Tax and incentivising commercial tenants – is cash still king?  


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Attracting new tenants can be tough at the best of times, but during uncertain times such as these, when it comes to offering effective inducements to prospective tenants, will cash remain king?

There are often several ways to achieve the same commercial objective, but they can have very different tax and financial considerations.  For simplicity, this article compares the payment of a reverse premium with the granting of a rent-free period and assumes that neither is given in return for any works or fitting out by the tenant as that raises more issues, such as capital allowances and the construction industry scheme.
Reverse Premium vs rent-free incentives 
Landlord Ltd (Landlord) is a retail property investor and wants to grant a 5 year lease to Newbiz Ltd (Newbiz) at a rent of £500,000 per annum plus VAT.  Landlord has opted to tax and Newbiz can fully recover VAT.  Landlord is considering either an upfront payment of £250,000 or a 6 month rent-free period worth £250,000 as an inducement to enter into the lease.

REVERSE PREMIUM

VAT 

  • Landlord - Newbiz should not charge VAT.

Possible trap If Newbiz tries to charge VAT then Landlord should not pay.  HMRC will refuse the Landlord's VAT reclaim as it is not actually VAT (even if Newbiz has paid it to HMRC).

  • Newbiz - Assuming Newbiz is simply entering into the lease in return for the payment then Newbiz should not charge VAT.  If Newbiz was doing anything else (such as agreeing to carry out works or acting as an anchor tenant) then Newbiz should charge VAT.

The £250,000 received by Newbiz will cover the base rent for 6 months but not the VAT.  Newbiz will have to pay the VAT on the rent to Landlord and reclaim it from HMRC.

 

CORPORATION TAX

  • Landlord - Landlord cannot claim a tax deduction for the payment against its rental income.  Instead, the £250,000 could increase Landlord's base cost in the property, thereby reducing the taxable gain which it would make on a future sale of the property but only if this sale took place whilst the lease to Newbiz remains in place.  

On the basis that Landlord is a long term property investor, it is quite possible, therefore, that Landlord will receive no corporation tax benefit from paying the reverse premium.

  • Newbiz - The receipt of the £250,000 would be subject to corporation tax in Newbiz's hands (although the timing of the taxable receipt might be able to be spread over time).

 SDLT 

  • Landlord - No SDLT consequences
  • Newbiz - The reverse premium is not liable to SDLT, but Newbiz would, of course, have to pay SDLT by reference to the aggregate rent (including VAT) payable under the lease in the usual way.

Compared to the rent-free position, Newbiz will pay £300,000 (ie £250,000 plus VAT) more in rent in the first year.

 

RENT-FREE

 VAT 

  • Landlord - Provided Newbiz is not making a supply (such as agreeing to carry out works or act as an anchor tenant) the VAT position is the same as above ie no VAT is chargeable by Newbiz. 

Possible trap – If Newbiz was making a supply then granting a rent-free is more complicated for VAT purposes as it will create a barter situation.  In a barter both parties will have to charge VAT to the other and the VAT provisions will need to be properly drafted to protect each party's position. 

 

  • Newbiz - As above, Newbiz should not charge VAT (assuming it is not supplying anything else).

As no rent is payable for the first 6 months there is no VAT payable either, thereby improving Newbiz's cashflow (although as set out below the position overall is worse for Newbiz's cashflow then a reverse premium).  

 

CORPORATION TAX

  • Landlord - Landlord‘s taxable income will be reduced producing a corporation tax benefit (which will spread over time in accordance with appropriate accounting practice). This reduces the cost to Landlord of providing a rent-free period compared to the payment of the reverse premium.  Landlord's cashflow is also improved.
  • Newbiz - Instead of receiving a taxable payment it will have reduced deductible expenses.

Overall, the corporation tax position should be neutral (subject to possible timing differences).

As the cashflow benefit for Newbiz is spread over the rent-free period rather than being received upfront this could be a material non-tax disadvantage for Newbiz.  

 SDLT 

  • Landlord - No SDLT consequences.
  • Newbiz - The total rent payable by Newbiz has been reduced by £300,000, which will lower the SDLT liability (and produce an upfront saving for Newbiz).

We appreciate that the final decision is unlikely to be made based purely on the tax consequences but the above very simple example shows the number of issues which could be relevant.  In the end, it may be that Newbiz simply needs the cash upfront regardless of whether or not this is the most tax efficient inducement for either party but it could also be that by spending more time considering all of the tax consequences the parties would come to a different arrangement (such as an increased rent-free or a combination of rent-free and reverse premium).  In some cases, this could even make the difference between the tenant agreeing to take the lease or not.

Commonly, lease inducement arrangements and also seeking to retain tenants in the current climate will involve more complex matters, such as landlord contributions to works or agreeing variations to existing leases, assigning leases or granting reversionary leases.  In such cases, it is important to consider the relevant tax treatment and identify tax efficiencies and traps at the earliest opportunity. 

This is the first in a series of articles highlighting some of those tax efficiencies and tax traps so watch this space.  In the meantime, please do get in contact with Karmeni Shahi or Andrew Sneddon to talk through the opportunities where we can help.  Legitimately reducing tax costs to improve absolute returns is arguably much more relevant and important to both landlord and tenant businesses now than ever before.

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