Lease inducement and surrender payments

Introduction

Recent tax reforms provide for changes to the taxation of lease inducement and lease surrender payments. This article outlines these reforms, which apply from 1 April 2013. 

The new rules only apply to commercial leases. Residential lease payments are expressly excluded from the new rules. 

Lease inducement payments

The previous position

Before 1 April 2013, a landlord could often claim an income tax deduction for a lease inducement payment, while the tenant would treat the payment as a non-taxable capital receipt. As a result, the tenant might have agreed to a higher level of rent. The result being that the tenant was in a better position after tax while the landlord was in the same position. 

Lease inducement payments were used by landlords to attract prospective tenants to enter into commercial leases, particularly during economic downturns. 

In the leading case in this area, CIR v Wattie, the parties had entered into a commercial lease together with an inducement agreement (providing for a lease inducement payment). IRD argued that the lease inducement payment was taxable. This was rejected by the Privy Council which agreed with the Court of Appeal and held that the lease inducement payment was paid for the tenant undertaking an onerous lease for a substantial period, and so was capital in nature. 

The current position

The new rule removes the tax advantage to the tenant of a lease inducement payment. These payments are now treated as taxable income in the hands of the tenant and deductible to the landlord. 

Lease surrender payments

The previous position for lease surrender payments was that these payments were taxable to any landlord that was in the business of leasing property (with some exceptions), and not deductible to the tenant. 

Lease surrender payments will, from 1 April 2013, also be treated as taxable income in the hands of the recipient and deductible to the paying entity. 

Application

These changes apply to: 

• Lease inducement payments on commercial leases entered into on or after 1 April 2013. Payments made on or after 1 April 2013 will not be affected by the new rules if the agreement to lease was entered into before that date; and
• Surrender payments made on or after 1 April 2013 (even if the agreement to surrender was entered into before 1 April 2013). 

The lease inducement payment changes apply to leases as well as sub-leases, licences and easements. 

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