Inland Revenue and Treasury have released an Issues Paper proposing further changes to the taxation of land-related lease payments. This followed the lease inducement and lease surrender tax reforms in Supplementary Order Paper No 167 to the Taxation (Livestock Valuation, Assets Expenditure, and Remedial Matters) Bill, currently before Parliament.
Submissions close on June 4, 2013.
The principal concern appears to be payments made to an existing tenant from a new incoming tenant for the transfer or assignment of a lease (lease transfer payments).
The Issues Paper noted that lease transfer payments are generally deductible to the incoming tenant under the depreciation rules and non-taxable to the exiting tenant, resulting in a tax asymmetry similar to the current situation with lease inducements. Officials are concerned that it would be more advantageous for a tenant to exit a lease by transferring the lease, for a tax-free payment, rather than surrendering it to a landlord for a taxable payment.
The proposal is therefore to introduce generic income, deduction and timing rules for land-related lease payments, such that any land-related lease payment (except in the case of residential leases) would be treated as deductible to the payer and taxable to the recipient.
Readers may recall the tortured history of the original lease inducement tax changes, with Government effecting alterations, including the application date of the reforms and extending deductibility to payers of lease surrender payments, to make the reforms more balanced.
When the Supplementary Order Paper was introduced, it was signalled that a wider-review of land-related lease payments would be carried out in early 2013.
The review, and its outcome, was therefore not unexpected.
The proposals will, effectively, extend the revenue account treatment proposed for lease inducements and surrender payments to other lease-related payments.
Not convincing
The focus seems to be on the so-called lease transfer payments as the main area of mischief. We are not convinced that the arrangements contemplated, including re-characterisation of revenue surrender payments as capital lease transfer payments, are widespread in practice.
The example given is a lessor setting up a subsidiary company that is assigned the lease for a non-taxable payment to the existing tenant.
If this is the main concern, it could be relatively easily addressed by deeming such payments as akin to a lease surrender payment (i.e. where the payment is made by the lessor or an associate of the lessor).
Where this is not the case, structuring an exit from a lease, using a lease transfer payment to achieve the same commercial outcome as under a surrender payment will create significant complexity and inflexibility.
Differing drivers
Ultimately, the commercial drivers will differ – terminating a lease (for instance, because the landlord has need for the space) will give landlords flexibility that is not available with an assignment (which will typically be tenant driven).
A consequence of this new rule is that any assignment of a lease by a lessee, whether or not a surrender payment by the landlord is contemplated, will be taxable.
This will convert what is normally a capital gain to a taxable revenue gain.
Single set rules
We acknowledge the desire of the officials to have a single and consistent set of rules. This is the justification given for moving fit-out contributions, which are the subject of separate income, deductibility and timing rules introduced in 2010, into the new land-related lease payment rules.
Fit-out contributions will become taxable to the lessee, and spread over the term of the lease. The resulting fit-out will be depreciable. At present, the lessee can choose either to return the value of the fit-out contribution as income over 10 years or reduce their tax depreciation base commensurately.
This is a clear change from the position taken in the Supplementary Order Paper and landlords and tenants should be aware of the (new) tax consequences from structuring lease incentives in this manner.
Welcome changes
The Issues Paper contains a reasonable technical detail, including a description of proposed changes to various provisions in the Income Tax Act, which is welcome.
We also welcome the clarification that the application date, if these changes proceed, will be prospective, given the myriad of issues with the retrospective application date of the original lease inducement tax changes.
In another desirable development, the Government has asked the Select Committee considering the Taxation (Livestock Valuation, Assets Expenditure and Remedial Matters) Bill to recommend repealing the 10% transitional imputation penalty tax. The penalty currently applies if companies have over-imputed dividends at the previous 30% company rate.
We strongly support this change, as the penalty is excessive.
The above commentary was written by KPMG executives Ross McKinley, John Cantin (Tax Partners based respectively in Auckland and Wellington) and Darshana Elwela, National Tax Director in Auckland. KPMG is the Sponsor of the ‘Business Excellence in ICT’ Category of the Indian Newslink Indian Business Awards 2013
