Financial Leasing in Ukraine
By Konstantin Pilkov
Lavrynovych & Partners
Ukraine is for several reasons
facing an urgent
need to develop the leasing
industry at the present time.
First of all, the majority of fixed assets
in the Ukrainian economy are
outda ted, run down and require
urgent replacement. Secondly, enterprises tend to fund capital
investment primarily with their own savings/capital due to the inadequacies
of the national banking system. Financial leasing is a
worldwide acknowledged instrument investment that enables the
acquisition of almost any type of investment assets.
However, focus on this type of instrument requires thorough
review of the legislation governing the transaction and examination
of business techniques developed by the market. Below we
will consider in general the terms of Ukrainian legislation that
govern financial leasing and the most serious barriers hindering
development of financial leasing.
The year 2004 was a crucial year for the development of leasing
in Ukraine. In that year the Civil Code of Ukraine (the Civil
Code), the Commercial Code of Ukraine (the Commercial Code),
and the new version of the On Financial Leasing Act of Ukraine
(the Leasing Act) came into force. These are the main documents,
which regulate the relations of financial leasing in Ukraine. The
Leasing Act combined the legal nature of financial leasing with
the economic essence of leasing. The Leasing Act is a positive step
towards the creation of a positive legal framework for leasing due
to the following:
• The definitions of financial leasing, the financial leasing
agreement, the subject of leasing, subleasing, etc. are consistent;
• The rights and obligations of the parties in a financial leasing
agreement and the main terms of the agreement are clearly
described;
• Important issues, which are also addressed by the Leasing
Act, include the possibility of sub-leasing, repossession in the
event of violation of the agreement by the lessee and the protection
of the lessor’s rights in the event of destruction or damage of
the property
• The Leasing Act also allows for individuals, not only companies,
to conclude financial leasing agreements
According to the Leasing Act, financial leasing means a type
of civil relation arising from a financial leasing agreement under
which the lessor shall be obliged to acquire an asset into ownership
from a seller (vendor) pursuant to specifications and conditions
established by the lessee, and transfer it to the lessee for a
specified term not of less than one year for the established fee
(lease payments).
Parties to the financial leasing agreement. While both an
individual and a legal entity can be a lessee, only a legal entity
can enter into a financial leasing agreement as a lessor. Moreover,
pursuant to the On Financial Services and State Regulation of
Financial Services Market Act of Ukraine (the Financial Services
Act) financial leasing is considered a type of financial service;
and restrictions envisaged to these services, inter alia, concerning
providers of the financial services also apply to financial leasing.
Thus, in the event that the lessor has already concluded three or
more financial leasing agreements during a calendar year, or the
aggregate value of such agreements comes to UAH 80,000 or
more, the lessor should either have the status of a financial institution
according to the prescriptions of Financial Services Act or
be registered by the State Commission of Ukraine on Financial
Services Markets Regulation pursuant to the Regulation of the
above Commission No.21 dated 22 January 2001.
The parties to the financial leasing should come to an agreement
concerning the object of the financial leasing agreement,
the term of leasing, the leasing payments and other provisions at
the demand of the party. Should the parties fail to set out in the
agreement all the essential terms and conditions the agreement
may be regarded as not having been executed.
In Ukraine an asset classified as a fixed asset can be the
object of a lease agreement. Land plots and other natural objects
(fo rests, water objects, natural resources, etc.), integrated property
complexes (production facilities) of enterprises and their
separate divisions (branches, departments, and units) may not be
the object of financial leasing.
Another important issue to be agreed by the parties is the
amount and composition of leasing payments. Pursuant to
le gislation the leasing payments can include: (1) an amount that
reimburses the cost of a leased asset; (2) the lessor’s commission
(fee); (3) compensation of interest on a bank loan; (4) other
expenses incurred by the lessor connected with the fulfilment of
its obligations under the financial leasing agreement. At the same
time, market practice recommends dividing the payments into
two parts: the reimbursement of the cost of the leased asset, and
the lessor’s commission (fee). Such division is evoked by the provisions
of Ukrainian tax legislation, in particular, the difference in
taxation of these two types of payments.
