A reverse premium is a payment by a landlord either:
- to induce a prospective tenant to enter into a lease, or
- to induce an existing tenant to vary his lease
Income and Corporation Tax
A reverse premium is taxable as income under ITTOIA 2005, s 101 and FA 1999, Sch 6. It is taxable as a trading receipt if the recipient is carrying on a trade and as a property income receipt in any other case. These provisions apply only where:
- a person receives payment or other benefit (such as meeting fitting out costs which are properly the tenant’s expense – BIM 41085) by way of inducement in connection with a transaction entered into by him or a person connected with him.
- That transaction is one under which the person receiving the payment or other benefit (or the connected person) becomes entitled to an estate or interest in (or a right in or over) land, and
- The payment or other benefit is paid or provided by either
- the person by whom that estate, interest or right is granted (or was granted at an earlier time) (the grantor),
- a person connected with the grantor, or
- a nominee (or connected person) of the grantor or a person acting on the directions of the grantor or of a connected person.
They will not apply where:
- the recipient already has an estate or interest in the land (but if the variation of the recipient’s lease amounts in law to a surrender and regrant does he “become entitled to” a different estate to the one he previously held?),
- the payment is made by a tenant to induce another person to take an assignment of his lease, or
- query, the payment is made by a head-landlord to induce a person to take an assignment of an existing lease and vary its terms (unless the variation can be regarded as the inducee becoming entitled to a different estate).
- d) the recipient is an individual and the interest taken is in premises to be occupied as an only or main residence (but not if it will be a second home)
- e) the sale price in a sale and leaseback transaction is not a reverse premium (BIM para 41140)
- f) a contribution of cash or surplus land by a public sector “purchaser” under a PFI contract in connection with the grant of a lease to the private sector operator on which the operator will construct the PFI property is not a reverse premium(BMI para 64175).
HMRC say that the following are not caught because they do not represent outlay.
- Granting the tenant a lease at a low rent, or a rent-free period of occupation.
- Replacement by agreement of an existing lease at an onerous rent by a new lease at a lower rent.
- Replacement by agreement of an existing lease with some other provision the tenant has found onerous by a new lease without the onerous condition.
(BIM para 41080). Under general principles the receipt of a reverse premium is unlikely to constitute income of the recipient unless the recipient is a property dealer. The leading case is CIR v Wattie and Lawrence (72 TC 639), A New Zealand case decided by the Privy Council. Wattie and Lawrence were partners in a large professional partnership (C&L). The firm agreed with a developer to take new premises at a figure in excess of the market rent on the basis that the developer would pay them NZ$5million and a monthly rent subsidy of $94,009. The firm accepted that the monthly subsidy was an offset against the rent and so was income. The CIR contention that the $5million was a trading receipt was dismissed both by the NZ Court of Appeal and the Privy Council. Although the payment was agreed to be commercially, financially and mathematically linked to the rent that also applies to a premium, which in both NZ and UK law has always been regarded as capital – probably, said Lord Nolan, because it is an expenditure made only once with a view to bringing into existence an asset or advantage for the enduring benefit of the trade. The same principle must apply to receipt for undertaking an onerous lease for a substantial period. HMRC do say that, in spite of Wattie, “it is still possible that a receipt described as a reverse premium may be in substance a contribution to:
- revenue expenditure such as relocation costs, or
- capital expenditure with capital allowance or capital gains consequences”.
(Business Income Manual, para 35610) As a reverse premium is normally capital the payer of a premium is unlikely to be able to claim a deduction for it as a trading expense unless he is a property dealer. It should be noted that if, for example, the agreement requires the tenant to carry out works and the payment by the landlord is conditional on those works having been carried out, HMRC consider that the tenant needs to register as a sub-contractor under the CIS scheme (CIS Manual, para 1308A). However a reverse premium within FA 1999, Sch 6 is not itself a contract payment under that scheme (Reg 20, Income Tax (Construction Industry Scheme) Regulations 2005).
Capital Gains Tax
A payment to induce a person to take on a liability is not a disposal of an asset by the recipient and is not therefore within the scope of CGT. This is conferred by HMRC who say: “Normally the reverse premium will be paid before the tenant has actually entered into the lease and in these circumstances it is not possible to argue that the reverse premium is derived from the lease. Unless there is some other asset from which the reverse premium derived, it will be exempt from CGT” (CGT Manual, para 70835). A payment to induce a person to vary an existing lease to make it more onerous is a part disposal of that lease as it is a payment to give up some of the existing rights under it, e.g. the right to occupy on payment of the current rent. It is therefore chargeable to CGT. If the lease expires and the inducement is paid to induce the person to take a new lease of the same premises that should not attract CGT as the only rights the tenant then has is his Landlord and Tenant Act rights to a new lease at a market rent. Where a reverse premium of £1m or more is received the local District is required to refer the case to Business Profits Division 4 (Schedule D) (CGT Manual, para 70838). The payment of a reverse premium will normally constitute enhancement expenditure as the increased rent will increase the value of the landlord’s interest. Bear in mind though that enhancement expenditure is deductible only if it is reflected in the state or nature of the asset at the time of disposal. The HMRC view is that it will not be so reflected once the lease has come to an end (CGT Manual para 70851).
