Lease Incentives - Considerations for Leasee's
Lease incentives continue to be used by landlords as an inducement to tenants to enter into a commercial lease. Finding the right commercial premises for your business can be a long drawn out process and when it is finally identified, the accounting, tax and cashflow implications of entering into the lease agreement are often misunderstood or not fully considered.
An area often overlooked is the position in relation to make good provisions and the associated terms and conditions. Make good provisions are becoming more onerous as landlords are giving away more upfront - but beware the catch up at the end!
The type of incentive and the associated terms and conditions can result in radically different outcomes and some of these have been highlighted below. The common types of lease incentive are as follows:
For leases each of the above may appear overall to be the cash net position, however, how these are accounted for and how they are treated for tax purposes needs consideration. For example, the contribution to fit out incentives on the face of it appear identical, however, one results in an immediate tax impact on receipt of the cash contribution with deductions in the future years and the other no upfront impact. Clearly, the loss of 30% of a cash incentive impacts the cashflow benefit of the incentive making it less attractive.
In addition there are a number of other issues that need to be considered which include fixed step increases in the rental and how these are accounted for. The general approach is to determine the actual cost of the lease including the respective incentives and increases over the period of the lease and then straight line that across the lease period, however such smoothing does not mirror the tax treatment resulting in timing differences for accounting purposes.
Importantly, whilst general principles are of use, it is only when the actual terms and conditions of the respective leases are considered in detail that the true treatment of the incentives can be identified. When dealing with large property holders, caution needs to be exercised as the terms and conditions of their leases can and do differ. Negotiating a slightly different form of incentive can be of major benefit for the leasee whilst the lessor may be indifferent. Such a difference could result in saving significant amounts of tax.
Lease incentives can take many forms and the accounting and taxation implications can be particularly complex depending on your circumstances. If you are considering entering or renewing an existing lease and you are uncertain about the tax and commercial consequences, please contact your relevant ESV engagement partner on 9283 1666 for advice and assistance.
In our next issue, we will outline the implications of the above for a lessor.
Article by Lisa Brink