Private ruling: Deductibility of lease incentive payments
Published: February 2015
Ruling period: 1 July 2014 to 30 June 2015 | 1 July 2015 to 30 June 2016 | 1 July 2016 to 30 June 2017 | 1 July 2017 to 30 June 2018 | 1 July 2018 to 30 June 2019
Date scheme commenced: 1 July 2014

Ruling: Q1: Will you be entitled to deduct, under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997), the amount of each Lessor's Contribution in the income year in which you become obliged to pay that Lessor's Contribution? | A1: Yes. | Q2: Do section 82KZMA and section 82KZMD of the Income Tax Assessment Act 1936 (ITAA 1936) apply to prevent you deducting the full amount of the Lessor's Contribution in the income year in which you incur the Lessor's Contribution? | A2: No.

Relevant facts and circumstances: You own and operate the commercial rental property. You have several retail tenancies in your portfolio and some form of lease incentive has been paid to a number of those tenants. Your obligation to pay the lease incentive is contained in the Agreement that is entered into between you and the Lessee. The lease incentive is known as the 'Lessor's Contribution'. The Lessor's Contribution can be either a specified amount of money or the lesser of a specified amount of money and the cost to the Lessee of carrying of the Lessee's Works (the fit-out of the Premises). No provision of the Agreement (or any other document) confers upon you an ownership interest in the Lessee's fit-out. The Agreement provides that the Lessor's Contribution is a contribution towards the fit-out of the Premises and that payment of the Lessor's Contribution is made in consideration of the Lessee accepting the Lease. The Agreement provides for when you must pay the Lessor's Contribution. In certain circumstances, the Agreement gives you the right to claw-back some of the Lessor's Contribution. For the purposes of the ITAA 1997, the Lessor's Contributions are not of a private or domestic nature and there are no provisions in the ITAA 1936 or ITAA 1997 that categorise the rent received by you as either exempt or non-assessable non-exempt income.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 8-1 | Income Tax Assessment Act 1997 subsection 8-1(1) | Income Tax Assessment Act 1997 subsection 8-1(2) | Income Tax Assessment Act 1936 subsection 82KZMA | Income Tax Assessment Act 1936 subsection 82KZMA(2) | Income Tax Assessment Act 1936 subsection 82KZMA(3) | Income Tax Assessment Act 1936 subsection 82KZMD | Income Tax Assessment Act 1936 subsection 82KZL(1) | Income Tax Assessment Act 1936 paragraph 82KZL(2)(b)

Reasons for decision: Summary: The Lessor's Contribution is necessarily incurred by you in carrying on a business for the purpose of gaining and producing assessable income. The Lessor's Contribution is not capital in nature or otherwise excluded by subsection 8-1(2) of the ITAA 1997. Therefore, the Lessor's Contribution is deductible to you under subsection 8-1(1) of the ITAA 1997. | Detailed Reasoning - An outgoing: Subsection 8-1(1) of the ITAA 1997 provides that you can deduct from your assessable income any loss or outgoing to the extent that: a) it is incurred in gaining or producing your assessable income; or b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income. From the facts provided, you are clearly carrying on a business of leasing. The Lessor's Contribution is an inducement provided by you for an unrelated party tenant to enter into a lease from which you will receive rent. This is confirmed by the Agreement which provides that the Lessor (you) agrees to contribute the Lessor's Contribution towards the fit-out of the Premises in consideration of the Lessee agreeing to accept the Lease. Therefore, the Lessor's Contribution is an outgoing made by you in carrying on a business for the purpose of gaining or producing your assessable income. | Detailed Reasoning - Incurred: There is no statutory definition for the term 'incurred'. A loss or outgoing is incurred for the purposes of section 8-1 of the ITAA 1997 if the taxpayer is definitely committed to and has a presently existing liability to pay the outgoing in the year of income. This is notwithstanding that actual payment may not have been made or the outgoing may be subject to defeasance. In this case, you will have incurred the Lessor's Contribution for the purposes of section 8-1 of the ITAA 1997 in the income years in which you become obligated to pay the Lessor's Contributions under the Agreement. Based on the Agreement, this happens when the certain stated conditions are satisfied by the Lessee. Therefore, the Lessor's Contribution is necessarily incurred in the ordinary course of you carrying on your business for the purpose of gaining or producing assessable income, and will be deductible to you under subsection 8-1(1) of the ITAA 1997, subject to any exclusions applying. | Detailed Reasoning - Non-deductible outgoings: Subsection 8-1(2) of the ITAA 1997 provides that you cannot deduct a loss or outgoing to the extent that: a) it is a loss or outgoing of capital, or of a capital nature; or b) it is a loss or outgoing of a private or domestic nature; or c) it is incurred in relation to gaining or producing your exempt income or