It is sometimes essential to offer incentives to attract tenants to take space in a vacant property. Typically these will be in the form of a general cash payment, contribution to tenant fit out or a rent-free period.
Of these the contribution route can be the most tax efficient for the landlord as there is a possibility of claiming capital allowances on the tenant fit out spend where it relates to qualifying plant and machinery fitted by the tenant. This is relevant as it is common for 60%-80% of office fit out expenses be on qualifying items such as air-conditioning, lighting and welfare facilities.
It is important the contribution is correctly described as, “capital contribution to tenant’s fitting out works” in the agreement for lease so the landlord can safeguard their entitlement to allowances on expenditure incurred by the tenant. This is an unusual situation in capital allowances where entitlement generally follows the person who directly incurs the expenditure.
Lovell Consulting have developed specific wording which can set out the priority order of set off of the contribution to give the greatest tax saving for either the landlord or tenant. It is usually the party with specialist advice who provides the appropriate contract wording and consequently benefits the most. Therefore agreeing this prior to agreement for lease is important.
In addition to the above, the draft legal documents can assist with practical matters and could include for;
- Agreeing the tenant will only claim capital allowances in respect of plant and machinery not covered by the contribution
- Require cooperation from the tenant and their fit out contractors to supply full cost breakdowns of the fitting out expenditure
Something to consider if the total contribution is higher than the potential qualifying expenditure is to make a rent-free period in lieu of the excess.
Contribution allowances conditions
There are a conditions to be met for the landlord to be able to claim capital allowances for the capital contributions it makes towards the costs of equipment and fixtures purchased by another person as follows;
- The person making the contribution should not be connected, for example where a group is split into an operating company and property holding company this would be caught;
- The tenant or person receiving the allowances must be entitled to claim allowances. This means where the tenant is a non-tax payer such as a charity it would usually be better for tax purposes for the landlord to incur the fit out costs directly and allow the charity to contribute to these;
- The landlords contribution needs to a capital item in the landlords accounts
Interaction with other capital allowances claims
It is worth noting that for property sales by landlords who have made contributions to tenants the new mandatory pooling rules will not impact on capital allowances that have been claimed by them on contributions as these are pooled and transferred separately. The unused benefit of allowances is always passed on to the new owner and it is not possible to fix the disposal value of plant and machinery covered by a contribution in a tax election.
Landlords can effectively reduce its net outlay by claiming capital allowances on the contribution that can be attributed to qualifying tenant fit out costs. For example, for every £100,000 contribution that can be attributed fully to qualifying plant this represents £20,000 tax savings, an effective 20% reduction in the net cost of the contribution expenditure.
There needs to be a net benefit to the tenant if it is to be worthwhile for the landlord to make a contribution. The idea is that the contribution meets costs that are the responsibility of the tenant but will not necessarily improve the value of the property. This means the expenditure is treated as if it benefits the tenant and so is a reverse premium on which the tenant is taxed, unless one of the following exceptions are met, in which case the tenant is not taxed;
- To the extent the contribution is used by the tenant towards costs of qualifying plant and machinery and the tenant sets off the contribution against fixed assets. The tenant is not taxed in this case.
- The tenant reimburses the landlord for the fit out costs met by the landlord. The additional rent needs to directly reflect the value contributed by the landlord and this needs to be documented to ensure HMRC cannot challenge that there is no net benefit received by the tenant;
- Where the tenant is responsible for completion of the landlords shell under the lease and the landlord reimburses these costs then there is an increase in the reversionary interest in the lease and the tenant effectively receives a tax-free value.