Tax effects of lease premiums

Parties often enter into leases of vacant commercial or industrial land, subject to payment of a ‘lease premium’ by the lessee to the lessor. Tax Partner at Cameron & Prentice Chartered Accountants, David Warneke, explains the tax effects of lease premiums.

The first point to note is what exactly is envisaged by the term ‘lease premium’. In a leading case, CIR v Butcher Bros (Pty) Ltd it was held that it means ‘a consideration having an ascertainable money value passing from a lessee to a lessor … distinct from and in addition to or in lieu of rent’. It differs from rent in that it is paid in respect of the whole period of the lease. It is usually paid in a lump sum at the commencement of the lease.

Section 11(f) of the Income Tax Act contains the deduction for the lessee. The amount must be spread over the period of the lease, from commencement to end, including renewal periods, to a maximum spread of 25 years. For example if the lease premium is R 5 million and the lease period is 15 years with a renewal period of 10 years, the spread is over 25 years. The deduction is further apportioned pro-rata for part of a tax year. If the premises are not used by the lessee for trade purposes, no deduction can be claimed.

In the above example, say the lease was entered into on 1 January 2008, the premises were not occupied for the first two months of the lease and the lessee has a 30 June year end, the deduction for the year ended 30 June 2008 would be 1/25 *4/12* R 5 million = R 66 667. (No amount can be claimed for the first two months, as the premises were not used for trade purposes during this time). If the lease is terminated before the full amount has been claimed, the lessee loses the right to claim the balance.

In order for the lessee to be able to claim a deduction, the lessor must not be a tax exempt institution. In order to constitute a lease premium the payment must pass from lessee to lessor: if for example it passes from lessor to lessee it is not a lease premium. It may nevertheless be deductible by the lessor in this case, but not in terms of this section.

The lessor will have to include, upfront, the full amount of the lease premium in ‘gross income’ for tax purposes i.e. no spread. This is in terms of paragraph (g) of the ‘gross income’ definition.

Article by: David Warneke -