your non-assessable non-exempt income; or d) a provision of this Act prevents you from deducting it. The exclusion in paragraph 8-1(2)(a) of the ITAA 1997 prevents an amount from being deducted if it is capital or of a capital nature. The established principles on the distinction between capital and income are well known; see for example, Dixon J's judgement in Sun Newspapers Ltd & Associated Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337; (1938) 5 ATD 87, and the Full Federal Court decision in FC of T v. Email (1999) 99 ATC 4868 at 4873; 42 ATR 698 at 704. The character of the advantage sought provides important direction. It provides the best guidance as to the nature of the expenditure as it says most about the essential character of the expenditure itself. The nature or character of the expenses follows the advantage that is sought to be gained by incurring the expenses. If the advantage to be gained is of a capital nature, then the expenses incurred in gaining the advantage will also be of a capital nature. Paragraph 38 of the Taxation Ruling IT 2631 Income Tax: Lease Incentives (IT 2631) relevantly states: The provision of lease incentives will usually give rise to an allowable deduction to the lessor under section 51(1). This would follow from the characterisation of the outgoing as having been incurred for the purpose of gaining or producing assessable income. However, that conclusion may not be appropriate where the true purpose of providing the incentive was not to induce the entering into of the lease, and it might therefore be appropriate to apply Part IVA. Examples might include the purposes of benefiting an associate or shifting income to an associate with carry forward losses. Such cases will depend on their facts including the degree of association between the parties, their relative financial positions and whether the incentive can be characterised as being at arm's length. The general conclusion expressed above would not be appropriate if the landlord retained ownership of the fit-out (refer to paragraph 26). In that case the expenditure is capital in nature and therefore not an allowable deduction under subsection 51(1). Depreciation would be allowable in respect of plant or articles. The Lessor's Contribution is a form of lease incentive paid by you to induce unrelated third party Lessees to enter into leases pursuant to which you will receive rental income. While in some cases, the Lessor's Contribution may be calculated by reference to the Lessee's fit-out costs, you do not obtain any ownership interest in the works that constitute the Lessee's fit-out. Payments of the Lessor's Contribution do not create a capital asset or an enduring benefit for you. Therefore, the Lessor's Contribution is not capital, or of a capital nature. On the facts, the Lessor's Contribution does not fall within any other exclusion in subsection 8-1(2) of the ITAA 1997. Accordingly, the Lessor's Contribution paid or payable by you under the Agreement is deductible under subsection 8-1(1) of the ITAA 1997 in the year in which you become obliged to pay the Lessor's Contribution. | Summary: Section 82KZMA and section 82KZMD of the ITAA 1936 do not apply to prevent you deducting the full amount of the Lessor's Contribution in the income year in which you incur the Lessor's Contribution because the Lessor's Contribution paid under the Agreement is not in return for the doing of a thing under the agreement that is not to be wholly done within the expenditure year. | Detailed Reasoning - Detailed reasoning: The Period of Deductibility of Advance Expenditure Provisions under Part III of the ITAA 1936 apply in certain circumstances to change the timing of a deduction for expenses incurred under section 8-1of the ITAA 1997. Under section 82KZMA and section 82KZMD of the ITAA 1936 certain expenditure that would otherwise be fully deductible under section 8-1 of the ITAA 1997 is instead deducted over a specified period. These provisions apply where the expenditure is seen to be in the nature of a prepayment and where the period of the agreement will not be completed wholly within the year of the expenditure. Subsection 82KZMA(3) of the ITAA 1936 provides that the expenditure must be incurred: a) in carrying on a business or otherwise than in carrying on a business by a taxpayer that is not an individual b) under an agreement (as defined in subsection 82KZL(1) of the ITAA 1936), and c) in return for the doing of a thing under the agreement that is not to be wholly done within the expenditure year. Where all the elements of subsection 82KZMA(3) of the ITAA 1936 are satisfied, subsection 82KZMD(2) of the ITAA 1936 provides for the expenditure to be deductible pro-rata across the eligible service period, which is defined by subsection 82KZL(1) of the ITAA 1936 as: eligible service period , in relation to an amount of expenditure incurred under an agreement, means the period from the beginning of: (a) the day, or the first day, on which the thing to be done under the agreement in return for the amount of expenditure is required, or permitted, as the case may be, to commence being done; or (b) if the expenditure is incurred on a later day - the day on which the expenditure is