In August and September last year we described changes proposed by the Inland
Revenue to the taxation of lease inducement and surrender arrangements. Draft
legislation containing the proposed reforms was put before Parliament in
In July last year the Inland Revenue proposed changes to the taxation of
lease inducement payments. Payments to induce a prospective tenant to take up a
lease would become taxable in the hands of the tenant regardless of whether that
lease may be a capital asset of the tenant, effectively reversing the decision
of the Privy Council in the 1998 Wattie case. The reforms would extend
to arrangements having a similar effect to inducement payments, such as
contributions to a tenant’s start-up or relocation costs and the meeting or
forgiving of a tenant’s rent or early termination obligations under an existing
In response to public criticism, the originally proposed retrospective
application of the reforms was abandoned in favour of a 1 April 2013 application
date. In addition, the Government announced that the deductibility of inducement
payments for landlords would be specifically legislated for, and that the
reforms would be extended to lease surrender payments (surrender payments would
be treated as assessable to landlords and deductible to tenants).
Please refer to our earlier articles for further detail about those early
proposals (Changes to Taxation of lease
inducement payments and Update on
proposed changes to taxation of lease inducement payments).
Draft legislation introduced
The proposed reforms were introduced to Parliament in December by way of a
Supplementary Order Paper (No. 167) to the Taxation (Livestock Valuation, Assets
Expenditure, and Remedial Matters) Bill currently before Parliament.
Key aspects of the draft legislation (in its present form) are:
The new taxing provision (to be included in the Income Tax Act as new section
CC 1B) will apply where a person (the "payee") derives an amount as
consideration for the agreement by that person to the grant, renewal, extension
or transfer of a right (a "land right"), being a leasehold estate or licence to
use land. The amount derived will be income to the payee ("amount" for these
purposes will include non-cash consideration).
Two exceptions to the new taxing provision will be included. The inducement
amount will not be income to the payee where the payee is a tenant of
residential premises, or where the payee is the holder of the land right and
receives the amount in return for the transfer of that right to the payer (the
example given by the Inland Revenue is an amount derived by an assignor from an
assignee for the transfer of an existing lease).
A matching deduction provision will be introduced (new section DB 20). The
inducement payment will be deductible to the payer provided certain conditions
are met. These include that the payer owns the land right or estate in land from
which the land right is granted, and that the payee is the person who is
obtaining the land right.
A specific timing provision will be introduced (new section EI 4B) to spread
income derived and expenditure incurred under a lease inducement arrangement.
The timing provision as currently drafted is not easy to interpret and could
benefit from simplification, but in essence the income or expenditure will be
spread over the term of the land right to which the inducement arrangement
relates (e.g. the term of the lease granted). If an inducement payment is made
prior to the commencement of the relevant lease, the spreading will still
be across the period of the lease (it will not commence at the point the
payment is made). Particular rules will apply where the payment is incurred or
derived during or at the end of the lease. Rules will also govern the
interrelationship of the new regime with the existing capital contribution
The draft legislation also applies to lease surrender payments. New section
CC 1C will tax amounts derived by a person as consideration for the agreement by
that person to the surrender of a leasehold estate or termination of a licence
to use land. This new rule will apply where the payee is either the landlord or
the tenant (i.e. a tenant which receives a payment to exit a lease will be taxed
on that payment, as will a landlord which receives a surrender payment from a
A matching deduction provision for lease surrender payments (new section DB
20C) is included in the draft legislation. However, no new timing provision will
be introduced with respect to lease surrender payments. The time at which those
payments are incurred or derived for tax purposes will remain to be determined
on the basis of the existing rules in the Income Tax Act (generally, the year of
incurrence or derivation of the surrender payment). This is not surprising given
that a surrender payment relates to the termination of an arrangement.
Submissions on the draft legislation
The draft legislation containing the changes is currently before the Finance
and Expenditure Committee. Submissions to that committee on the draft
legislation can be made on/or before 7 February 2013.
If you have any questions about the possible impact of these reforms on your
business, please contact the authors or your usual Bell Gully advisor.
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.