A reverse premium to induce someone to take a lease of new premises is not consideration for a supply of services to the landlord, provided that he undertakes solely to become a tenant. However the future tenant would make a VATable supply of services if the landlord, taking the view that the presence of an anchor tenant in the building will attract other tenants, were to make a payment by way of consideration for the future tenant’s undertaking to transfer its business to the building concerned. (C&E Commrs v Mirror Group plc (Case C-409/98) (2001 STC 1453). HMRC have eventually accepted that lease obligations to which tenants are normally bound do not constitute supplies for which inducement payments on entering into leases are consideration (Business Brief 12/05) Accordingly most such inducement payments are outside the scope of VAT. HMRC give as examples of what they consider would be VATable.
- Carrying out building works to improve the property by undertaking necessary repairs or upgrading the property
- Carrying out filling-out or refurbishment works for which the landlord has responsibility and is paying the tenant to undertake.
- Acting as an anchor tenant.
It is probably actually a question of fact as to whether the payment is in return for being prepared to become a tenant or if it is in consideration of the provision of a services (or, probably, if it is apportionable between the two). In contrast a payment to induce a person to take an assignment of an existing lease is a VATable supply of services by the recipient. It is not exempt as the letting of immovable property, as that essentially involves the landlord of a property assigning to the tenant in return for rent and for an agreed period the right to occupy his property and to exclude others from it (C&E Commrs v Canter Fitzgerald International (Case C-108/99) (2001 STC 1453)). If a transaction is outside the scope of VAT for the recipient it must also be outside the scope for the payer. For completeness it should be mentioned that a payment by a landlord to a tenant to surrender a lease is a supply of the letting of property (C & E Commrs v Lubbock Fine & Co (Case C-63/92) (1994 STC 101). So is a payment by a tenant to his landlord to accept a surrender of a lease (Central Capital Corporation Ltd (VTD 13319) and Note 1 to Group 1, Sch 9, VATA 1994 (Grant….includes the supply made by the person to whom an interest is surrendered when there is a reverse surrender – i.e. one in which the person to whom the interest is surrendered is paid by the person by whom the interest is being surrendered to accept the surrender).
A reverse premium is not chargeable consideration for the grant, assignment or surrender of a lease, provided that it is either:
- a payment by the landlord to the tenant for the grant of a lease,
- a payment by the assignor to the assignee for the assignment of a lease, or
- a payment by the tenant to the landlord to accept a surrender
(FA 2003, Sch 4, para 15). HMRC say, “Upfront lease payments or capital contributions” are often received from landlords to assist tenants establish business. These up-front payments are essentially financing which is recouped or repaid, through higher rentals during the life of the lease. As such the up-front contribution is, in commercial terms, a negative rental. Reverse premiums are not to be treated as chargeable consideration as they are not rent. Rent is consideration given by the tenant (SDLT Manual para 11800).
Other Capital Payments by Landlords and Tenants
A payment by the tenant to the landlord to vary or waive any of the terms of a lease is deemed to be a premium payable in relation to the unexpired period of the lease (s 21, ITTOIA 2005, sec 34(5), ICTA 1988). If at that time the lease has less than 50 years to run, part of this deemed premium is taxable on the landlord as income. The taxable part of 2% of the premium for each year by which the complete years in the unexpired part of the term less one, falls short of 50. The balance is taxed as a capital gain, i.e. as a part disposal by the landlord of his rights under the lease. The tenant is entitled to tax relief as a trading or property income expense spread rateably over the remaining terms of the lease. For VAT a variation payment is consideration for the grant of an interest in land by the landlord and is VATable if the landlord has elected the property into the scope of VAT. For SDLT if a lease is varied so as to increase the amount of the rent (other than in pursuance of a provision of the lease) the variation is treated as if it were the grant of a separate lease in consideration of the additional rent (para 10, Sch 5, FA 2003). The deemed separate lease will be linked transaction with the actual lease as it forms part of a series of transaction between the same vendor and purchaser (s 108, FA 2003).
A payment by the landlord to the tenant to surrender a lease will be consideration for the disposal of the lease and will attract CGT. It will be enhancement expenditure of the landlord. A payment by the tenant to the landlord will be liable to CGT in the hands of the landlord. It will not attract tax relief for the tenant unless he is a dealer. It is a payment to be relieved of an onerous liability, not consideration for the disposal of an asset. It is unlikely to qualify as a deduction in computing trading profits or rental income of the tenant; CIR v Falkirk Iron Co Ltd (17 TC 625), Mallett v Stavely Coal & Iron Co Ltd (13 TC 772), Concher v Richard Mills & Co Ltd (13 TC 216), Union Cold Storage Co Ltd v Ellerker (22 TC 547). Curiously if the tenant had instead continued to pay the rent, the rent would have been a revenue expense (Hyatt v Lennard (23 TC 346)). The surrender of a lease is exempt from VAT (note 1, Group Sch 9, VATA 1994). A payment for the surrender of a lease is not liable to SDLT as it is not rent (para 16(2)(c), Sch 17A, FA 2003). (SDLT Draft Manual para 11800). If a lease is granted in consideration of the surrender of an existing lease between the same persons the grant of the new lease is not chargeable consideration for the surrender and the surrender is not chargeable consideration for the new lease (para 16, Sch 17A, FA 2003). A surrender and regrant (e.g. an extension of the lease) will attract SDLT on the regrant. In such a case the probability is that the payment is a premium for the new lease.
A premium paid for an assignment of a lease as opposed to a grant of a new lease does not attract income tax in the hands of the assignor and does not create a right to tax relief for the assignee. It is simply a capital gains tax item.
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