Car Lease

From many of my co-students here, I learnt that various software companies are following a unique incentive scheme - owning car through company lease. It works something like this. The company leases out to the employee the car of his choice. The car will be in the name of the company and the lease payments are cut from his salary. At the end of say 3 or 4 years, the employee has to pay the salvage value at that point of time and get the car transferred into his name.

As per the tax laws, the company provides conveyance to the employees which can be treated as expenses in the profit-loss account. Instead of charging it to expenses under wages & salaries, the company charges the expenses to the conveyance account. Or if someone wants to treat it differently, the car can be capitalized to fixed assets and can be depreciated every year over its useful life. Now, instead of the wages & salaries, the expenses are under depreciation.

This is just one part of the story. The other part of the story is that the income of the employee is reduced, because the lease payments are not made out of his pocket. So, the employee will be paying less income tax.

We shall come back to the company’s side now. Since the company is providing car with fuel, maintenance etc (that’s what the scenario as per the accounts), the company is liable to pay the FBT at the rate of 20% over 20% of the expenses which works out to be a net of 4% on the total expenses. If this option is not provided by the company, the company would not have needed to pay this 4%. So, logically this has to be passed on to the employee. Also, if this option is not provided, the employee has to take a loan for his car at the market rate or pay out of his pocket. Adding to that, he will not be able to save the income tax. So, naturally the lease rent payable will be greater than the market rate. That is because the company is under no obligation to provide this option. Since it has designed such an exotic option, it wants to have its pie too.

I have made a simple calculation taking car’s price to be INR 400,000 and recurring expenses of INR 2,500. If someone decides to use the car for a 4 year period, one can save around 18% of total expenses under the lease option. The company also earns a 10% in the present value terms. This calculation is based on some assumptions which are also clearly stated in the calculation.

Excel sheet is uploaded.

Educational Loan

I am studying a course on Financial Management as a part of our third term here at IIM Lucknow. In that, we get acquainted to concepts like present value, discount rates, cash flows etc. I just thought about applying these principles to an educational loan.

Below, I make a comparison of paying out now v taking an educational loan.

Assume that you have taken an educational of Rs 2,00,000 on 1st Jan 2009. The interest on educational loan is calculated assuming simple interest till the course gets over and after that the interest is compounded. Lets us assume that the course gets over in March 2010. So, the interest accrued at the end of March 2010 is Rs 25,000 (S.I @ 10% for 15 months). From April 2010, the principal and interest = Rs. 225000 has to be repaid in EMI. Suppose, if the tenure of repayment is 5 years, the EMI (compounded monthly) comes to be Rs 4780.59

As per the existing Income Tax rules in India, the interest on educational loan is tax exempted. Taking that into account, the present value of cash outflows from our hand is Rs 184862.6. If it has to be paid out now, one has to pay Rs 200000. This means, one saves a little over Rs 15000 as on today’s value by taking an educational loan of Rs 200000

I have made a simple model of the same in google spreadsheet.

Views, comments and criticisms are invited.