If, for example, Siberian Leasing Company promises to pay a supplier for a piece of equipment in three days’ time, the supplier meets us half way and delivers the equipment immediately, without waiting for full payment. Basically, this is something like credit against goods. One supplier gave us credit against goods for a whole month. This kind of trust with our suppliers developed over the course of several years, and now both sides can fully rely on each other and take advantage of the benefits of our partnership. Do you sign other kinds of agreements besides financial leasing?Yes. Lease buy-back is also popular among our clients. When clients come to us for the first time they often have no idea what lease buy-back is. When the leasing company discusses the details of the client’s business plan with him, the question eventually arises as to whether they have enough working capital to buy raw materials, etc. If the client doesn’t have enough working capital, then in addition to signing a lease agreement with him we also sign a lease buy-back agreement for the equipment he already owns. That way the client gets the equipment he needs through leasing, and he gets the working capital he needs through lease buy-back. What hinders the more active development of leasing in Russia in general and in the regions where Siberian Leasing Company does business in particular?The development of leasing is impeded most of all by the underdeveloped legal base and the twisted tax code, which is fair enough to lessees (it allows them to include lease payments in the cost of production) but simply brutal towards leasing companies. I’m thinking of two kinds of tax in particular. The first is the so-called turnover tax, which, for leasing companies, are calculated on the basis of total lease payments, not on the basis of price difference, as is the case for trading enterprises. This significantly raises the cost of our services, which is undoubtedly bad for the lessee. The second kind of tax is value-added tax. If a leasing company is growing -- that is, if it is constantly acquiring more equipment -- then the VAT it pays on newly acquired equipment is always significantly higher than the VAT it receives as part of the lease payments. According to the law, this difference must either be reimbursed as a tax refund or counted as tax paid for the following period. But in practice the tax agencies never refund taxes. So the way it works out is that from quarter to quarter, and year to year, we finance the state budget interest-free. That is to say that the company is constantly overcharged on VAT. This drains funds that might otherwise be effectively invested in leasing operations. We are hoping that these problems will be resolved. Thank you for granting us this interview. We wish Siberian Leasing Company success.

Contact tel.: (3842) 36-2871

SAKHALIN LEASING COMPANY:

A UNIQUE APPROACH TO THE LEASING BUSINESS WITH REGIONAL CONDITIONS IN MIND

Irina Likhachova

Sakhalin Leasing Company, a closed joint-stock company, was founded in 1996 by five local enterprises. Intertrust Closed Joint-Stock Company owns the controlling block of shares. The company received its leasing license in the spring of 1997. It specializes exclusively in financial leasing. In 1998 the company received 16 applications, all of



Aleksei Malashich, general director of Sakhalin Leasing Company

which were financed. The company currently has 82 leasing contracts worth more than $8 million. It operates in Sakhalin Oblast and the Khabarovsk Krai.Every region of Russia has its own specific characteristics, which to a large extent determine the forms of its economic development. Sakhalin, of course, suffers from problems that are common throughout Russia: a high demand for equipment, a lack of capital, difficulties in attracting investment, etc. But the situation is further complicated by Sakhalin’s remote location and the seasonality of virtually all of its industries, whether fishing or coal mining or timber. This significantly increases the commercial risks, since local business managers tend to plan for quick seasonal earnings rather than long-term gains. It was under these conditions that Sakhalin Leasing Company started doing business. The company has managed to adapt its leasing strategies very successfully to the region’s external conditions and consequently to develop its own approach to doing business.That approach consists the following. From the very beginning, Sakhalin Leasing

Company decided not to advertise its services, but rather to search independently for projects that were likely to attract investment. In other words, the company researches the Sakhalin market and finds companies with which it could theoretically do business, then gathers as much financial data as possible about potential clients. On the basis of that data, it advises potential clients to consider the option of leasing. If negotiations reveal that a potential those client has radically different ways of doing business or has given false information, then the leasing company refuses to do business with that company.The leasing company adopted this approach to finding projects because, first of all, it wanted to eliminate the risk of doing business with unfamiliar clients; second, it did not have enough funds in the beginning to finance a large number of leasing contracts. “Since we didn’t have any credit lines when we founded the company, we didn’t even know at first where we could get the credit to finance our projects. We adopted very conservative policies so as not to be seen as denying credit to our clients,” notes Aleksei Malashich, general director of Sakhalin Leasing Company.After taking on a new project, Sakhalin Leasing Company tries to find sources of funding for contracts not only through banks and other credit organizations, but also (preferably) through companies that either directly or indirectly have a vested interest in the development of the project. This approach has already demonstrated its effectiveness in practice. In addition to allowing the company to significantly expand its leasing finance base, this approach helps the company avoid problems over the course of the project. “Of course we can’t foresee everything and avoid all problems. But since all of our investments are connected -- i.e., investors know exactly what they’re investing in a project, and in a specific company -- investors are willing to be patient when external factors prevent the lessee from making lease payments. We pretty much never have to impose any penalties or fines, since investors don’t demand it,” says Aleksei Malashich.

The banks focus on short-term investment and profits, and not on developing their client’s business; while we, in order to make the leasing mechanism work, have a

The August 1998 Crisis disrupted some of the company’s operations. But since their approach to selecting clients generally enables them to foresee potential problems before entering into a leasing agreement, Sakhalin Leasing Company managed to emerge from the crisis without major losses. One example of the company’s adaptation to post-crisis conditions is the leasing agreement it signed with a young printing company. This agreement was financed with loans from Inkom-Bank. After the crisis, Inkom-Bank started making tough demands of the leasing company to pay back the loans. Sakhalin Leasing Company was faced with a choice: either to pass these demands on to the lessee, knowing full well that the latter, being in a tight situation like everyone else, would not be able to meet the demands; or else to find another investor. Sakhalin Leasing Company chose the second option. Having analyzed the situation, Sakhalin Leasing Company made a proposal to other organizations that had lost money at Inkom-Bank to finance a leasing project for printing equipment. These companies, realizing that they stood to lose all of their money at Inkom-Bank, agreed to invest in the leasing project and used the remaining funds in their accounts to cover Sakhalin Leasing Company’s debt to the bank. These days the printing company is making all of its lease payments, and everyone involved in the project is satisfied.Yet another example of how Sakhalin Leasing Company’s nonstandard approach helped it find a way out of a difficult situation is the deal it made with a dairy plant to supply a Tetra Pack Hoyer



vested interest in seeing the client’s business continue no matter what. And when difficult situations arise, the company looks for solutions together with the client. This enables us (though not always) to solve problems at the local level.”

Aleksei Malash

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(Italy) ice cream production line and packaging equipment worth over $700,000. One day the lessee stopped making his payments, not because the production was going badly but, on the contrary, because the company was starting to make a profit and, unable to resist the temptation of money, decided not to pay its debts.The leasing company was once again faced with a choice: either to sue the lessee (at that time the banks refused to deduct arrears from the company’s account without its permission), or to find other means of persuasion. They immediately decided not to take the matter to court. “Considering that our lessee is, after all, a production company on Sakhalin and there aren’t so many of them, and that it’s the only large dairy factory, while we are a newly developing company, it might have damaged our reputation if we had used harsh methods to pressure them,” explains Aleksei Malashich. But when the deal was under discussion, the local government took an interest in it, as part of its program for the support of local producers, and decided to provide guarantees to the deal. The leasing company made use of this, and now the government acts as an investor in the project. Thus it became the government’s problem how to settle the debt -- through the courts or by trying to come to an understanding with the debtor company. In the end the problem was resolved, so that the government is now offering financing to Sakhalin Leasing Company for yet another, still larger project to lease equipment to the dairy plant.An important element of Sakhalin Leasing Company’s approach to evaluating each individual deal is evaluating the company’s own position in relation to the planned project. More specifically, whether the company will be able to support the client with its own funds if temporary problems arise. In the words of the general director, “The company’s policies differ somewhat from the policies of local banks. The banks focus on short-term investment and profits, and not on developing their client’s business; while we, in order to make the leasing scheme work, have a vested interest in seeing the client’s business grow no matter what. And when difficult situations arise, the company looks for solutions together with the client. This enables us (though not always) to solve problems at the local level.”In the two and a half years since it was created, Sakhalin Leasing Company has gained experience in

