The income tax implications of property lease incentives
Lease incentives are commonly used by landlords to entice tenants to enter into a lease. The most common type of lease incentive relates to new tenancies in commercial buildings.
These inducements can take many forms, including upfront cash payments, non-cash items such as motor vehicles or boats, expensive paintings or holiday packages.
Also on offer are rent-free or rent-discounted periods for the leased premises or for premises in other cities, free fit-out of the premises, payment of removal costs or for the surrender of any existing leased premises, and interest-free loans. The enticements can even be a combination of any of the above.
What are the income tax implications?
The income tax treatment however of such lease incentives can vary depending on the nature of the incentive provided.
For tenants in receipt of a lease incentive, it must be determined as to whether the incentive is assessable in their hands as “ordinary income” or alternatively under a specific tax provision. Certain incentives may not be assessable.
Further, the incentive may affect the extent to which certain tenancy costs are deductible to the tenant.
The circumstances in which certain lease incentives are assessable to the tenant have been established based on a body of case law. As a general rule, lease incentives received by a tenant would be treated as assessable income in their hands.
For cash incentives, the Tax Office considers that the receipt would typically be assessed as ordinary income. This applies irrespective of whether what is offered is an incentive to:
- move into a new building
- stay in an existing building
- to take up additional floor space, or
- a relocation in the same building.
Non-cash incentives such as motor vehicles, boats, expensive artworks and paintings and other benefits, which can be converted into cash, will be taxable at their full money value.
The law would ordinarily assess taxpayers on the receipt of a non-cash benefit as if it were convertible into cash. The value assessed would generally be the arm’s length value less any consideration paid. It should be noted, however, that the assessable amount would be reduced to the extent that:
- the cost of the benefit, if it had been incurred by the tenant, would have been deductible, or
- the provider of the benefit would not be entitled to a deduction for the cost of the benefit provided (such as where the expenditure would constitute entertainment).
Further, a deduction for depreciation will generally be available if the item is used to produce assessable income.
The receipt of a rent-free period will typically not be subject to tax. The receipt of a rent free period or reduced rent incentive from a landlord would result in an assessable amount, but a deduction equal to the value of the incentive would also be available. The net effect is that no amount would be assessed to the lessee.
For other non-cash incentives (such as free fitouts, holidays, interest free loans, free plant, holiday packages, etc), the tax treatment can vary.
For example, the receipt of an interest-free loan is generally treated as tax-free if it is a genuine business loan.
Free fit-out is typically assessable on value provided, and a capital allowance deduction may be available if the tenant becomes the “holder” of the fit-out. Conversely, the fit-out may not be assessable if it is owned by the landlord instead. Removal expenses are normally assessable.
The table below sets out the tax treatment for the tenant in respect of certain types of lease incentives received.
For landlords, the primary tax issue is typically whether the provision of the incentive would be an allowable deduction either under the general deduction rules or some other provision under the law (such as the capital allowance provisions).
As a general proposition, the provision of lease incentives should give rise to an allowable deduction if the landlord is in the business of leasing properties. This is so provided that the outgoing is not capital or private and domestic in nature.
Note that the general anti-avoidance provisions may apply where the provision of lease incentives is for the purposes of benefiting an associate of the landlord or shifting income to an associate.
For interest-free loans, no amounts would be treated as being deductible for both principal and foregone interest. Rent-free periods are also not deductible, as rent foregone is not a loss or an outgoing.
For free fit-outs, if the landlord owns the fit-out, a capital allowance deduction is permitted. The gift of a free holiday is treated as an entertainment expense, and is therefore not deductible. Removal expenses however are deductible.
The relevant lease incentive should be properly documented as part of the lease agreement. Your solicitor should be able to assist in this regard. Note that there are also possible GST considerations. If this applies to your situation and you would like some specialist advice, please contact our office on 02 6621 8544.