Income Tax Implications of Lease Incentives
Lease incentives have been making their way back into the commercial property market. The most common ways in which a landlord may offer lease incentives are...
- provide a rent-free period;
- offer a cash incentive; or
- contribute to the tenant’s relocation and/or fit-out costs. The income tax implications of these options may be significantly different and should be carefully considered.
If the landlord grants the tenant a rent-free period, the foregone rent is neither a tax deduction nor assessable income to the landlord but other operating expenses incurred by the landlord will continue to be tax-deductible to the extent that the expense is not capital in nature. If the expense is capital in nature, the landlord may be able to claim a depreciation or capital works deduction in respect of the expenditure.
A cash incentive paid by the landlord to the tenant will generally be tax-deductible to the landlord upfront. However, the cash incentive will generally be assessable income in the tenant’s hands. The law is not entirely settled on this point but even if the cash incentive is not characterised as income, it is likely that the incentive will be treated as a taxable capital gain. The same treatment applies to cash incentives that are paid to induce and encourage the tenant to vary the lease to take up more space, relocate within the same property, or stay in the same premises.
If the landlord pays the tenant a cash amount to contribute towards the tenant’s relocation costs, the relocation contribution will be tax-deductible upfront to the landlord. For the tenant, the cash contribution will be treated as assessable income in the tenant’s hands like a cash incentive. However, the tenant may claim a tax deduction on the actual relocation costs incurred to offset the contribution assessed, depending on the nature of the thing that was relocated. If the contribution is made by the landlord directly to a third party, eg, if the landlord pays the removalists directly, the tax outcome will essentially be the same as if a cash contribution is made by the landlord to the tenant.
The income tax treatment of a fit-out contribution is even more complicated and will depend on how the fit-out contribution is made and whether the fit-out will be owned by the landlord or the tenant.
Provision of fit-out
If the landlord acquires the fit-out directly from a third party and retains ownership of it, the fit-out contribution will be treated as a capital expenditure incurred by the landlord, which will allow the landlord to claim depreciation and/or capital works deductions. The fit-out contribution will not be treated as assessable income to the tenant. If the landlord acquires the fit-out directly from a third party but the ownership of the fit-out is immediately passed onto the tenant, the landlord will be entitled to a tax-deduction on the fit-out costs upfront. The tenant will be assessed on the market value of the fit-out as income but will be entitled to claim depreciation and capital works deductions on the fit-out costs.
Provision of cash contribution
Likewise, if the landlord provides a cash contribution to the tenant to contribute to the fit-out costs but the fit-out belongs to the landlord, the landlord may claim depreciation and capital works deductions on the cash contribution and the contribution will be tax-free to the tenant. However, if the landlord provides a fit-out contribution to the tenant as a cash payment and the ownership of the fit-out is passed onto the tenant, the landlord will be entitled to claim a tax-deduction on the cash contribution. For the tenant, the cash contribution will be assessed as income but the tenant may then claim depreciation or capital works deductions to offset the assessable contribution.
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