Commercial property lease inducements and surrender payments – Beware of the tax issues!

Property

"Sweeteners" are increasingly common in the current commercial property leasing environment, especially in Christchurch with the influx of space available. However, with the tax obligations they may not be as sweet as they first seem.

The rebuild in Christchurch is continuing at great pace. We are seeing a lot of activity amongst our commercial clients, with many of them investing in commercial and industrial property. There is also a significant amount of leasing activing, particularly in industrial areas and also in the CBD.

Lease inducements of one kind or another are common in Christchurch at the moment. Lease inducements include “sweeteners” for a tenant, such as cash inducements, contributions to fit out, and rent free periods. Previously, lease inducements were tax free in the hands of the tenant, but following substantial reform in this area of the law over recent years, tenants now have to pay tax on any lease inducements they receive.

The concept of taxing lease inducements has been discussed since the late 1990s, but was not such an issue during the economic boom of the mid 2000s (when there was more competition for space and therefore lease inducements were not so common). With events such as the GFC and the Canterbury earthquakes taking a toll on the Government coffers, the Government is now increasingly keen to extract as many dollars as it can from the tax system.

Under the current law, lease inducement payments are treated as taxable income in the hands of tenants and as deductible payments for the landlord. This differs from the past situation where cash payments were tax deductible for the payer (typically the landlord) but non-taxable for the recipient (tenant).

Historically, lease surrender payments (where a tenant pays a landlord money to exit a lease early) were regarded as income to landlords but non-deductible to tenants. Now, lease surrender payments are treated as deductible payments for tenants and income for the landlord.

At the moment, given the supply of commercial and industrial space in Christchurch, lease incentives are more common than lease surrender payments. Accordingly, when negotiating an Agreement to Lease or a surrender payment, whether you are the landlord or the tenant, it is important to be clear on the tax status of such payments.

We are happy to assist with this, but we also strongly advise our clients to speak with their accountant given that this can be a tricky area. Agreements to Lease are often treated as a “pro forma” document, but there are many suggested modifications to achieve a better long term outcome (bearing in mind that your leasing arrangement may go on for 10-15 years!) As always, it is best to understand your obligations early, thereby avoiding any nasty surprises down the track! Please feel free to contact us for expert advice.

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