leasing transactions ranging from very small contracts, such as a photocopier, to large contracts worth up to $4.5m. The range of equipment the company leases is very broad: technical equipment in the food industry, automobiles, real estate, road-building equipment, office equipment, printing equipment, and drilling equipment for developing the Sakhalin oil shelf.It has turned out that due to its remote location, Sakhalin has stimulated more interest among Western investors than among Russian ones. When working with foreign partners, Sakhalin Leasing Company uses foreign loans and cross-border leasing schemes. The company has signed cross-border lease agreements for a fishing boat and some drilling equipment. These schemes are currently the most attractive, since more and more Russian companies are competing for contracts to develop the Sakhalin oil shelf. But in order to do this they first of all need the technology. So the most efficient option is to lease Western equipment with the participation of Western investors. Since Federal Law #64 of 3/31/99 “On the Introduction of Amendments and Additions to Various Legislative Acts of the Russian Federation Regarding Taxation” went into effect, the regulations for calculating taxes, the payment schedule for profit tax, and tax bookkeeping have all changed for foreign legal persons doing business in the Russian Federation. Leasing is becoming the most attractive form of foreign investment with the most favorable tax regime. Sakhalin Leasing Company considers this a promising trend in light of its active work on developing the shelf.It is note worthy to examine the mechanisms of Sakhalin Leasing Company’s cross-border leasing transactions. Since Sakhalin Leasing Company is a resident of the Russian Federation and it leases equipment to Russian lessees, these transactions are effectively subleases, not cross-border leases. It is equipment suppliers who are the investors in these projects, so this is essentially a case of commercial credit given by the supplier. The supplier retains property rights to the equipment and leases it to Sakhalin Leasing Company under a cross-border leasing agreement on condition of payment by installment with interest, and the leasing company then subleases the equipment to Russian lessees, who are informed of the terms of the agreement. This sort of plan allows the parties to do business in compliance with Russian legislation and tax regulations. This type of agreement with foreign suppliers is also used because there is currently no



commercial bank on Sakhalin that could guarantee the transactions.When asked which problems were most pressing for Sakhalin Leasing Company, Aleksei Malashich answered that the problems are numerous. “As far as cross-border leasing is concerned, the biggest problems have to do with complications in customs procedures and the disparity between the Tax Code and the Law on Leasing. High interest rates, the lack of long-term financing, and the unwillingness of Russian banks to finance leasing contracts complicate the search for investors and impede the active use of leasing schemes. But if you work creatively, then all problems are solvable,” notes Mr. Malashich.

Contact tel.: (42422) 5-68-11, 5-32-55

Email: [email protected]

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LEASING IN RUSSIANovember - December 1999, Issue 6 (6)

OVERVEW OF THE RUSSIAN LEASING MARKET

Results of the IFC Leasing Development Group’s market study, 1998-1999

Gail Bowkett

Deputy Project Manager IFC Leasing Development Group

INTRODUCTION The Leasing Development Group (LDG) of the International Finance Corporation (IFC) has completed its survey of the Russian leasing market for 1998-1999. This research is unique for several reasons. First of all, no Russian organizations or government agencies specifically study the development of the Russian leasing sector; consequently, it is practically impossible to find official statistics on the Russian leasing sector. Rosleasing, Russian Association of Leasing Companies (Rosleasing), does provide statistical information on its member companies (which number more than 60). Unfortunately, however, the association’s statistics do not reflect the state of the leasing market as a whole. Second, the International Finance Corporation conducted its research from the perspective of all leasing parties, namely: lessors (leasing companies), lessees and equipment suppliers (vendors). The information on which we based our analysis of the Russian leasing market was gathered from a variety of sources. For the most part, this information was provided first hand by 37 leasing companies from 17 regions of Russia, 22 lessee companies and 24 supplier companies, who participated in interviews, surveys and focus groups. Data was also provided by the Registration Chamber of the RF Ministry of Justice and Rosleasing. Of course, the LDG’s analysis of the development of leasing may not be a complete reflection of the state of the Russian leasing sector today, but to the best of our knowledge it is currently the only research that even attempts such a multifaceted study of the Russian leasing market. We would like to present our readers with a short summary of our research. The results of this research will soon be published in full and presented to all interested parties. It will also become available on our Web page at http://www.ifc.org/russianleasing/ in the “Analysis” section. SURVEY RESULTS Economic OverviewIn order to understand the state of the Russian leasing market during 1998-1999, one must consider the general economic conditions of the country in this period. The financial crisis of August 1998 has had a negative effect on virtually all sectors of the Russian economy. In 1998 the volume of imports and exports fell by 25% and 17% respectively, inflation reached 70%, devaluation of the ruble reached 70%, and 18 of the leading 25 banks were declared bankrupt. The banking crisis led to a $50 billion decrease in the volume of financing available, according to Russia’s









http://www.ifc.org/russianleasing/



Central Bank.Naturally, the financial and banking crises have also had a negative impact on the leasing sector. With the decrease in the volume of bank financing, it has become harder to obtain loans to finance leasing transactions. Consequently, the cost of refinancing has grown, which has raised the cost of leasing transactions to lessees. Looking at sources of refinancing for leasing transactions, Russian leasing companies that can obtain refinancing in hard currency are now forced to pay a minimum of LIBOR + 12%. Lessor spreads often range from 6 to 18 percentage points over the lessors’ costs of funds . Assuming LIBOR to be 5%, one can see that the minimum refinance rate that a Russian lessor is likely to pay is 17% . In order to cover its costs and make a profit on such a transaction a Russian lessor would have to charge its best clients at least 22%. A weaker lessor would be paying up to 25% for its hard currency funds. Its clients would then be paying anywhere from 30 to 40% for the advantage of obtaining hard currency financing. A leasing company with refinancing in rubles would need to pay near 60% per annum and need to add a spread of 20% to cover overheads. Thus, a Russian lessee has the unhappy choice of paying anywhere from 20% to 35% for USD indexed funds or up to 80% per annum for ruble financing. Legal EnvironmentSince the IFC 1997-99 market survey on leasing activity , Russia has taken several positive steps in the development of its leasing sector. For example, the Federal Law “On Leasing” was passed in November 1998, which provided a concrete legal foundation for leasing activity. While the law did create the basis for engaging in leasing activity, it also introduced some problems of its own to the sector. For example, the law contains several contradictions within itself, with the Civil Code of Russia, and with other legislative acts that governs leasing activity such as customs, currency and tax regulations. In addition, Russia ratified the UNIDROIT Convention on cross-border leasing in 1998; this document now constitutes a part of leasing legislation in Russia. In spite of all the intricacies of Russian tax legislation, leasing operations are now given a more beneficial tax regime than any other method of purchasing equipment. Today, the tax benefits include the ability of parties to a lease transaction to use accelerated depreciation of the leased asset thereby lowering profit tax payable, the ability of the lessee to include the full amount of lease payments into the cost production. Thereby reducing profit tax, and the ability of lease companies to include into the cost of production interest charges on loans used to purchase equipment for leasing. There is, however, a danger that some of these tax benefits will be annulled if Part II of the Tax Code is adopted in its current form. For example, the current redaction of Part II of the Tax Code does not provide for the application of accelerated depreciation for leased assets. SIZE OF THE LEASING SECTOR Number of Leasing CompaniesThe IFC Leasing Development Group’s research on leasing activity in the Russian market for 1998-1999 shows that although the Russian leasing sector is still poorly developed, it has demonstrated a trend towards growth. One indicator of the growth of the leasing sector is the increase in the number of leasing companies. Since leasing activity requires a license in Russia, and all leasing companies must register and receive licenses from the Registration Chamber of the RF Ministry of Justice, we have at our disposal the exact statistics on the number of registered leasing companies on the Russian market. According to the statistics of the Registration Chamber, the number of registered leasing companies has grown by 51% over the past year (Table 1).

