Lease incentives continue to be an important aspect of the office leasing market. 

The three main types of lease incentives provided by landlords to tenants are:

• Rent-free period
• Capital contribution
• A combination of the above two

From our experience, capital contributions on office fit-outs range in size from a mere few thousand pounds to in excess of £10 million.

Capital allowances (‘contribution allowances’) are therefore a significant part of capital contributions and of the overall lease transaction.

From both the landlord’s and tenant’s perspective, it is important that there is a comprehensive contribution agreement.  This usually takes the form of a number of clauses within the overall lease agreement document.  The agreement should, at the outset, specifically state the words ‘capital contribution’, so that there is no misunderstanding.

The agreement should clearly state the order in which the contribution is allocated towards each category of asset.  In particular, the categories of plant and machinery.

For a landlord, where an entire capital contribution is towards plant and machinery, the capital contribution payment is very tax efficient.  Not only can the landlord claim plant and machinery contribution allowances during ownership (section 538, CAA 2001) – the capital contribution payment itself is treated as part of the base cost when calculating the capital gain when selling the property (section 38(1)(b), TCGA 1992).

Contribution allowances – both plant and machinery contribution allowances and structures and buildings contribution allowances – can only be claimed during ownership of the particular property.  When a landlord sells a property, on which it has made a capital contribution and claimed contribution allowances, the remaining contribution allowances must be transferred to the new owner on sale.  Plant and machinery contribution allowances cannot be included within a section 198 election.        

Capital contributions provided by a landlord to an incoming new tenant or as part of a re-gear, are classed as an inducement.  The contribution payment is therefore a reverse premium in the tenant’s hands (section 96, CTA 2009).  However, any part of the contribution payment that reduces the tenant’s capital allowances, is not a reverse premium (section 97(1), CTA 2009).  Hence the contribution is not taxed as income in the tenant’s hands.

A capital contribution made to a connected person, does not qualify for contribution allowances.  For example, if a PropCo made a capital contribution to its OpCo, the PropCo would not be entitled to contribution allowances on the contribution.

Separate to capital contributions, since COVID, landlords of larger offices are undertaking ‘CAT A+’ floor fit-outs (sometimes referred to as ‘plug and play’) direct for incoming tenants.  Frequently, these CAT A+ fit-outs are undertaken speculatively as part of marketing a newly refurbished office floors to specific desired potential tenants.

© Smith Kelland Limited

This is for general information purposes only. It is not advice and is not intended to be advice.