Inbox: Lease incentives’ tax twists

Although the commercial property market is in recovery mode, tenants still hold the balance of power when it comes to office accommodation and most are using it to secure incentives from landlords when leases are being entered into or renegotiated. However, businesses should be aware of the tax implications of different types of inducements.
PwC partner Mark Russell says the tax position of the tenant varies significantly depending on the form of the incentive. The most commonly used is rent-free period at the beginning of the lease. Rent “holidays” have the benefit of being easy to arrange and administer and do not require an upfront cash payment by the landlord.
However, Russell says while they are the most convenient from property owner’s perspective, they are the least tax effective for tenant. rent holiday reduces the deductible expenses of the tenant, so in effect the value of the holiday is taxable to the tenant over the period of the holiday, which can be anything from several months to over year depending on the length of the lease.
Cash inducements are also popular. In some cases the payment is specifically made as contribution to fitout costs, and in other cases there is no requirement as to how the money is spent. These payments are particularly attractive to businesses looking to fund an expensive new fitout.
Russell says fitout contributions are significantly more tax effective than rent holidays, while general inducement payments are the most tax-effective of all. “A lease inducement payment that is not contractually tied to fitout requirement is generally regarded as non-taxable capital receipt to the tenant, provided the rental under the lease is market rental.”
However, Russell cautions that since lease inducements can provide tax advantage to the tenant, they are open to scrutiny by Inland Revenue. “It is therefore critical that such arrangements are strictly on commercial terms, that the basis for the inducement has been properly recorded and that the rent payable under the lease is market rent that has not been increased to compensate for the inducement payment.” M