Table 1 July 1998 April 1999 August 1999

Licenses Issued 620 824 937



It is worth noting that this dramatic growth in the number of leasing companies over the past year has occurred in the context of very unfavorable conditions for financing and a decrease in the level of domestic investment and GDP. This growth was probably due to the fact that, with the almost total absence of available bank financing, many enterprises turned to leasing as an alternative means of acquiring the equipment they needed. This generated a demand for leasing services and, consequently, led to an increase in the number of applications for leasing licenses. It must also be noted, however, that although there were over 900 registered leasing companies in August 1998, according to the Registration Chamber, only 419 of these companies actually specialized in leasing. Moreover, according to statistics gathered by the IFC in eight Russian regions, only 30 of the 108 licensed leasing companies in these cities currently engage in leasing operations (Table 2). Thus, according to the IFC’s calculations, approximately only 30% of registered leasing companies actually engage in leasing activity.

Table 2 Registered Active

Vladivostok 12 3

Voronezh 6 2

Ekaterinburg 27 7

Irkutsk 4 3

Lipetsk 3 2

Perm 9 2

St. Petersburg 40 10

Kemerovo 7 1

Total 108 30

Geographically, most leasing companies are located west of the Urals, with the highest concentration in Moscow (240 companies). The geographic distribution of leasing companies is depicted in the following diagram:



Volume of Leasing OperationsAs the number of leasing companies has grown over the past year, so too has the volume of leasing transactions. The Russian Association of Leasing Companies calculates that in 1998 the volume of leasing operations conducted by its member companies reached $4 billion . By the IFC’s more conservative calculations, leasing comprised 3% of total investment, or approximately $1.4 billion, in 1998. This figure is lower than the 1997-1998 figure, but it reflects the actual economic situation of 1998 and the changes that occurred after the August 1998 crisis. (Table 3).

Table 3. Leasing’s Share of Total Gross Domestic Investment

1997 1998 1999

GNP (US$ billions) 443 276.6 187.1

Investment/GNP (%) 18.8% 17.4% 15.2%

Total Volume of Gross Domestic Investment (US$ billions)* 83.24 48.1 28.43

Leasing as Share of Total Investment 3% 3% 1.5%

Total Volume of Leasing Operations (US$ billions) 2.497 1.443 0.427

In spite of the increase in volume of leasing operations, the Russian leasing market is still in an early stage of development. By way of comparison, leasing accounts for some 20-30% of total investment in the member-nations of the OECD, while in countries with less developed leasing sectors, its share of domestic investment comprises 3-15%. Types of Leasing CompaniesIn the 1997-1998 market survey for Russian leasing companies were divided into four categories, according to their shareholders, specifically: 1) leasing companies held by banks, 2) by municipal or federal government agencies, 3) by financial and industrial groups, and 4) by foreign companies, or with the involvement of foreign capital. Leasing companies remain in these categories, but two new categories have been added: 1) companies created for individual transactions (special purpose lease vehicles) and 2) small companies founded primarily by private persons and engaging



in small-scale leasing transactions.The State Registration Chamber’s statistics on the major founders of leasing companies are presented in Table 4.

Table 4. Founders of Leasing Companies

Founding Organizations July 1998 August 1999

Number of Companies

% Number of Companies

%

Legal Persons or Combination of Legal and Physical Persons (including companies founded by federal agencies)

240 39 384 41

Banks 135 22 193 21

Regional Governments 114 18 188 20

Private Persons 111 18 140 15

Foreign Investors 20 3 32 3

Types of Leased EquipmentRussian leasing companies lease a very broad range of equipment. The diagram below shows the types of assets leased, according to statistics from the Registration Chamber.

Note: The category “financial intermediaries” refers to companies that are licensed to engage in leasing transactions and perform a variety of financial services, without a defined business profile. An important trend in the leasing sector is the increase in business with small and medium-sized enterprises. For those sectors of the Russian economy where imports predominated before the crisis, productivity has grown in the post-crisis period. This pertains especially to small and medium-sized manufacturers who increasingly feel a need for financing in order to expand and modernize their production. This has determined the types of equipment that leasing companies have obtained for small and medium-sized enterprises. Portfolio of equipment leased by the Moscow Leasing Company is an example of a company working primarily in the SME sector:



Sources of Financing for Leasing Transactions Today, a year after the August 1998 crisis, regional banks are once again beginning to extend credit to leasing companies. Of the leasing companies we surveyed, 27% indicated that they financed leasing transactions through bank loans (meaning banks that did not participate in the founding of these leasing companies), while 14% of the companies had access to the funds of their shareholdering banks. At the same time our research revealed that many leasing companies make use of such nonstandard finance plans as inter-enterprise debt settlement, barter and promissory notes.



ProblemsLeasing companies encounter certain problems due to the absence of clear mechanisms for the repossession of leased assets from lessee who default on lease payments, as well as from the ambiguity of leasing legislation in general. The biggest obstacle to the development of the Russian leasing market today is the shortage and high cost of financing for leasing transactions; this is the common opinion expressed not only by the leasing companies that participated in the survey, but also by the equipment suppliers and lessees. EQUIPMENT SUPPLIERSFor equipment suppliers, leasing is an important financial tool that enables them to sell their products at minimum commercial risk. Suppliers also view leasing as a means of marketing their services. A supplier’s ability to offer his clients not only a product, but also the financial services to help him purchase it, gives the client an added incentive to work with that particular supplier. Leasing becomes an even more important sales tool in markets where end consumers lack the spare capital to purchase equipment outright. Russia currently falls into this category of markets. Equipment suppliers working in the Russian market can be divided into two main categories: foreign suppliers working through various leasing companies, or their own captive leasing companies in Russia, and Russian suppliers. Most of the participants in our survey were foreign suppliers, so the information below pertains mostly to them. Several suppliers surveyed had not yet made use of the leasing mechanism in Russia. The reasons cited were as follows:

Why Suppliers Do Not Make Use of Leasing Reason % of Respondents

Leasing companies’ insufficient access to financing 42%

Leasing is not company policy 17%

Ineffectiveness of regulatory framework for leasing 17%

Unfavorable conditions for the realization of leasing transactions 17%

Unfavorable tax system 17%

The above statistics clearly show that leasing companies’ insufficient access to financing is the biggest factor deterring equipment suppliers from a more active application of the leasing mechanism. Due to the high cost and limited nature of loans, leasing companies are forced to increase their spreads on leasing transactions to as much as 35%, which ultimately raises the costs to the lessee. The high cost of lease agreements discourages lessees from signing deals, which means lower equipment sales for the supplier. As a rule, suppliers prefer to work with foreign backed leasing companies, since these companies have regular access to cheaper financing for leasing transactions and can therefore charge the lessee less interest. One developing trend in the Russian leasing market is the need for suppliers to share risks with leasing companies. Under current conditions, equipment suppliers must be willing to share commercial risks with leasing companies if they hope to remain competitive in their segment of the market or to increase their presence in that segment. Risk sharing can take the form of supplier’s commercial credit, recourse arrangements (such as buy-back arrangements) , guarantees or service agreements. Of the 24 companies surveyed, ten offer some form sales financing. Sixteen respondents, or 67% of the suppliers surveyed, expressed a willingness to share risks and take part in financing leasing transactions together with leasing companies. Of those that indicated a willingness to finance sales through leasing companies, 68% were willing to provide buy-back guarantees for equipment supplied through leasing. LESSEESThe leasing mechanism allows lessees (whether they be small, medium-sized or large enterprises) to increase their



