Tim Lynch and Andrew Bath outline some considerations for lessors offering incentives for commercial real estate leases.
It is common for lessors to offer incentives in relation to commercial real estate leases such as cash incentives, rent free or discounted periods, fit-out contributions, interest free loans and relocation costs to name a few. The different forms of incentives create different income tax outcomes, which require careful consideration and necessitate regard to the lessee’s circumstances and tax profile.
For example, whilst a tenant may receive ‘free’ fit-out, the contractual mechanics of how this arrangement works may produce different outcomes (including whether the ownership of the fit-out has passed to the tenant or remains with the landlord). In some incentive arrangements, the tenant is responsible for the initial cost and installation (normally, providing the tenant with maximum flexibility) with a later reimbursement from the landlord. If the fit-out consists of division 43 expenditure, rather than just division 40 expenditure, the sequence of expenditure followed by recoupment of that expenditure may necessitate additional analysis and adopt different positions before arriving at the intuitive ‘tax neutral’ conclusion.
Further, delays between the timing of the incurrence of the expenditure and the recoupment of the expenditure can further complicate the outcomes.
In accordance with the decision in Federal Commissioner of Taxation v. Cooling 90 ATC 4472, lease incentives received by a taxpayer in the course of its business activity would generally be treated as assessable income in its hands. Thus, the receipt of cash incentives, which are used to acquire division 40 items, would likely give rise to immediately assessable income, presumably followed by depreciation deductions over time. This gives rise to cash tax implications (and then there’s changes in tax rates during the lease period…)
Non-cash incentives, which can be converted into cash, will be taxable at their full money value (but note the “otherwise deductible” rule in IT 2631).
For most, entering into a new lease is not a common event. Early engagement with your projects team and reviewing the draft contract will enable an assessment of how ‘free’ the ‘rent free’ really is.