It should be noted that by executing the financial lease agreement
the lessee obtains only the right to use the assets but not the
ownership right. Thus, one important barrier hampering development
of finance leasing is the clause (Point 7 Part 2 Article 11)of the Leasing Act, according to which the object of leasing must
be returned to the lessor upon termination of the financial leasing
agreement. Meanwhile, the law allows repayment of the
lease asset value by the lessee within the leasing payments (Point
a, Part 2 Artic le 16 of the Leasing Act). Therefore, the lessee is
obliged to return the asset to the lessor irrespective of whether he/
she may have repaid the cost of the asset in full or in part during
the financial leasing agreement term. The parties to the financial
leasing agreement may sell the asset to the lessee by executing a
separate sale-purchase contract. To improve this situation changes
to the Leasing Act, by complementing Point 5, Part 2 Article 10 and
Point 7, Part 2 Article 11 with the following phrase “…unless otherwise
provided by the financial leasing agreement”, are necessary.
A review of Ukrainian legislation on financial leasing would
not be complete if we omit the matter of taxation. Financial leasing
agreement should be executed with due attention being given to
tax legislation, since the consequences of improper tax treatment
of a transaction could well outweigh the benefits thereof. First
of all, tax legislation contains specific criteria as regards defining
financial leasing (See On Corporate Profit Tax Act of Ukraine, hereinafter
— the CPT Act). Consequently, the contemplated transaction
should be considered from the point of view of the CPT Act
prior to implementation of the financial leasing agreement.
We would like to emphasize the need to resolve the most
crucial problems that emerged after the amendments to the On
State Budget Act and some other taxation laws were adopted on
25 March 2005. These include:
1. Amendments to the On Value Added Tax Act of Ukraine
(Clause 3.2.2). Charging VAT on the interest and fees within
the financial leasing payment will substantially increase the cost
of leasing services, leaving no chance for leasing companies to
compete with other financial establishments. The interest and fees
are the payment for financial services, on which neither banks nor
insurance companies of Ukraine pay VAT.
2. Amendments to the On Value Added Tax Act of Ukraine
(Clause 7.4.2). The execution of this provision will mean the double
charging of VAT during the purchase of the leasing subject by
the lessor and its transfer to the lessee.
The issue of payment of the 1% duty to the Pension Fund in the
event of the financial leasing of real estate should also be considered.
Thus, Ukrainian state policy regarding the creation of conditions
for attracting foreign and national investment through the
mechanism of financial leasing still raises concerns. There are
a number of things which are holding back the development of
lea sing in Ukraine. The major one is imperfect legislation, particularly
taxation. We understand that the basis for tax pressure on
the leasing business is the justified striving by the state to eliminate
any opportunities for shadow cash flows to pass through a financial
leasing mechanism. Provision of such a powerful and worldwide
acknowledged tax benefit as accelerated depreciation to lessors
only, may create strong incentives for tax optimization. In other
words, in order to reduce tax liabilities, nearly every business may
feel the urge to formally treat any purchase of capital assets as
finance lease, which may be enforced either via its “captive” lessor,
or via another company involved in “pseudo-leasing”. This situation
may be addressed in two ways: (1) accelerated depreciation
introduced for certain categories of fixed assets regardless of the
way in which they have been purchased; or (2) strict government
control exercised over the operations of lessors, in order to preclude
formation of a large “pseudo-leasing” market. As the capacities of
the government’s budget are not likely to allow the introduction of
fast-track depreciation for some types of fixed assets irrespective of
the way they were acquired, option (2) looks more feasible.
This review should be regarded as general guidance through
legislation on financial leasing, and not as detailed research. Each
situation is unique and attracts special consideration and treatment.
Thus, an investment by means of financial leasing requires
profound collaboration with a legal adviser. The legal adviser may
review the capacity of the parties to be involved in the financial
leasing, conduct due diligence of the target assets, develop the
most appropriate scheme of financial leasing and transaction
documents and provide transaction support.
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