Tax Treatment of Commercial Lease Incentive Adjustment for Purchase

I am trying to determine the tax treatment in the following situation.

• A commercial property has a lease incentive in the form of a rent free period and the payment of a contribution to the tenant’s fit out.

• The property is being sold and the purchase price (say $100) has been agreed on the assumption of no lease incentives. The vendor agrees to adjust the purchase settlement amount for the lease incentives so that the amount that the buyer pays on settlement is reduced from the agreed purchase price (of $100) by:

(a) the amount of rent that would have been payable to the owner in the remaining rent free period (if it was not rent free) (say $10); and​

(b) the amount of fit out incentive payable to the tenant (say $5).​

What is the tax treatment of these amounts from the perspective of the purchaser?

(a) Does (a) of $10 get treated as assessable income to the purchaser or is it treated as an adjustment to the cost base of the property so the cost base is $90 ($100 - $10)?​

(b) Does (b) of $5 get treated as assessable income to the purchaser or is it treated as an adjustment to the cost base of the property so the cost base is $95 ($100 - $5)?​

Depending on the answers to the above, perhaps the character of the amounts could be changed if, for example, a simple purchase price was agreed that took into account the adjustment for the incentives and structured in a way that optimises outcome based on preference for capital return or income return?

 

It seems to be part of the purchase price so neither of your a or b.

 

Thanks Terry. So what you are saying is that it should all be reflected in the cost base for the property, so the net amount would be the cost base.

 

Just to mess with your mind, if the lease provides that the tenant must repay the incentive if they assign the lease prior to the end of the first term (not uncommon), then the repayment/recovery of the incentive to you will be income.

 

Legal Database

There is a tax ruling. This suggests specific tax advice may be recommended

 

Thanks, I think the ruling relates to the position of the lessee or lessor but may not consider the perspective of a purchaser.

 

But the buyer and seller both need to consider the ruling for the potential capital / revenue impacts. The ruling doesnt specifically cater for the issue but does address much of the key issue.

The mistake that can be easily made is to consider the acquisition as a single CGT asset and the second mistake is to assume all proceeds are capital. They wont be. The CGT asset also comprises rights. Thus many of the lease matters will be on capital account. However some may be on revenue account....

eg -
Adjustment for lease bond held. Capital
Adjustment for rent paid in advance - Revenue for the buyer. Revenue decrease for seller.
Adjustment for existing agreement to provide a lease incentive - refer to ruling
Adjustment for the prepaid land tax, strata and rates for the land - Revenue
The adjustments may also have a GST effect and the tax invoice should be carefully prepared. Its common to find they are not correctly prepared.

 

Thanks Paul.

I think if we apply this to the initial scenario that would mean a different conclusion to that indicated previously.

That is, any adjustment to the settlement amount where the vendor effectively adjusts the settlement amount by the amount of rent ($10) that would have been payable on the property, if it was not rent free, would be considered revenue in nature. Therefore, this amount ($10) would be treated as assessable income to the purchaser, rather than a lowering of the cost base of the asset ($100 - $10 = $90) and the cost base would remain at $100.

 

I dont know. Each case requires advice.