Surrendering a lease: a hidden tax trap

Side effects

An indirect consequence of the coronavirus pandemic was that many employees stopped commuting to offices and started working at home. While many have returned to the office a large minority have not. Some employers are now tied into leases requiring them to pay rent for office space they don’t need. Their landlords might agree to the early termination (surrender) of the lease but this can have tricky and sometimes undesirable tax consequences.

Reverse premium

Here we consider the position from the viewpoint of a tenant who pays the landlord to accept the surrender of a lease. HMRC calls this a “reverse premium”. However, in its guidance it points out that this type of reverse premium is not the same as one where the landlord pays the tenant an inducement to take on a lease. The tax rules for that type are different and not covered here.

When reading HMRC’s guidance about reverse premiums make sure you know which type you’re dealing with so you don’t refer to the wrong information.

Deductible from income?

A general tax principle, derived from case law rather than statute, is that a business is entitled to a deduction from its income for a sum paid to release it from an “onerous liability”. In other words, the business can claim a deduction where the reason for making a payment is to reduce its costs in the long run. That suggests a payment made to persuade a landlord to accept the early surrender of a lease should be tax deductible from its income. However, that’s not the case.

Deductible for capital gains tax?

The principle referred to above, also based on case law, is that a payment made to release your business from an onerous liability relating to a capital asset is a capital expense. It’s only deductible for capital gains tax (CGT) purposes when working out the gain or loss when the asset is sold or transferred. While HMRC accepts this, its view is that in the case of a reverse premium for the surrender of a lease no deduction is due.

Accordingly, payment made by a tenant to a landlord to accept the surrender of a lease isn’t tax deductible at all. If negotiating the amount of payment to surrender a lease keep in mind that the cost won’t be reduced by tax relief.

HMRC’s view

As we’ve mentioned, a payment for release from an onerous liability relating to a capital asset can only be deducted for CGT purposes. Such expenses are taken into account when working out the capital gain or loss made from selling or transferring the asset. The trouble is, the legislation only allows a deduction if the expense is “fees, commission or remuneration paid for the professional services of any surveyor or valuer, or auctioneer, or accountant, or agent or legal adviser and costs of transfer or conveyance” .