Lease incentives are more important than ever in the post-COVID office leasing market, in attracting occupiers. 

There are various types of lease incentive that landlords can provide to tenants, depending on circumstances:

• rent-free period
• capital contribution to the tenant’s fit-out
• a combination of the above two
• undertaking a CAT A Plus fit-out direct for the tenant

Our experience of capital contributions for office fit-outs, range in size from a mere few thousand pounds for the smallest lettings to in excess of £8 million on large single lettings.

Capital allowances on capital contributions (‘contribution allowances’) are a key aspect of capital contributions and to the overall lease transaction.

For the benefit of the landlord and tenant (and also for future owners of the property), it is vital that a capital contribution agreement is entered into and that it is comprehensive and unambiguous.  The agreement should be contained within the Agreement for Lease. 

At the outset, the agreement should: clearly state that the landlord is making a ‘capital contribution’ towards the tenant’s fit-out expenditure;  the landlord will claim capital allowances on the contribution;  state the amount of the capital contribution, excluding any VAT;  refer to sections 537, 538 and 538A of CAA 2001 as relevant.    

The agreement should clearly state the order of assets to which the contribution is allocated, in particular:  first-year allowances, the main pool, the special rate pool and buildings.

Other important aspects to address in the contribution agreement, include:

• the provision by the tenant of information such as cost breakdowns and invoices
• which works/assets are part of the tenant’s fit-out
• ownership of the plant and machinery, including after the tenant lease expires  
• the tenant will not claim capital allowances on the capital contribution

Vital issues to be aware of are:

• whether the landlord and tenant are connected
• if plant or machinery assets could be caught by the long funding lease rules
• the tax status of the tenant and whether or not it is a public body
• whether the landlord is a developer

For a landlord who is within the charge of UK tax, where an entire capital contribution is towards plant and machinery, the capital contribution payment is super tax efficient.  Because, not only can the landlord claim plant and machinery contribution allowances during property ownership – the capital contribution 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 claimed contribution allowances, the remaining contribution allowances must be transferred to the new owner on sale.  Plant and machinery contribution allowances claimed by the seller cannot be transferred in a section 198 election.        

Meanwhile, from a tenant’s point of view, 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).  Therefore, where the landlord is entitled to capital allowances on the entire contribution, the contribution is not taxed as income in the tenant’s hands.  This means the tenant receives a non-taxable payment.

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.

Post COVID, landlords of larger offices are undertaking CAT A Plus floor fit-outs, where necessary.  In many cases, these are undertaken direct for the incoming tenant as a condition of entering into the lease.  More frequently however, these CAT A Plus fit-outs on larger offices are undertaken on a speculative basis (not as part of a lease negotiation), to attract desirable corporate tenants.

© Smith Kelland Limited

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