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Lease Incentives And Their Tax Implications

If you’ve ever looked for a new place for your business, you’ll know that lease incentives are all around.  Developers trying to lease new builds (so they can sell it faster), and other places just trying to compete and get a tenant for their vacant property.

Sounds wonderful, a few hundred grand towards a fitout, rent free periods, helicopters whatever you want. Just sign here and its yours.  But is it? And how does the Tax Office look at these?

Like anything if it sounds too good to be true, it probably is.  In this article I’ll show you how the type of lease incentive you get can give you a very different tax outcome.

Rent free period

As far as tax goes this is the best of the bunch. The rent-free benefit could constitute assessable income.  However, if the landlord just paid you the cash equivalent and you then just paid them the normal amount of rent, you end up with the same net position. That’s where the “otherwise deductible” rules kick in.  Essentially your business would be in the same position whether they give you cash equal to the rent-free period amount, or instead of writing each other cheques you just net the two off and don’t have to pay rent for 6 months.

So this is a win. You don’t have to pay tax on this and neither does the landlord. Yay!

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Fitout Contribution

This one is really common and unfortunately can leave tenants with a tax bill they can’t afford depending on who owns the fitout.

Tenant owns fitout

This is the usual case, essentially the landlord is giving you a big cheque, you go out and spend it on the fitout with things like joinery, electrical, plumbing, tiling etc.  All sounds good, but the amount you received from the landlord is income in the eyes of the tax legislation.

That’s all well and good you might say, but I’ve spent it so I get the deduction for the fitout.  You’d be correct, but the vital piece missing from this is the time over which you get the deduction.  

You see fitouts are subject to a different division of the tax law, division 40 to be precise.  This division does not qualify for the immediate write off (currently $30k) for small business, nor can you self-assess the effective life of the asset.  

In other words you can’t say my lease is 5 x 5, and I’ve got a make good, so I can write this off over 10 years at worst.  The unfortunate reality is that division 40 says the effective life is 40 years.  That means you get to claim a whopping 2.5% of the fitout cost per year (Don’t believe me? Then click this bit right here to get it straight from the tax man himself). Then if you leave the premises; either find a new home, sell the business or shut it down, you then write off the remaining balance of that fitout.  Not overly helpful I’m sure you’ll agree. 

Let’s look at some numbers of the damage this can create.  For example purposes the fitout contribution is $100,000 from the landlord, and the fitout cost the same (what’s the chances of that!);

Taxable income

Fitout Contribution         $100,000

Less Capital works          $2,500 (2.5%)

Taxable Income               $97,500

Tax at 27.5%                    $26,812

That’s right, you pay $26,812 in tax on this fitout contribution in the year you receive it.  

Most likely in the year when you’ve got no cash and the business is in its early stages. So practically that $100k fitout is only worth $73,188 ($100,000 - $26,812).

A big poo sandwich right?  So why is this the most common incentive? 

Because the landlord gets an immediate tax deduction for the incentive so its great for them, and in a lot of cases small business owners don’t have the few hundred grand required to fitout the premises, so it helps them, but the sting in the tail is a big, and usually unexpected one because you’ve gone and spent the full $100G’s and haven’t left any for the tax man.

Landlord Owns Fitout

Another option for fitout incentives is that the landlord owns the fitout up to the amount the contributed, anything over their fitout contribution is yours (because you paid for it).  In this case, you don’t receive “income” and you don’t claim any deduction.  If you’re going to get a fitout incentive this is the one you want, because really – a fitout is worth $0. Nobody is going to say Wow! that’s an amazing fitout can I buy it from you? And you can’t take it with you when you go.

The rub here is that the landlord doesn’t get an immediate tax deduction and instead gets to claim the capital works deduction at 2.5% a year. That’s not terribly exciting for them.


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Interest Free Loans

Honestly, I’ve never seen this happen in practice, but I’m sure some exist.  The agreement is the landlord gives you an interest free loan to fund the fitout and get up and going.  The tax office sees this as ok provided it’s not part of some arrangement where you avoid tax under Part IVA (so if the landlord magically forgave this loan – it’d look a bit suss). 

It doesn’t matter that the loan is interest free because if the monies were used for income generating purposes, you would have been able to claim the interest as a deduction (and the landlord be taxed on the interest) so for the treasury coffers they’re not out of pocket, the technical term is “otherwise deductible”, but that just means you’re sweet.

I guess you’d just make the loan repayments each month along with the rent. The risk here for the landlord is your business is one of the 45% of new businesses that don’t make it and they’ve got to try and get their money back from someone who has gone bust.

Helicopters And Other Non-Cash Benefits

Again, never seen this happen, but I’m sure it's out there.  Here the landlord gives you something – something that’s not a fitout, or cash. 

A non-cash something in the eyes of the tax man is basically treated as convertible to cash and therefore income.  

All that’s happened here is the landlord has skipped the cash part but under the principle of constructive receipt, you’re taken to have received the cash and then spent it on a Bentley or something.  The tax rules have catered for this, so you’ll be taxed as if you received cash.

Conclusion

Lease incentives can be great. And these days they are getting very big. I’ve heard of 50% in some cases, but you need to understand how they are structured so you don’t end up losing a bunch of cash to the tax man.  If you want to have a chat about your new premises contact us before you sign the agreement.


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