By Mark Lodder
It’s been widely reported that Inland Revenue and Treasury is proposing a law change to tax lease inducement payments received by prospective tenants.
We can’t be shocked at this move.
Firstly, there is the pressure to protect the tax base and Government revenue.
Secondly, “capital contributions” towards items like building fit-out (which can be viewed as a form of lease inducement) were brought into the tax net a couple of years ago, along with removal of depreciation on buildings.
Thirdly, the tax rules around rent subsidies (which are taxable) can be relatively easily circumvented (or for want of a better word, “disguised”) by structuring property-related incentives as lease inducements. That, and the current lack of tax on lease inducement receipts, when the payer is often entitled to take a tax deduction for the inducement offered, (i.e. “asymmetry”) are offered as the justification for the proposed change.
Let’s suppose the proposals are legislated by Government. If we are to have a conversation around this from a Christchurch perspective, how would it sound?
Surrender and tax
To answer this, it is necessary to also consider the tax implications for lease surrender payments, i.e. penalties that may contractually be required to be paid in the event a tenant decides to exit a lease prior to the full term. The default position is that lease surrender payments are non-deductible for tax purposes, to the tenant, but are generally taxable income to the landlord.
Lease surrender payments aren’t unusual: a business may have outgrown its existing premises, the current lease may be too expensive, you may have more space than you need... or you may simply want to get back into the CBD and support the Christchurch resurgence.
To start the conversation, firstly, there are a significant number of businesses that have had to relocate outside of the Christchurch CBD. Secondly, we have a significant number of businesses that want to relocate back to the CBD, at an appropriate time. All going well, in the medium term, the CBD will be ready for businesses to return. But what if the businesses looking to move back are subject to long-term leases at their current premises? Given the competition and rush to find new premises following the earthquakes, long-term leases in the City outskirts were not unusual.
IRD's asymmetrical system
Joining the dots together, let’s suppose a business is offered a $100,000 lease inducement to come back to the CBD, and commit to the CBD in the longer term, but has to pay an equivalent lease surrender payment to leave its existing premises on the outskirts. At first glance the net cash-flow position looks neutral. However, the tax cost of the move will be $28,000 (i.e. the $100,000 inducement is taxable, in this example at the company rate, but with no corresponding tax deduction for the surrender payment). And for the landlord paying the lease inducement, there is no guarantee that the payment will be deductible, as the changes (surprisingly) do not “lock-in” a tax deduction, unlike assessable income for the tenant.
Leaving aside the fact the tax system is not symmetrical, any tax reform in this area should not be one-sided (as presently proposed, this is clearly in favour of the Government’s tax take, by ignoring the treatment of lease surrender penalties). The proposals need to be balanced.
The other concern I have is the 26 July 2012 start date for the proposals, when there is no legislative authority at present. Businesses entering into new lease arrangements, and commercial property owners, are effectively being asked to take a tax position (which will impact on their provisional tax, etc) based on nothing more than a set of draft proposals.
The potential impact on business looking to move back to the Christchurch CBD, once it is “ready for business”, is a good example of the need for tax policy that is coherent and forward looking, rather than one-sided and retrospective. We hope Officials and Government take heed of these concerns.
*Mark Lodder is tax director at KPMG in Christchurch. To read his previous column on tax tainting provisions affecting the Christchurch rebuild click here.