productivity by obtaining fixed assets on favorable financial terms. By obtaining equipment through leasing, an enterprise gains the right to use that equipment without having to pay the full cost of the equipment up front. In order to enter into a leasing deal, a lessee must demonstrate not credit history, but rather ability to generate enough revenue to meet its lease payment obligations. Leasing schemes can be very advantageous, not only to start up businesses, but also to large companies that might not have enough working capital at hand to purchase new equipment, or that want to optimize their cash flow. Enterprises can generally choose between buying their capital assets outright, often with the help of bank loans, and obtaining them through leasing. Participants in our survey expressed a preference for leasing over bank loans. They justified their choice by referring to the tax benefits given to leasing operations, the lack of financial alternatives, and the excessively long waiting periods usually required for obtaining bank loans. The main advantages of leasing, according to the lessees in our survey, are its economic efficiency, flexibility and accessibility. The economic incentive of leasing, from the lessee’s point of view, consists of various tax benefits. Most important is the ability to include lease payments in the cost of production, which lowers profit tax, and the ability to use accelerated depreciation on the leased assets, which lowers property tax. The tax benefits for leasing operations lower the final costs to the lessee of acquiring new equipment. The lessees in the survey considered an extremely important feature or leasing to be its flexibility, which allows them to structure leasing deals with regard to the specific nature of their businesses (such as the cyclical nature of their turnover of the seasonal nature of their sales, etc.). Furthermore, when lessees run into financial difficulties, leasing companies are willing to restructure their lease payment schedule and reconsider the term for the lease agreement. Another advantage of leasing, according to the lessees in the survey, is its accessibility. In their experience it was easier to sign a leasing deal than to obtain bank loans. Leasing companies also require fewer guarantees and collateral than banks. Among the respondents were some companies that had never used leasing before, for a variety of reasons. For example, leasing was not company policy or, the terms of the deal were unacceptable or leasing companies lacked the financing to conclude a leasing deal, or else they simply did not know about leasing in general. The majority of the companies surveyed (68%), however, said that they intended to use leasing in the future.Among the problems that lessees most often encounter in practice, the respondents named the following:

Problems Encountered by Lessees

Problems Encountered by Lessees % of Respondents

Too many guarantees required 38%

Leasing companies’ lack of financing 15%

Complicated procedures for signing contract 15%

High cost of leasing transaction 8%

Insufficient legal framework 8%

Leasing companies’ excessive spread 8%

Inability to communicate directly with equipment suppliers 8%

According to lessees, the disadvantages of leasing include the lack of financing from leasing companies and the unclear legal framework for leasing activity. In addition, the term for leasing transactions can be too short, depending on the type of equipment leased and the lessee’s turnover cycle. In order to ensure that a leasing deal is effective for the lessee, it must be thought through completely and structured clearly before the contract is signed. CONCLUSIONAfter the financial and banking crises of 1998, many thought that the Russian leasing sector would deteriorate. But in



spite of the lack of financing that stemmed from the crisis, as well as the ambiguity and inconsistency of the legal and regulatory framework, the absence of a clear mechanism for repossessing leased equipment and the continuing lack of understanding of the leasing mechanism in general among Russian entrepreneurs, the leasing sector in Russia has clearly grown over the past twelve months. Considering the economic conditions of Russia today, leasing remains the most attractive and promising means of acquiring new fixed assets, advantageous to all parties involved. The Russian leasing market will continue to develop actively in the near future.

Spread is the difference between the lessor's cost of refinancing and the rate charged to the lessee and included in lease payments. You can find the analytical reports "The Legal and Regulatory Framework for Financial Leasing in Russia" and "Survey of Financial Leasing

Activity in Russia" on our Web site: http://www.ifc.org/russianleasing "Leasing Activity in the Russian Federation", RF Ministry of the Economy, State Registration Chamber, Moscow, 1998, Vestnik, quarterly

publication of the RF Ministry of Justice, State Registration Chamber "Leasing Technologies and Investments", Russian Association of Leasing Companies, #1, 1999 The Economist Intelligence Unit, Country Risk Service, Russia 2nd Quarter Report, 1999


DEVELOPMENT GROUP








THE LEASING PROJECTNovember - December 1999, Issue 6 (6)

● CONFERENCE ON “LEASING IN RUSSIA: PROBLEMS OF LEGAL REGULATION” ● PAMPHLET ON “RISK MANAGEMENT IN THE RUSSIAN MARKET” ● TRAINING ● SECOND ALL-RUSSIAN CONGRESS OF SMALL BUSINESS

CONFERENCE ON “LEASING IN RUSSIA: PROBLEMS OF LEGAL REGULATION”

Irina Likhachova On 28 October 1999 a conference was held in Moscow on “Leasing in Russia: Problems of Legal Regulation.” The IFC Leasing Development Group and the Canadian law firm Macleod Dixon together hosted the conference. Representatives of the State Duma, State Registration Chamber, State Customs Committee, Ministry of Tax and Duties, Ministry of Finance, Ministry of Trade, Ministry of the Economy and chief administration of the Central Bank of the Russian Federation for the city of Moscow participated in the conference.The goal of the event was to acquaint the representatives of legislative and executive bodies with a variety of legal problems that are often encountered by the leasing sector participants. The conference was designed to initiate a dialogue between the practitioners of leasing and the government agencies that regulate leasing activities, so that the two groups will be able to discuss possible solutions to existing legal problems and work out a unified approach to resolving issues in the future.Olga Shishlyannikova, attorney with the IFC Leasing Development Group, presented the point of view of Russian leasing companies, by citing concrete examples of the problems that leasing companies encounter in their leasing operations. The IFC Leasing Development Group is familiar with these problems through its research on the Russian leasing market and through its contact with leasing companies in many regions of Russia. Attorneys from Macleod Dixon covered the leasing sector’s legal problems from a more theoretical point of view.All those present at the conference took an active role in discussing the issues that were raised. We hope that this conference was just the first step toward examining and resolving the current legal problems in the leasing sector.










PAMPHLET ON “RISK MANAGEMENT IN THE RUSSIAN MARKET”

Irina Mirolyubova, Assistant IFC Leasing Development Group

The IFC Leasing Development Group has published a pamphlet entitled “Risk Management in the Russian Market,” which summarizes issues raised during the conference “Leasing Transactions in the Russian Market: Risk Management.” The pamphlet presents a short summary of the speeches given by participants in the round-table that took place on the second day of the conference. The participants included 50 representatives of Russian and foreign leasing companies and financial institutions working in various sectors in several regions of Russia. Participants shared their experience in the assessment of risks and risk management under Russian conditions. The reports included in the pamphlet reflect a variety of approaches to risk management in the Russian market: Western and Russian approaches, the strategies of Moscow-based and regional leasing companies and banks. The pamphlet also presents the questions posed by round-table participants and the answers they received.If you would like to receive a copy of this pamphlet on “Risk Management in the Russian Market”, please send your request to the IFC Leasing Development Group, and we will mail the pamphlet to your mailing address. You can also review the contents of the pamphlet on our Web page: http://www.ifc.org/russianleasing, in the “Round Table” section. (Note: the brochure is published in Russian.)

TRAININGAndrei Pisarenko

Training Manager IFC Leasing Development Group 18-19 November 1999. The Leasing Development Group conducted a seminar in Ekaterinburg entitled “The Principles of Leasing in Russia.” Another seminar is planned for Rostov-on-Don on December 14-15. Since November last year, the Leasing Development Group has conducted 17 training seminars in 15 regions of Russia. Some of these seminars included training for potential instructors and organizers of seminar on leasing. Over 700 people have taken part in the seminars to date.

SECOND ALL-RUSSIAN CONGRESS OF SMALL BUSINESS On 27-28 October 1999, the Leasing Development Group participated in the Second All-Russian Congress of Small Business in


http://www.ifc.org.ru/russianleasing/

http://www2.ifc.org/russianleasing/eng/rtable/index.html


Gail Bowkett, Deputy Project Manager, at the Leasing Development

Group’s booth at the Second Entrepreneurs’ Conventionй.

