Lease premiums

By Tolley
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The following Owner-Managed Businesses guidance note by Tolley provides comprehensive and up to date tax information covering:

  • Lease premiums
  • Outline
  • Short-term leases
  • Lease surrender, waiver, variation or assignment
  • Sale with right to reconveyance
  • Sale and leaseback
  • Reverse premiums

Outline

When a property investor grants a lease, the tenant may pay an up-front sum, a premium for the initial grant of the lease, in addition to also paying rent over the term of the lease. In the absence of specific legislation to the contrary, such premiums would be regarded as purely a capital receipt, taxed wholly under the capital gains tax (CGT) legislation, and indeed for ‘long’ leases (over 50 years) that is the case. For short leases (not exceeding 50 years) there is specific legislation to treat some or all of such premiums as income, as discussed further below.

Note that, it may be the other way around and the property investor might pay the tenant to take on the lease (a reverse premium). This is also discussed further below.

Short-term leases

Where a short-term lease is granted under terms that a premium must be paid, a certain proportion of that premium is treated as rental income, taxed in the year of the grant of the lease.

ITTOIA 2005, s 277; CTA 2009, s 217

That proportion is found by the following formula:

Where:

  • P is the premium
  • Y is the number of complete periods of 12 months (other than the first) comprised in the effective duration of the lease

In other words, the part of the premium charged as rental income is 2% for each complete year by which the term of the lease falls short of 50. See Example 1.

In the event that a lease is granted which requires the tenant to carry out capital work on those premises that can, under ITTOIA 2005, s 278 or CTA 2009, s 218, be deemed to be a

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