The Inland Revenue has proposed further reforms to the tax treatment of
payments relating to leases and other interests in land. The reforms were first
signalled last year in the context of the reforms to the treatment of lease
inducement and surrender payments (please see our earlier article for further details about those
reforms). These latest proposals will similarly be relevant to many lessees and
lessors of commercial property.
The Inland Revenue's Issues Paper in which the proposed reforms were
announced can be found here. This article summarises the key aspects of the
Lease transfer payments
Payments received by a lessee for the transfer or assignment of its interest
in a lease (referred to in the paper as lease transfer payments) are a
particular focus of the proposals. Generally, such a payment will be regarded as
a capital, non-taxable receipt in the hands of a lessee (the rationale being
that the lease is typically a capital asset of the lessee). However, the
incoming lessee usually obtains a deduction for the payment under the
The Inland Revenue is concerned that this asymmetrical treatment (non-taxable
to the recipient but deductible to the payer), and the fact that lease surrender
payments will become taxable in the hands of a lessee (assuming the current
reforms before Parliament are enacted), may lead to distortions in taxpayer
behaviour. A lessee would in theory be incentivised from a tax perspective to
transfer a lease to a new tenant rather than surrender it to a lessor for a
surrender payment. Whether this is a likely outcome in practice (at least to any
significant degree) is debatable but the theory at least is hard to dispute.
The Inland Revenue therefore proposes to make lease transfer payments taxable
in the hands of lessees, in effect legislating away their "capital" nature.
Matching legislative confirmation of the deductibility of the payment to the
incoming lessee would be introduced.
The tax treatment of lease transfer payments is not the sole focus of the
Inland Revenue's Issues Paper, however. The Inland Revenue notes that the
taxation of land-related lease payments has been the subject of ad hoc reforms
over the years which have resulted in inconsistencies and incoherent outcomes
for taxpayers. Lease transfer payments are one example but others are noted.
Lease premiums are taxable to a lessor, the lessor being able to spread the
taxable income over a six year period if the Commissioner's consent is obtained.
This spreading rule does not match the spreading of the deduction (usually)
available to the lessee making the premium payment and is inconsistent with the
spreading rules about to be introduced for lease inducement and surrender
Fit-out contributions are another example. A lessee that receives a fit-out
contribution can elect to treat the payment as taxable income spread over a ten
year period, or to reduce the cost base of the assets acquired for depreciation
The Inland Revenue therefore proposes to rationalise the tax treatment of
land-related lease payments under one set of rules. Put simply, under the new
rules any land-related lease payment would be treated as taxable to the
recipient and deductible to the payer. In effect, as the Inland Revenue states,
leases (or licences) of land would be put on revenue account. New timing rules
would be introduced to spread income and deductions over the term of the
relevant land right in a consistent fashion.
The reforms would not apply to payments derived by most lessees of
residential premises. Nor would they apply to payments (other than rent) in
respect of an interest in land with a term of 50 years or more (such as a
Further details of proposed reforms
To effect the reforms the Inland Revenue proposes to replace existing section
CC 1 of the Income Tax Act 2007 with a new charging provision. That
provision would treat all land-related lease payments derived by a person as
The provision would apply where a person derives an amount in relation to a
right in land that is an estate in, or a licence to use, land (the land
right) and that person:
owns the land right or the land in respect of which that right is granted; or
obtains the land right or used to own the land right,
and where the amount is in the nature of rent or the land right has a period
of less than 50 years.
Examples noted by the Inland Revenue of amounts derived in connection with a
land right would include a fine, a premium or inducement payment, a payment for
breach of a covenant and a payment for termination or transfer of the land
right. Fit-out contributions are also specifically noted by the Inland Revenue
as payments that will be covered by the new rules.
As mentioned, the new provision will not apply to residential tenancies (at
least where the tenant is a natural person). Other exclusions from the reforms
amounts derived as compensation for a loss in relation to a land right;
payments relating to forestry, petroleum mining and other mining licences to
which other provisions of the Income Tax Act apply.
The Issues Paper proposes a matching deduction provision for the payer of a
land-related lease payment.
Spreading provisions will be introduced to spread income derived and
expenditure incurred evenly over the period between the point the relevant
payment is derived or incurred and the end of the term of the land right to
which the income or expenditure relates. For the purpose of the timing rules,
the term of a land right would not include renewals or extensions of that term.
The Issues Paper states that, if these proposals do proceed, they would apply
to payments derived or incurred on or after the 1 April date following the
enactment of the relevant legislation.
Submissions on the Issues Paper are requested by the Inland Revenue by 4 June
2013. In particular the Inland Revenue seeks views on:
whether presently non-taxable lease transfer payments should be made taxable
in light of the recent lease surrender payments reform;
whether any aspect of the proposals could be improved upon to provide a more
consistent and coherent tax treatment of land-related lease payments;
transitional issues arising from the proposals; and
compliance cost implications of the proposed reforms.
This publication is necessarily brief and general in nature. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.