Moscow. The Group distributed its informational bulletin, the “Leasing Courier”. Representatives of the Group also fielded questions on leasing and the Russian leasing market from convention-goers, who included both entrepreneurs and agencies for the development of small enterprise.


DEVELOPMENT GROUP







NEWSNovember - December 1999, Issue 6 (6)

● EVENTS IN THE RUSSIAN LEASING MARKET ● EVENTS IN THE FOREIGN LEASING MARKET

EVENTS IN THE RUSSIAN LEASING MARKET

Two leading American manufacturers of agricultural machinery, John Deere and Case, plan to invest US$ 1 billion over the next five years into the production of equipment in Russia. The joint production of agricultural machinery will be set up in St. Petersburg, Rostov-on-Don and Bashkiria. In the early stages, the production will be based entirely on imported components. Depending on sales results, the proportion of components produced in Russia is expected to increase to 70%. The finished machinery will be leased to agricultural producers on an 8-year payment deferral, for which John Deere and Case will obtain funding for the program. Ex-Im Bank USA has already agreed to extend the company US$200m in credit over the next five years.

From Nezavisimaya Gazeta, 3 December 1999

Transaero Airlines and the leasing firm Ilyushin-Finance (I-F) have signed an agreement to lease 10 medium-range Tu-204 passenger planes to the airline. Delivery of the new planes is expected to begin in the year 2001. As founder of the leasing company, the National Reserve Bank will guarantee financing for the project. The planes will be manufactured for Transaero at the Aviastar factory in Ulyanovsk.

From Finmarket, 1 December 1999

Aeroflot has signed a deal with Ilyushin-Finance (I-F) leasing company for 7 long-range IL-96-300 passenger planes. According to the agreement, I-F will finance the completion of six IL-96-300s currently on the stocks at the Voronezh aviation plant. The leasing company will buy a seventh IL-96 from Aeroflot, equip it with new engines and electronic equipment, and then lease it back to Aeroflot. Deliveries are expected to begin in the year 2001. Before that, however, I-F must obtain government guarantees for the construction. According to Aleksandr Rubtsov, general director of the leasing company, the contract cannot be fulfilled without these guarantees.

From Vremya MN, Mikhail Kukushkin, “Aeroflot Decides To Buy Ilushins”, 30 November 1999

A new leasing company, Stroyleasing, will be formed in St. Petersburg with the support of governor Vladimir Yakovlev. According to Lev Kaplan, general director of Soyuzpetrostroy, the company will specialize in operational leasing. He noted that Soyuzpetrostroy had written a letter to the governor urging him to support the future leasing company, since it was created with the goal of “solving municipal transportation problems, as well as problems of construction and road technology in St. Petersburg. GUTA-Bank and Baltisky Bank of St. Petersburg have agreed to










participate in the project.RBC,

30 November 1999 The United Arab Emirates has decided to lease 100 KamAZ automobiles per year over the next ten years. This announcement was made by the managerial board of the Kamsky auto plant. The information was confirmed by Timur Akulov, director of the Department of Foreign Affairs of the President of Tatarstan. Mr. Akulov has just returned from the UAE, where he was attending an exhibition entitled “Air Show 2000”, on an invitation from the UAE Minister of Defense, Sheik Mukhamed.

From Finmarket, 29 November 1999

“The member-countries of the European Union have 25-30 small businesses for every 1,000 citizens, while Russia has only 7.” Thus Vladimir Putin opened a government meeting on state programs for the support of small enterprise. This support is still weak: neither last year nor this year did small enterprise receive a single ruble from the federal budget. Since the government is still not able to offer small businesses any financial support, proposals at the meeting tended to focus on creating a more favorable tax and investment climate. The government announced (though too vaguely, once again) the principles it will follow in regard to the support of small enterprise. These include a simplification of registration procedures, the adoption of a package of laws guaranteeing economic freedom, the expansion of regional rights while maintaining a unitary legal framework, and the fostering of new financial principles such as leasing, franchising, etc.

From RBC, 19 November 1999

Aeroflot Russian Airlines plans to finish expanding its air fleet by the end of this year by leasing four new Boeing 767 airplanes. Aeroflot’s press service announced that the company had already received and commissioned the first two aircrafts.

Finansovaya Rossiya, 43, November 1999

The Republic of Tatarstan and the Perm and Novgorod oblasts signed an agreement in Moscow today to support the development of new Russian aviation technology and to expand its use by Russian aviation companies. According to the agreement, three Tu-214 planes from the Kazan Gorbunov Aviation Production Association, equipped with PS-90A engines from Perm Motors Open Joint-Stock Company, will be leased to Siberia Aviation Company (Novosibirsk). Organizational support and financial plans will be provided by Avialeasing Corporation (Perm), a closed joint-stock company. According to Anatoly Makarov, deputy general director of Avialeasing Corporation, the project is valued at 1 billion rubles. A preliminary agreement has already been reached with the manufacturers, under which the first finance installments will go towards the completion and commissioning of aircraft already under construction. Payment for the full value of the machines will be made over the course of several years according to an agreed timetable. Siberia Aviation Company expects to receive its first Tu-214 aircraft within 10 months after the project is financed. Mr. Makarov has emphasized that the agreement was signed by the regions’ highest officials, who have assumed personal responsibility for the project and promised to give it their full support.

RBC, 16 November 1999

Sberbank of Russia will give US$6.3m in credit to finance a leasing deal that will provide Orenburg-Gazprom with equipment for granulating liquid sulfur. The deal was announced by the directors of Sberbank’s public relations department. RG Leasing will act as the lessor in the deal. The project to convert liquid sulfur, a by-product of natural gas purification, into granular sulfur has great ecological importance. It will enable the region to improve its environmental conditions, create new jobs and expand the range of Russian exports.



RBC, 16 November 1999

The regional Duma of Primorsky krai has adopted a Law “On a Leasing Fund for the Acquisition of Agricultural Equipment by Agricultural Producers in Primorsky krai”. This announcement appeared in the weekly newspaper Zolotoy Rog (Golden Horn). The law is meant to improve the technological base and promote the modernization of tractors among the regions’ farmers. It provides for a leasing fund that leasing companies will be able to use in order to purchase agricultural equipment. The equipment will be leased to agricultural producers for temporary use under contract. The law will also allow farmers to purchase the leased equipment. The leasing company contract will be awarded to a commercial organization that possesses a leasing license and wins a regional competition for the right to supply the agricultural equipment.

IS-Courrier, RBC, 16 November 1999

The St. Petersburg branch of Bank of Moscow has initiated a program to finance small and medium-sized businesses, which was developed by the US-Russia Investment Fund (TUSRIF). According to the bank’s press service, the program will give loans to enterprises to enable them to replenish their working capital and purchase new equipment. Loans of US$1,000-150,000 will be given on liquid securities for periods of up to two years at 15-18% APR in hard currency. The Petersburg branch of Bank of Moscow plans to work with TUSRIF in the future on several types of programs: leasing, mortgage, and credit to consumers for purchasing automobiles.


Siberia Aviation, one of the largest Russian aviation companies, is expanding its sphere of influence. According to available information, the company plans to take over a significant share of the air transportation market in the Perm oblast in the very near future. The directors of Siberia Aviation, Perm Airlines and Perm Avialeasing Corporation have come to an agreement on “the possibility of consolidating the air transportation market.” Together they founded the Perm Siberia Company, which will gain access to new traffic volume in exchange for the acquisition through leasing of three Tu-214 aircraft produced in Kazan with PS-90A engines from Perm. The deal is valued at over 1 billion rubles. Payment for the aircraft will be spread out over ten years. In order to help “Siberia” obtain the loans it needs to purchase the aircraft, Avialeasing Corporation intends to lend the aviation company one of its Tu-204 airplanes, which will be used on the Moscow-Novosibirsk route.

