The Financial Lease, Leasing and Ijarah

According to Article 54 of the Tax Code of Uzbekistan, under Financial Lease the Lessor transfers the right of ownership and operation upon the Financial Lease object for a period of more than 12 (twelve months).

Herewith, the Financial Lease must meet at least one of the following requirements:

• Financial lease object shall be transferred to the Lessee;
• final cost of the Financial Lease object at the end of the Financial Lease agreement is less than 20 percent of its initial cost;
• the lessee has the right to pay for the object of the Financial Lease at a fixed price;
• discounted payments exceed 90% of the current value of the object.

The Tax Code identifies Leasing as a type of Financial Lease, which is used as a cumulative term for Financial Lease and Leasing.

LEASE:

According to the same Article 54 of the Tax Code of Uzbekistan, under Leasing the Lessor undertakes to enter into an agreement with a third-party seller to acquire property for the Lessee, and, in turn, the Lessee undertakes to pay lease payments to the Lessor. As a Financial lease does, the Leasing must meet one of the requirements for the former stipulated above. As opposed to the Financial Lease, the Lessor in the Leasing shall acquire the Lease object from a third party for and on behalf of the Lessee.

IJARAH:

Under the concept of Ijarah in Islamic financing, a customer can use an asset or equipment, which is owned by an Islamic bank, for a fixed period against a fixed price. Although the nature of the Ijarah is the same as the Financial Lease, the former does not contain an obligation of the Lessor to transfer the ownership title to the Lessee and the Lessor bears the responsibility to reimburse expenses associated with keeping the Lease object.

Nowadays, financing services based on Islamic mechanisms are being provided by many financial institutions and part of such financing – Ijarah has a tendency to become even more popular in Uzbekistan. In terms of its structure, Ijarah is similar to the Leasing, but there are a number of fundamental differences as discussed in detail below.

DIFFERENCES

Holding the status of ownership

Financial lease:

According to Article 2 of the Law “On Leasing” No. 756-I dated April 14, 1999 (the “Law on Leasing”), Leasing is carried out under a three-party (Seller – Lessor – Lessee) or two-party (Lessor – Lessee) Leasing agreement. That is, the Lessor can lease the object of leasing to the Lessee without holding the ownership rights to the Leased object. The following actions are carried out at the same time by signing the relevant tripartite agreement:

• the Seller transfers the ownership of the object of Sale to the Lessor;
• simultaneously, the object of Sale shall be leased to the Lessee by the Lessor.

Ijarah:

However, if the ownership right is not held by the financing institution, but by a third party, then the ownership right to the Ijarah object must first be acquired by the financing institution, because according to Rule No. 3/1/2 of the Accounting and Auditing Organization for Islamic Financial Institutions Shariah Standards (the “AAOIFI Shariah Standards”) “the disposal of property that is not owned is prohibited”.

Transfer of ownership rights

Financial leasing:

According to Article 2 of the Law on Leasing, the right to the leased object is automatically transferred to the Lessee upon the expiry of the leasing payment period. Herewith, as far as the Lessee makes the last payment in the schedule specified in the Leasing Agreement, the right of ownership to the leased object shall be transferred directly from the Lessor to the Lessee without any additional agreements. In practice, this is achieved by signing the bilateral transfer-acceptance act by the parties.

Ijarah:

In terms of Ijarah, the ownership right to the lease object shall not be transferred automatically to the Lessee. According to Rule No. 8.1 of the AAOIFI Shariah Standards, ownership rights can be transferred only through a separate document. That is, as far as the Lessee makes the last payment in the schedule specified in the Ijarah Agreement, the property shall be transferred to the Lessee by signing a separate gift or sales contract for a symbolic price.

Penalty

Financial leasing:

According to the content of Article 263 of the Civil Code, the creditor (in our case, the Lessor) has the right to demand a penalty (forfeit or fine) from the debtor (in our case, the Lessee). The parties may set a penalty clause in Leasing agreements.

Ijarah:

According to Rule No. 2/1/2 of AAOIFI Shariah Standards charging an additional fee for improper performance of contractual obligations is prohibited by Islamic financing principles. Nonetheless, modern Islamic scholars admit the usage of such fines as a preventive mechanism to ensure contractual discipline, and such payments must not be assessed as income of the financing institution but must be used for charitable purposes in the future (Resolutions of the International Islamic Fiqh Academy: Resolution No. 109 (3/12) on Penalty Clause).

Risk-sharing

Financial lease:

According to Article 19 of the Law on Leasing, the Lessee bears the risks associated with the Lease object, including the risks of its accidental loss (destruction), as well as theft, wreck, and damage, as agreed by the parties in the leasing contract. Herewith, the risks pass to the Lessee from the moment of receiving the object of the lease.

Ijarah:

In Islamic financing, According to Rule 5/1/8 of AAOIFI Shariah Standards, the risk of the leased object remains with the Lessor until the ownership of the leased object is transferred to the Lessee. In other words, the lease object is the responsibility of the Lessor: all costs related to risk management and capital repairs cannot be charged from the Lessee. Therefore, although the Lessor is permitted to take out insurance on the lease object whenever possible, such insurance expenses must be borne by the Lessor.

The table is a brief illustration of the differences between the Financial Lease and an Ijarah: