The days of low vacancy rates and high rents are well and truly over. As a consequence lease incentives are increasing in regularity as landlords compete for tenants.
It is important to ensure that any incentive is worded correctly so that it has the effect the parties intent and does not lead to a dispute. Further, there can be large differences in the way that different types of incentives are treated for tax purposes. Tenants and Landlords should discuss incentives with their accountants to make sure they are getting their money’s worth by structuring the incentive in the most tax effective way.
Incentives can take many forms. Some of the most common ones are:
1. Rent Abatements
A rent free or rent reduced rent period is probably the most common incentive. It is important to consider what is being offered in negotiations. Usually other payments such as outgoings or promotion funds are still required during this period however if it is not clear a dispute can arise.
Rent abatements are effectively tax free. The disadvantage of rent abatements is that the tenant can be required to take the incentive over a number of months or years. A tenant often needs an injection of cash at the lease commencement to help with the costs of its fit out. It may be that the tenant is better off requesting a lump sum payment for cash flow reasons.
2. Lump Sum Payments
It is not uncommon for a landlord to give the tenant a cash incentive to enter into the lease. A carefully worded clause in the lease is essential to deal with issues such as what must the cash be used for, when must it be used, how will it be paid, if used for fit out who owns that fit out, when if at all is the incentive refundable, what happens if the tents breaches the lease. GST is also an important factor to be considered.
Courts have previously held that cash incentives are generally treated as income in the tenant’s hands and are liable to income tax. This may erode the benefit of the incentive. For example, if a corporate tenant is paid $100,000 as a lump sum incentive, based on the current company tax rate of 30%, the value of the incentive would be eroded to $70,000.
3. Free Fit Outs
Another popular form of incentive is a free fit out. Again the lease needs to deal with ownership, maintenance and replacement. The tax treatment of this type of incentive will depend on who owns the fit out.
For example, a free fit out which is owned by the landlord is generally tax free for the tenant. In many instances this is a popular type of incentive for landlords as it may enable the landlord to claim depreciation in relation to plant and equipment forming part of the fit out. The tenant will need specialist advice about the situation if the tenant has an obligation to remove the fit out at the end of the lease term.
A free fit out which is owned by the tenant or the tenant has the right to remove may be assessable to the tenant, however it may be open to the tenant to claim a deduction for depreciation.
The tax implications for this type of incentive usually comes down to the exact wording of the clause so these types of provisions in leases often need to be carefully crafted to ensure that they reflect the agreed position on which party is to bear any tax liability.
Conclusion
Whether you are a landlord or tenant, the next time you are negotiating a lease incentive, seek expert advice from Ferguson Cannon Lawyers about the wording of the lease. There is no sense in negotiating a good incentive only to see that good work wasted due to poor drafting. It is also vital to obtain expert taxation advice about how an incentive will affect your situation. As well as income tax issues, there may be capital gains tax and GST issues associated with lease incentives.
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