From Nezavisimaya Gazeta, Nikolai Ivanov, “Perm Acquires ÔSiberia’”, 10 November 1999

A final decision will be taken in December 1999 on realization of a joint project of the Russian government and America’s John Deere Company to lease agricultural equipment. This announcement was made by Alexandr Kudel, director of Roskhleboprodukt Corporation, at a conference dedicated to the five-year anniversary of the Grain Union. The American company is to invest one billion dollars into the construction of 100-120 machine-tractor stations, which will serve approximately 8 million hectares of land. Project development is nearing completion, and two international auditing companies are currently finishing up their analysis of the project’s financial structure.

RBC , 10 November 1999

Elektrosila Open Joint-Stock Company is building a new engineering and construction center with the help of leasing. The equipment is valued at over $300,000. The center will be computerized as part of the factory’s global automatization program. Petroleasing Ltd. and Balton Ex-Im Leasing, daughter companies of Petrovsky Bank and Balton Ex-Im Bank respectively, will act as lessors for the deal. One of the equipment suppliers will be Links VSS Closed Joint-Stock Company.

From Delovoy Peterburg (Business Petersburg,



10 November 1999 The board of directors of Aeroflot Russian International Airlines approved the company’s development plan at its scheduled meeting. According to the company’s press service, the board of directors recommended that the company continue its project to renovate its air fleet. A decision was made to include the project in the company’s development plan and present it to the board of directors in February 2000. It was also decided to take the necessary legal and organizational measures and to present a business plan for a project to lease six IL-96-300 planes. The board of directors agreed with the working group’s conclusions on the need to expand regional air fleets (flight ranges up to 1,200 km) and recommended working out the various issues relating to the choice of aircraft for regional transportation.


The most important problems facing enterprises and requiring immediate remedy, according to Ilya Yuzhanov, head of the Ministry for Antimonopoly Policy, are the lack of coordination between federal and regional guiding agencies for small businesses, Russian tax legislation, and access to financial resources (enterprises receive neither state funding nor affordable credit). There is also a whole set of problems related to financial legislation for leasing and franchising. The Minister made this announcement at the Second All-Russian Congress of Small Business, which took place in Moscow on 27-28 October 1999. Yuzhanov sees round-table discussion between representatives of small and medium-sized businesses and the executive branch as the solution to the problems in their relationship. This will mitigate the current “conflict between entrepreneurs and the authorities,” and will also help inform the authorities of the real situation of entrepreneurs in Russia and help them solve problems much more quickly “through lobbying -- in the best sense of the word.” As for problems relating to financial legislation, Yuzhanov believes that current leasing and franchising legislation must be supplemented with a special law pertaining exclusively to small enterprise.

From RBC, 27 October 1999

EVENTS IN THE FOREIGN LEASING MARKET Airzena Georgian Airlines has signed a deal with Germany’s Hapag Lloyd to lease two Boeing 737-500 airplanes. The first aircraft will arrive at Tbilisi airport on December 10, while the second is scheduled for delivery in April 2000. Siko Gegiadze, director of the Georgian Aviation Workers’ Union, noted that aircraft leasing will enable the aviation company to open new air routes. An agreement has been reached with British Airways and Turkish Airlines that will allow Airzena Georgian Airlines to fly once a week to London and Istanbul. Flights to Paris and Amsterdam, discontinued after the airports of these cities closed their runways to Tu-154 and Tu-134 aircraft, will also be resumed in the future. Three Airzena Georgian Airlines flight teams left for Germany on November 8 to be retrained to work with Boeing 737 aircraft.


The Uzbek Association of Automobile Manufacturers, Uzavtosanoat, has decided to form a leasing company to sell automobiles from the Uzbek-Turkish joint venture SamKochavto. According to Kudrat Parpiev, Chairman of the Board at Uzavtosanoat, the leasing company will be registered in Uzbekistan by the end of November. The company’s founders, with US$10m in charter capital, are the Uzavtosanoat Association, SamKochavto Joint-Venture, Asaka Commercial Bank and Koch Leasing, a daughter company of the Turkish auto giant Koch Holding. The automobiles are expected to be leased on both the domestic market of Uzbekistan and the foreign market. The chairman of the board at Uzavtosanoat announced that SamKochavto has already begun to establish its dealer network both in Uzbekistan and abroad. SamKochavto Joint Venture was founded in Samarkand in 1996 on equal terms by the Uzavtosanoat Association and Turkey’s Koch Holding (50/50) for the production of low-tonnage trucks and buses.



Between April and September of this year the company produced 294 trucks and 140 buses. All of these were sold on the domestic market. In the year 2000 the joint venture plans to put out 3,000 vehicles, including 2,500 buses. About 300 of these buses are intended for export.

From Nezavisimaya Gazeta, Mekhman Gafarly, “ Uzbek Automobiles on the CIS Market”, 30 October 1999

Prepared by Irina Likhachova








LEGISLATIONNovember - December 1999, Issue 6 (6)

POSITIVE CHANGES IN THE LEGAL FRAMEWORK FOR LEASING IN UKRAINE

Denis Vasilenko Leasing Development Group Consultant

IFC Ukraine Business Development Project Ever since the Ukrainian Law “On Leasing” was passed on 16 December 1997, its reception among leasing business circles has been lukewarm. The law contains numerous flaws and contradictions, which often impose unjustified limitations on the parties to a lease transactions or make the leasing deal itself impossible. In this article we present certain positive changes that have been introduced into the legal framework for leasing in Ukraine and identify the problems that have yet to be resolved.According to contemporary notions, leasing is a transaction in which a leasing company provides internal or borrowed funds to a lessee in the form of leased assets. The lessor’s creditor rights are ensured by his ownership rights to the leased assets for the duration of the contract. This right is recognized, of course, in Ukraine’s Law “On Leasing”.It is precisely the lessor’s ownership rights to the leased assets that decrease potential risks to the financing party and, ultimately, lower the cost of leasing to the lessee.The lessor’s ownership rights lose their effectiveness, however, if the lessor (the financing party at risk) does not have access to fair, affordable and effective legal mechanisms that would empower him to repossess leased assets in the event of lessee default or contract violation.Ukraine’s Law “On Leasing” gives lessors the right to repossess leased assets out of court by obtaining a notarized writ of execution from the State Notary’s Office:“Article 9, Clause 5:In the event of two consecutive lease payment defaults by the lessee, the lessor may demand return of the equipment without dispute in accordance with a writ of execution from the State Notary’s Office (Ukrainian Law “On Leasing”)Notaries’ activities are in turn regulated by the Ukrainian Law “On Notarization”, which contains the following provisions: Article 87. Exaction of monetary compensation and repossession of property with a writ of execution:“When exacting monetary compensation or repossessing property from a debtor, notaries must issue a writ of execution based on documentation that establishes the debtor’s indebtedness.The list of documents that serve as a basis for writs of execution in the recovery of debts is established by the Cabinet of Ministers of Ukraine.Thus the Law “On Leasing” of 16 December 1997 provided for the recovery of property from lessees without dispute in the event of two consecutive non-payments. But until 29 June 1999, notaries did not have the right to draw up writs of execution based on lease agreements that had not been notarized, as they were constrained by the “List of Documents...” of 12 October 1976, which only provided for writs of execution on notarized agreements. Here it should be noted that the cost of notarization is 5% of the contract value.The situation improved for the better on 29 June 1999, when the Ukrainian Cabinet of Ministers ratified a new “List of Documents for the Recovery of Debts Without Dispute.’ The new list allows for the return of assets leased under simple written (non-notarized) agreements:“Return of Leased Assets:Lease Agreements Stipulating the Return of Leased Assets Without Dispute.The following documents must be submitted in order to obtain a writ of execution:a) original lease agreementb) copy of invoice sent to lessee and certified by lessor, with a note indicating non-payment after written notification”(“List of Documents for the Recovery of Debts Without Dispute on the Basis of a Notary’s Writ of Execution,” ratified by Ukrainian Cabinet of Ministers’ Decree of 29 June 1999.)The










passing of this document freed Ukrainian lessors from situations where notaries denied them writs of execution on the grounds that their lease agreement had not been certified (even though the law does not require certification), simply because the notaries were acting in accordance with an Instruction from 1976 that did not (and could not) even mention leasing. The new List also frees lessors from raising the cost of their leased assets by 5%.It should be noted that allowing for the recovery of leased assets without dispute on a notary’s writ of execution only in the event of two consecutive non-payments is far from sufficient. There are many other cases where the lessor’s property is in danger of damage or destruction, or the terms of the contract are violated: inappropriate use of the leased property, unauthorized subleasing to a third party, transfer of the property outside the bounds of the agreed territory, improper maintenance or exploitation, etc.We must also point out that state duties on return of property under a writ of execution should be purely symbolic, since the lessor is effectively returning his own property to himself. Recovery of leased property currently costs lessors 2% of the property’s original value.Unfortunately, the above-mentioned change is currently the only positive development in Ukrainian leasing legislation. Now let’s consider some of the unresolved problems:

