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Tax likely on lease sweetener

Tax likely on landlords' lease inducements

Last updated 18:14 01/08/2012
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STUNG: Inland Revenue wants to tax the lease inducements commercial landlords pay tenants.

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Inland Revenue wants to tax the lease inducements commercial landlords pay tenants to encourage them to enter into a commercial lease.

This is likely to be a controversial step, PricewaterhouseCoopers tax partner Geof Nightingale says.

In an issues paper released last week, Inland Revenue argues that because the inducement payment is tax-deductible for the landlord, and non-taxable in the hands of the tenant, it creates a tax advantage and poses a risk to the Government's revenue base.

Landlords of commercial property use lease inducements to attract high-quality anchor tenants to sign long-term leases.

A landlord may pay a lump sum of several million dollars to induce a large business to sign a long-term, say 12-year, lease for its head office.

The payment is made when the tenant signs the lease and does not affect the rent payable.

Nightingale says the proposed change is a sign of the Government's intent to maximise revenue out of the existing tax system, as indicated in the 2012 Budget.

The proposed tax on lease inducements is almost certain to go ahead, Nightingale says.

"The Government's consulting on it, but I'd be very surprised if it didn't proceed. They're chasing every last dollar of tax revenue at the moment.

"I suspect submissions will have an influence on the design, but it won't change their mind that they're going to do it.

"They're pretty committed, this Government, to meeting fiscal targets by 2015, so they're squeezing things pretty tightly."

If the measure is passed into law - which could be about mid- year 2013, Nightingale believes - it would apply retroactively. The tax benefit of the lease inducement arrangement will disappear and the landlord or the tenant will lose out.

"So if the landlord is to bear the cost, essentially, let's say they were going to pay a $1 million inducement payment to someone that would have been tax-free, to get the same inducement payment value into the hands of the tenant, they would have to gross up the $1m by the tax.

"On the other hand, if the tenant suffers the cost, instead of the tenant getting $1m in their hands tax-free, they'd get $1m taxable - only $720,000 in their hands."

So who will suffer the cost? Nightingale says it will depend on the negotiating power between the landlord and the tenant in each case.

Britain, Ireland and Canada have passed laws to make these payments taxable.

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The other asymmetry the Government should address at the same time is the non- deductibility to tenants of lease termination payments, which are taxable to landlords when received, Nightingale says.

Following the same reasoning, tenants' lease termination payments should be tax-deductible, because the termination payment in the hands of the landlord is taxable, so it's the mirror image of the inducement.

Stakeholders must make submissions before August 31 and Nightingale thinks it likely the measure could be in a tax bill by November.

Nightingale thinks the law change is likely to deter people from using this method of encouraging anchor tenants and they will find others, such as contributions to fitout or rent holidays.

"It will have a behavioural changing effect, so it won't necessarily raise lots of tax - it'll just stop people from using it."

- The Press


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