Further changes to the taxation of lease payments

Introduction

There have been a number of changes in relation to lease inducement and lease surrender payments in 2013. Previously, lump sum payments to terminate or to induce entry into leases were treated as capital even though these payments were generally in substitution for rental income. From 1 April 2013, these payments are no longer treated as capital. Inland Revenue is now proposing broader changes to payments relating to leases, other interests in land, and licences to use land.

Proposed changes

The broad principle underlying the proposal is that a payment to acquire, dispose of, or terminate an interest in land or a licence to use land should be treated as income to the recipient and (if the deductibility tests are met) as deductible to the payer. This rule applies even where such amounts  would ordinarily be of a capital nature. A new rule would allocate income or expenditure (as the case may be) evenly over the life of the relevant right for the recipient or payer.

The latest proposals, if passed into law, will affect tax treatment of payments relating to land rights: 

• From 1 April 2014 at the earliest;
• With a life of less than 50 years (not including periods of renewal or extension);
• In relation to commercial leases and other land rights (but does not apply to residential tenancies).  

There is a matching deduction provision which would apply to such payments. As part of "rationalising" the existing rules, the "right to use land" category of depreciable intangible property would be repealed.

Examples

Some examples of application include:

• Contributions toward fit-out costs; 
• Payments associated with the assignment of a lease. Where an incoming tenant is making a  payment for the transfer of a lease with a term  of less than 50 years, the payment would result in taxable income to the exiting tenant. The exiting tenant would be required to return its income when derived because it is exiting the lease and has no remaining term over which to spread the income. The incoming tenant would be required to spread the expenditure over the remaining term of the lease. 

Under current law, the assignment payment would generally be a non-taxable capital receipt for the exiting tenant and depreciable to the incoming tenant.

Conclusion

Landlords and tenants need to be aware that the tax treatment of lump sum payments relating to commercial leases or other land rights is now subject to two separate stages of reform, each with a different application date.

If you would like further information please contact Dale Thomas on 07 958 7428.