managing risk.pdf

Managing Risk and Creating Value with Microfinance81The process of repossessing the equipment can vary. In Bolivia and Ecuador, repossessing equipment takesonly one or two months (compared to one or two years in the case of a defaulted loan). In Ecuador, the MFIsubmits a standard packet of documents to a judge and obtains an order to repossess the equipment. Theprocess is unilateral and functions well without the need for a police escort. It is fairly inexpensive, between1 and 2 percent of the total lease value. In Chile, Colombia, El Salvador, Honduras, and Mexico, the laws andprocedures are similar for the recovery of leased equipment.Tax and Regulatory Considerations with MicroleasingAlthough leasing may make financial sense, tax considerations may outweigh the benefits. For formallyregistered microbusinesses, the tax advantages or disadvantages change according to the country. Advantagesare greater when accelerated depreciation is permitted for the equipment. In some cases, the tax codes favorequipment leasing. In other cases, they introduce a bias for equipment loans. Under some national tax codes,the client can deduct principal and interest from taxable income. For the MFI’s informal business clients, thedepreciation expense deduction from taxes disappears, and loans can be more effective than microleasing.From the MFI’s perspective, the tax considerations affecting leases include value added taxes (VATs), equipmentstamp taxes, and any special tax and regulatory treatment of financial leases. In some countries, an MFI canreduce its tax burden by deducting the depreciated value of the leased equipment, because it retains formalownership during the life of the lease. In other countries, taxes are charged on the total lease amount (bothprincipal and interest). In addition, different countries apply the VAT differently. In some cases, the VAT isapplied against the lease charge but not to a loan. Examples of other taxes include a stamp tax on equipmentwith a value over US$27,000 (Colombia), an asset tax (Mexico), and a tax on imported equipment (Romania).Although the MFI (as the asset owner) pays those taxes, it can pass them on to the client as part of thetransaction costs included in the lease.Regulatory issues can play an important role in expanding or limiting microleasing. For example, governmentsunnecessarily limit the market by requiring a subsidiary specialized in leasing. The lack of clear definitions forleasing and the responsibilities and rights of each party in a leasing contract also limit the market’s expansion.However, in some countries, equipment leasing is exempted from the interest rate ceilings imposed on lending.The advantages and disadvantages of leasing, compared to long-term lending, are summarized in table 6.1.Table 6.1 Advantages and Disadvantages of Financial LeasesFactors Advantages DisadvantagesLegalenforcementThe MFI has a strong legal posionto repossess and sell equipment ifthe client does not pay the lease.There can be a greater potenal formisunderstanding and legal disputes.Costs Enforcement costs are lower. Set-up costs are higher.Operaonal costs are higher.RegulatoryaspectsTax issuesOen, regulaons do not imposeinterest rate caps for leasing.Possible tax deducon or otheradvantages are available forformal businesses that pay the VATand ulies taxes.Source: Adapted by authors from Westley (2007).Banking regulaons somemes prohibitfinancial leasing or limit it to a specialsubsidiary, making it harder for an MFI tostart a leasing product.No tax advantage occurs from leasing forinformal firms.