The heady days of low vacancy rates and high rents may be drawing to a close for commercial property owners. As times get tougher, lease incentives are likely to increase in popularity as landlords compete for tenants. There can be big differences in the way that different types of lease incentives are treated for tax purposes. Fit-out incentives, where structured correctly, are generally tax effective for both landlords and tenants. And right now landlords or tenants may be eligible to claim a bonus 30% tax deduction where fit-out contracts are entered prior to 30 June 2009!
The tax treatment of a fit-out incentive will largely depend on who owns the fit-out.
Free fit-outs which are owned by landlords are generally tax-free for tenants. Fit-outs are also a popular type of incentive for landlords who can claim depreciation deductions in relation to plant and equipment comprised in the fit-out.
Free fit-outs which are owned by tenants are generally assessable to tax in the hands of the tenants. However, tenants may be able to claim depreciation deductions in a similar way to landlords.
It is important that fit-out agreements are drafted carefully to ensure the desired tax outcome is obtained. For example, care should be taken to ensure that tenants are not in fact provided with a cash incentive (assessable to tax) which is then used to acquire the fit-out.
Small business and general business tax break
On 3 February 2009, the Federal Treasurer announced the introduction of a temporary business tax break as part of the Federal Government's Stimulus Package. On 25 February 2009, an Exposure Draft of the legislation (Tax Laws Amendment (Small Business and General Business Tax Break) Bill 2009) was released for public comment. Draft legislation to introduce the bonus tax deduction has been released for public comment.
What is the bonus tax deduction?
Taxpayers who "acquire" an "eligible asset" (or incur new expenditure on an existing eligible asset) after 12 December 2008 and before 30 June 2009, and have the asset installed ready for use by 30 June 2010, will be entitled to a bonus tax deduction of 30% of the cost of the asset.
Taxpayers who do not qualify for the 30% bonus tax deduction, but acquire an "eligible asset" (or incur new expenditure on an existing eligible asset) before 31 December 2009 and have the asset installed ready for use by 31 December 2010, will be entitled to a lesser bonus tax deduction of 10%.
The bonus tax deduction is in addition to normal depreciation deductions. Therefore, over the life of an asset, a taxpayer can effectively claim deductions of up to 110% or 130% of the cost of the asset (as the case may be).
What are eligible assets?
The bonus tax deduction is available for tangible depreciating assets for which depreciation deductions are available under Division 40 of the Income Tax Assessment Act 1997 (ITAA1997).
Common examples of assets a landlord (or tenant) may be able to depreciate under Division 40 include carpets, appliances, light fittings, furniture, blinds, curtains, air-conditioning, ventilation systems, lifts, fire alarms and sprinkler systems.
Capital works covered by Division 43 of the ITAA 97 (e.g. building works) do not, however, qualify for the bonus tax deduction.
Fit-outs can include some assets that are deductible under Division 40 and others that are deductible under Division 43, such as the removal of walls or structural improvements. Accordingly, the distinction may be important when applying the bonus tax deduction.
The "eligible" assets must cost $1,000 or more (small business entities) or $10,000 or more (other businesses). Expenditure on multiple assets cannot be aggregated in order to reach these thresholds. As such, the bonus tax deduction cannot simply be applied to the entirety of the expenditure on a new fit-out. The expenditure on each depreciable asset will need to be monitored.
Importantly, the "eligible assets" must be "acquired" before the dates listed above. The Exposure Draft defines the acquisition time to be the time at which the taxpayer enters into a contract to hold the asset, starts to construct the asset or starts to hold the asset in some other way. "Refreshing" a contract entered into before 12 December 2008 will not meet this requirement.
Bonus tax deductions may be claimed in the income year in which the asset is installed ready for use.
Who is entitled to the bonus tax deduction?
Division 40 of the ITAA 97 provides a framework for determining whether it is the lessor or lessee under a leasing arrangement that is entitled to claim depreciation deductions. These rules will also apply to the bonus tax deduction.
What should you do?
The legislation giving effect to the bonus tax deduction is only in exposure draft form. Accordingly, there is no guarantee that the legislation will pass or will pass in its current form.
Landlords looking for new tenants should keep the bonus tax deduction in mind when considering or negotiating the form and amount of any lease incentives offered to tenants. If a fit-out incentive is offered, both landlords and tenants should take care in documenting the arrangement to ensure that it is tax-effective. Landlords (and tenants) have until 30 June 2009 to enter into a fit-out contract to be eligible for the maximum 30% bonus tax deduction.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.