incurred; until the end of: (c) the day, or the last day, on which the thing to be done under the agreement in return for the amount of expenditure is required, or permitted, as the case may be, to cease being done; or (d) if that day or last day ends more than 10 years after the beginning of the period - 10 years after the beginning of the period. In this case, the relevant agreement, as that term is defined in subsection 82KZL(1) of the ITAA 1936, is the Agreement, under which you pay the Lessor's Contribution. The issue is therefore whether the Lessor's Contribution is incurred in return for the 'doing of a thing' under the Agreement that is not to be wholly done within the expenditure year. In Taxation Ruling IT 2646 Income Tax : Television Program Licences (IT 2646), the deductibility of costs incurred by television stations under the Television Program License Agreements (TPLA) is considered in paragraph 14 as follows: Expenditure incurred to acquire program licences is not expenditure "incurred in return for the doing of a thing...that is not to be wholly done within 13 months" in terms of subparagraph 82KZM(b)(i)). Because the "thing" to be done is the granting of the right to use the program and this "thing" is done only once (usually at the commencement of the agreement), expenditure incurred to acquire program licences would not, of itself, fall within section 82KZM. If, however, the expenditure fell within the expression "payments of a similar kind" in paragraph 82KZL(2)(b), the "thing" to be done would be taken to be done over the period of the agreement. Where that agreement was for a period in excess of 13 months, section 82KZM would apply. The expression "payments of a similar kind" in paragraph 82KZL(2)(b) is considered to refer to payments: a. the nature of which is similar to the nature of rent and lease payments; and b. the object or benefit sought by the payments is similar to the object or benefit sought by a payment of rent or a lease payment. The intention of the legislation is to create a symmetry between advance expenditure and either the service to be provided or the income to flow. Bearing in mind this intention and the above construction of the expression "payments of a similar kind", expenditure to acquire program licences is considered to not be a payment of a similar kind to a payment of rent or a lease payment in terms of paragraph 82KZL(2)(b). Accordingly, the advance expenditure provisions (Subdivision H of Division 3 of Part III of the Act) do not apply to change the timing of deductions for expenditure on program licences. Although the above quote refers to a section 82KZM of the ITAA 1936, which has been modified since IT 2646 was issued, sections 82KZMA and 82KZMD of the ITAA 1936 have similar application to the previous section 82KZM. Similar to the previous section 82KZM of ITAA 1936 referred to in IT 2646, section 82KZMA and section 82KZMD of ITAA 1936 collectively require an advance payment that is deductible under section 8-1 of ITAA 1997 be pro-rated over a specified period. The only material difference being that sections 82KZMA and 82KZMD of ITAA 1936 will apply if expenditure is made in exchange for something that is not to be wholly done within the expenditure year. IT 2646 provides that expenditure incurred to acquire a program license is not considered to be expenditure as defined under the previous paragraph 82KZM(b)(i) of ITAA 1936, as it is incurred in return for the doing of a thing that is done only once at the commencement of the agreement and not for a thing that is not wholly done within 13 months. The payment to acquire a program license is also not taken to be a payment of a similar kind under paragraph 82KZL(2)(b) of ITAA 1936, as expenditure to acquire the program license is not seen to be in the nature of a rental or a lease payment. The Lessor's Contribution made by you to the Lessee under the Agreement is comparable to the payments made under the TPLA that are addressed in IT 2646. The Agreement provides that the Lessor's Contribution is a contribution towards the fit-out of the Premises and it is made in consideration of the Lessee accepting and entering into the Lease. As for a TPLA, the thing to be done under the Agreement is the Lessee's accepting and entering into the Lease. On the terms of the agreement entered into, there is no other ongoing thing to be done by the Lessee under the Agreement in response to the Lessor's Contribution. The thing is also done only once, at the commencement of the agreement, and is made for a single point in time obligation rather than an ongoing obligation or as a prepayment for goods or services. For the same reasons as set out for a payment to acquire a program license in paragraph 14 of IT 2646, the Lessor's Contribution paid in consideration of the Lessee accepting and entering into the Agreement is not a payment of a similar kind under section 82KZL(2)(b) of the ITAA 1936, as it is not in the nature of a rental or lease payment. As such, it is considered that the views expressed in IT 2646 apply to the Agreement, and that the Lessor's Contribution would not be pro-rated over a specified period under the combined application of sections 82KZMA and 82KZMD of the ITAA 1936.