● Excessive profit tax on lease payments. The problem here is that, under the Ukrainian Law “On Taxation of Enterprises’ Profit”, the portion of a lease payment that goes towards the “settlement of the principal cost” is considered as part of the lessor’s gross income. Here it should be noted that under financial leasing it is the lessee who charges depreciation on the leased assets. Thus the lessor receives income for which there is no compensation within gross expenditures. The situation is complicated still further by the fact that the Law does not allow lessors to include money spent for the acquisition of leased property within gross expenditures.

● Procedures for calculating and paying VAT. No VAT is charged on lease payments, in accordance with the Law “On Value-Added Tax.” Lessors must, however, pay VAT when purchasing equipment from a supplier or clearing customs. Thus a lessor, having purchased an item for $100 plus a VAT of $20, leases the item to a lessee at an increased principal cost of $120, but does not have the right to claim the VAT as a tax credit. This regulation raises the costs of leasing to the lessee and drains funds from the lessor. Moreover, the tax regulations become totally unclear when ownership rights to the leased assets are transferred after completion of the agreement.

● Definitions of leasing stipulate unacceptable periods for lease agreements. According to the Ukrainian Law “On Leasing”, leasing is defined as paid use of leased property for a period in which depreciation exceeds 60% of the property’s value. The regulations for depreciation are, in turn, strictly defined under the Law “On Taxation of Enterprises’ Profit.” Comparing the established depreciation periods with the requirement for 60% depreciation on leased assets, we find that a lease agreement for an automobile or a piece of office equipment cannot be concluded for a term longer than 3 years and 3 months. Lease periods for any other kind of movable property must be at least 5 years and 6 six months (or 2 years and 9 months with accelerated depreciation). Moreover, depreciation rules change every year with the introduction of revised depreciation rates, which, consequently, also changes contract periods. Thus the law establishes the investor’s (lessor’s) minimum term of investment, and this term is often unacceptable to the leasing parties.

Resolving the above-mentioned problems would make leasing more attractive, which would in turn increase the flow of investment into the country’s economy.


DEVELOPMENT GROUP






ACCOUNTINGNovember - December 1999, Issue 6 (6)

COMMERCIAL CREDIT IN LEASING PURCHASE AGREEMENTS: BOOKKEEPING AND TAXATION

Nina Zhuravlyova,

Accountant-Auditor

The Concept of Commercial Credit in Purchase AgreementsIn the course of realizing a leasing transaction, the lessor assumes ownership of the leased property, while the seller transfers it to the lessor under a purchase agreement . At this stage the parties to the purchase agreement may use commercial credit. This credit may be given :

● by the lessor to the supplier in the form of an advance or prepayment for the property ● by the supplier to the lessor by means of deferred payment or payment by installment.

General Aspects of Bookkeeping and Taxation for Transactions Involving Commercial Credit Sales proceeds are to be recorded in the books as stipulated in the agreement signed by the parties.If the purchase agreement does not stipulate terms for the transfer of property rights, then common regulations take effect, according to which the lessee obtains property rights from the moment he receives the goods . In this case, proceeds from the sale of the leased assets are to be reflected in supplier’s books at the time of shipment and invoicing.Supplier companies that calculate sales proceeds “at the time of payment” for tax purposes, according to standard accounting practice , should take note of this, since the calculations for profit tax, VAT, highway tax, turnover taxes and other taxes, for which sales proceeds are the taxable base, depend on the definition of proceeds “at the time of payment.”










Advance Payment or Prepayment for Leased Assets Commercial credit given by the lessor to the supplier.Advance payments (prepayments) are made in cases where the purchase agreement stipulates that the buyer must pay for the goods completely or partially before receiving them from the seller .Since the right of ownership is not actually transferred in such cases (the goods are not alienated), the transaction does not count as a sales transaction (neither for accounting nor tax purposes).The supplier records the received funds in his books as an advance payment using account 64 (“Advance payments received”), in correspondence with cash accounts. The leased property is recorded on account 41 (“Goods”), the debit balance of which is included in the supplier’s property tax at the end of the accounting period. Advance payment is accounted for when the property is delivered and the payment documents are presented.Under existing tax laws, if the supplier defines the sale according to the time of payment for tax purposes, then the funds he declares on credit account 64 in correspondence with cash accounts are subject to value-added tax and must be included in the tax declaration for the accounting period in which they were received .Upon receiving the leased property and settling the payment documents presented by the supplier, the lessor accounts for of the transferred prepayment.The following hypothetical example illustrates the bookkeeping methods for these operations. In order to simplify the example we include only such entries as pertain directly to the matter at hand. ExampleThe parties have concluded a purchase agreement for leased assets. The value of the goods has been set at 1,200,000 rubles (including 200,000 rubles in VAT). The lessor has made a 100% prepayment using long-term bank credit. The following entries are made in the accounting records: Supplier’s Records:Debit 51 Credit 64: 1,200,000-received prepaymentDebit 64 Credit 68: 200,000-VAT levied on prepaymentDebit 64 Credit 46: 1,200,000-leased assets shippedDebit 46 Credit 41-cost of leased assets written offDebit 68 Credit 64-reversed VAT on prepayment: 200,000Debit 46 Credit 68: 200,000-VAT levied on sales proceeds Lessor’s Records:Debit 61 Credit 51: 1,200,000Debit 51 Credit 92: 1,200,000-prepayment with long-term bank credit transferred on delivery of leased assetsDebit 08 Credit 60: 1,000,000Debit 03 Credit 08: 1,000,000-leased property receivedDebit 19 Credit 60: 200,000-VAT on value of propertyDebit 68 Credit 19: 200,000-VAT offset



