Leasing incentives and tax implications

When considering entering into a commercial lease both landlords and tenants should seek to ensure that they are obtaining as much benefit as possible from offering or accepting a leasing incentive.

Leasing incentives can have both GST and income tax consequences for landlords and tenants and these implications need to be considered carefully in the negotiation stages of entering into a lease.

Forms of incentives

Leasing incentives can take many forms, this article will focus on three types of incentives:

  • the provision of a rent free period to the tenant;

  • a cash payment to the tenant as a contribution to its fitout; and

  • a cash payment to the tenant which is not linked to the fitout and can be used by the tenant as it wishes.

Clearly, there are many variables which will affect a party’s tax position and this will differ on a case by case basis.  This article provides general advice only and may not be applicable in all circumstances. 

Rent free periods

A rent free period is perhaps the most commonly used leasing incentive in the Perth commercial leasing market.  Landlords will often provide the tenant with a rent free period of anywhere up to 12 months in order to induce a tenant to enter into a lease.

If the rent free period is part of the negotiation of the original terms of the lease, the tenant does not pay any GST for the rent free period, as the tenant does not pay rent for that period, and the landlord does not receive the payment of rent and as a consequence does not receive any GST.

From an income tax perspective, the landlord does not receive a deduction for the period in which rent is not payable by the tenant and the benefit of the rent free period is not assessable as income to the tenant.  

The position maybe different if the landlord is offering a rent free period on an existing lease in exchange for the tenant entering into a new lease. 

In these circumstances the income tax consequences are the same as set out above, but for GST purposes, both the landlord and the tenant are deemed to be making a taxable supply and both must pay GST.  Both the landlord and the tenant can then claim input tax credits in relation to the incentives they receive from each other.

The release of the tenant by the landlord from rent obligations in return for entering into a new lease is deemed to be a taxable supply from the landlord to the tenant.  Similarly, the tenant makes a taxable supply by entering into the new lease for the consideration of being released from rent payments.

Cash payment to tenant as contribution to fitout

Commonly, a landlord will make a cash contribution to the tenant to be used by the tenant in the fitout of the premises.  Often in these circumstances, the tenant undertakes the fitout and retains ownership of that fitout.

The landlord is able to claim an input tax credit for the supply of the payment.  This is because the tenant makes a taxable supply of entry into a lease in return for the payment.  The tenant must issue a tax invoice to the landlord and must remit the GST.

The fact that the tenant has ownership of the fitout means that the payment by the landlord is treated as a deductable cash contribution for the landlord’s taxation purposes. 

The payment to the tenant is assessable as income for the tenant.  As the tenant owns the fitout in the premises, the tenant may be able to claim depreciation and capital works deductions in respect of the fitout.  The tenant will usually do this on an item by item basis.

Cash payments to be used as the tenant wishes

When a landlord makes a cash payment to a tenant for no specific reason other than as consideration for entering into a lease this payment will be dealt with as an input tax credit for the landlord for GST purposes.  The tenant makes a taxable supply to the landlord, being the entry into the lease, for the cash payment.  The tenant must issue a tax invoice to the landlord for the payment and must remit the GST.

Considering the income tax and GST implications of a leasing incentive is an important aspect of any negotiation between a landlord and a tenant.  There are many variables which impact on whether payments are treated as taxable income or as deductions.  To avoid any unexpected tax implications, it is important to ensure that specific advice is obtained prior to finalising leasing negotiations.