Debit 60 Credit 61: 1,200,000-Sum of advance payment that has been offset Deferred Payment (Payment by Installment) for Leased Property Commercial credit given by the supplier to the lesso r.A special feature of purchase agreements with installment plans is that they are considered a variety of sale of goods on credit and are recognized as valid if they stipulate additional essential conditions for the price of the goods and the method, volume and schedule of payment .When goods are sold on commercial credit in the form of deferred payment or payment by installment, the proceeds are entered into the books for the full amount of accounts receivable, as defined under the purchase agreement regardless of the duration of the deferral or installment plan.When the leased property is shipped and the invoice is presented to the lessor, the supplier enters the proceeds from the sale of the leased assets into his books, while the lessor enters the leased property of which he has received ownership. Remember that the lessor can only offset VAT on the acquired leased property in proportion to the payment . ExampleThe parties have concluded a purchase agreement for the leased assets. The price of the goods has been set at 1,200,000 rubles (including 200,000 in VAT). The lessor has been granted a 50% payment deferral. The first payment has been made. The following entries are made in the bookkeeping records: Supplier’s records:Debit 62 Credit 46: 1,200,000-leased assets shippedDebit 46 Credit 68: 200,000-VAT levied (if proceeds are determined “upon shipment”)Debit 51 Credit 62: 600,000-partial payment received for shipped leased propertyDebit 46 Credit 68: 100,000-VAT levied (if proceeds are determined “upon payment”) Lessor’s records:Debit 60 Credit 51: 600,000-supplier’s account partially paid taking into account the conditions of the commercial creditDebit 08 Credit 60: 1,000,000Debit 03 Credit 08: 1,000,000-leased property receivedDebit 19 Credit 60: 200,000-VAT on value of propertyDebit 68 Credit 19: 100,000-VAT offset If the supplier determines proceeds “upon shipment” for tax purposes, taxes for which sales proceeds are the taxable base should be calculated at the time of shipment from the sum indicated in the invoice, VAT excluded (in the given example, the proceeds amount to 1,000,000 rubles).If the supplier determines proceeds “upon payment” for tax purposes, then he calculates tax on proceeds upon receiving payment for accounts receivable for the shipped leased property, in accordance with the installment plan or deferred payment; and he adjusts his profits for tax purposes (in the given example, proceeds amount to 500,000 rubles).



The buyer may be required under the agreement to pay an amount of interest equal to the value of the goods for the given deferral.The lessor includes interest payments for the given deferral in the cost of the leasing transaction for the accounting period to which they pertain, regardless of the time of payment for the received leased assets .The supplier includes interest earned from commercial credit in turnover, subject to value-added tax and profit tax .Thus, when deciding issues relating to bookkeeping and taxation for commercial credit, it is worth becoming familiar with the terms of the purchase agreement for the leased assets. This will allow you to avoid errors when calculating your tax liabilities.

Article 4 of Federal Law #164-FL "On Leasing" (29/10/98) Article 823 of the Civil Code of the Russian Federation (CC RF) Clause 1, Article 223; Clause 1, Article 224 CC RF Clause 13 of the "Statute on the Composition of Expenditures…", confirmed by Resolution #552 of 05/08/92 and State Tax Service Letter #PV-

4-13/3n "On Checking the Correctness of Organizations' Calculations of their Taxable Base" (05/01/96) Article 380 and Article 487 of the CC RF Clause 1, Article 4 of the RF Law "On Value-Added Tax" (06/12/91); Clauses 9 and 31 of RF State Tax Service Instruction N39 "On

Regulations for the Calculation and Payment of Value-Added Tax" (11/10/95) Clause 3 of RF Ministry of Finance Decree #15 "On the Treatment of Leasing Operations in Bookkeeping Records" (17/02/97) It is presupposed that the transaction will be entered into the books "upon shipment". Clause 1, Article 489 of the Civil Code Clause 2, Article 7 of the RF Law "On Value-Added Tax" of 06/12/91 (04/05/99 redaction) Subclause "C" of Clause 2 of the "Statute on the Composition of Expenditures…", confirmed by Resolution #552 of 05/08/92 Clause 1, Article 4 of the RF Law "On Value-Added Tax" (06/12/91) Subclause "C" of Clause 2 of the "Statute on the Composition of Expenditures…", confirmed by Resolution #552 of 05/08/92; and Ministry of

Finance Letter #04-02-05/1 of 15/01/99








QUESTIONS AND ANSWERSNovember - December 1999, Issue 6 (6)

Olga Sishlyannikova, a legal expert with the IFC

Leasing Development Group, explains some

moot points concerning the legal aspects of

leasing.

Are there any norms for the correlation between the cost of leased assets and additional services?According to Article 7 Clause 4 of the RF Federal Law “On Leasing”, a leasing transaction may include terms for the rendering of additional services connected in some way to the lessee’s use of the leased assets. As follows from Article 29 Clause 2 of the same Law, payment for additional services stipulated in the lease agreement is to be included in the lease payments. The legislation does not impose any limitations on the correlation between the cost of leased assets and the cost of additional services rendered as part of a lease agreement. Can one purchase leased assets from individuals who own the property on the basis of shared ownership rights? If so, then what is the correct way to draw up a sales agreement for the leased assets?Current Russian legislation does not impose any restrictions on the seller of leased assets. The only condition in relation to the seller is the expressed will of the lessee, or the lessor in cases where the obligation to choose a seller lies with the lessor.A sales agreement for jointly owned leased assets is drawn up in the usual manner. All of the owners must participate as the selling party in signing the sales agreement (Clause 1 Article 308 of the Civil Code of the Russian Federation). Consequently, the sales agreement must either be signed by each of the partial owners, or by one of them having power of attorney for all.


DEVELOPMENT GROUP

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November - December 1999, Issue 6 (6)

Dear Readers!

The Leasing Courier information bulletin has reached its first anniversary! In preparing the first edition of LC, after deciding to create our own publication, we set ourselves the goal of promoting the development of leasing in Russia by:

● popularizing leasing; ● bringing entrepreneurs’ attention to leasing and

improving their understanding of its benefits; ● bringing regional governments’ attention to

leasing as an effective tool for investment in regional production;

● providing leasing companies with practical assistance with the legal, economic and accounting aspects of leasing activity;

● providing a forum for the discussion of issues that were interesting to all leasing parties.

In other words, we wanted LC to be informative, useful in practice and interesting to the various audiences that are in one way or another interested in the development of leasing in Russia. Considering the growth in the number of our subscribers and the responses and suggestions of LC readers over the past year, it seems fair to say that we have met many of our goals.Since the publication of the first edition of the Leasing Courier, our subscriptions have almost doubled. The bulletin is read in 63 regions of Russia. 50% of out readers are entrepreneurs (both experienced lessees and potential ones), suppliers and equipment manufacturers. 16% of our subscribers are leasing companies representing 22 of Russia’s regions. Regional governments, mainly committees for economic development and the support of small enterprise, comprise another 13%, while 12% come from foundations for the development of enterprise and

Chief Editor:Irina Likhachova Articles prepared by:Gail BowkettIrina LikhachovaIrina MirolyubovaAndrei PisarenkoLeonid PrilutskyOlga ShishlyannikovaDenis VasilenkoNina Zhuravlyova Translation by:Daniel Kohn Comments, proposals, questions and submissions may be sent to: IFC Leasing Development Group Gazetny Per. 5, Bld. 2 Moscow 103918Email: Telephone: (095) ...Fax: (095) ... IN THE NEXT ISSUES: THEORY & PRACTICEAdvice to the Lessee: How To Negotiate With Leasing Companies LEASING IN THE REGIONSUsolye-Sibirskoe

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both federal and regional chambers of commerce. Federal and regional media comprise another 9%.The Leasing Development Group would like to thank you, our readers, for your support and your interest in the Leasing Courier. Thank you for your responses, suggestions and materials, which have enabled us to find the topics of most interest to you and to shed light on them in the LC.In the upcoming year we will continue to strive to make this bulletin useful to you in your work, whether that be the development of the legal and regulatory framework for leasing, the creation and development of leasing companies or your own production, or consulting services and promoting public awareness, etc. We rely on you to help us with our task. We are always happy to hear your questions, comments and suggestions and to receive your materials. The pages of LC are always open to the sharing of experience and the discussion of issued pertinent to the development of leasing in Russia. Thank you once again for your support. See you next year!

Irina Likhachova Chief Editor, LC

TAXATIONTax on Exchange Rate and Differences in Sums of Leasing Transactions SMALL BUSINESSThe Experience of the USA-Russia Investment Fund for the Support of Small and Medium-Sized Enterprise NEWSPress Digest and Events in the Leasing Market LEGISLATIONLeasing Regulation in Belarus

and much more . . .

The Leasing Courier newsletter is distributed free of charge as a part of the Leasing Development Project, implemented by the International Finance Corporation with financial support from the Canadian International Development Agency (CIDA) and the British Know How Fund (BKHF).


DEVELOPMENT GROUP

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