Landlords and leases - tax may be due even when no cash is received

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Tax advisers are used to working out the income tax (or corporation tax) payable by a landlord when receiving rents from a tenant. A cash lump sum or 'premium' can also be liable to tax, at least in part, as income in the hands of the landlord if under a lease of less than 50 years. However, tax can sometimes arise even when no rent is paid to the landlord.

Section 278 of ITTOIA 2005 sets out the rules for 'deemed premiums' where improvement works are carried out by the tenant under the terms of the lease. The rule applies if:
• a lease is granted subject to terms imposing on the tenant an obligation to carry out any work on the premises, and
• the cost of the work concerned would not be deductible by the landlord as an expense of the rental business, if the landlord had paid for it.

The increase in the value of the property is treated as a premium and the amount of the receipt is given by the formula:

P x (50 - Y)

P is the premium, and Y is the number of complete periods of 12 months (other than the first) comprised in the effective duration of the lease.

The HMRC manuals give the following example:

Colin lets a shop to Dorothy from 6 January 2005 for 11 years at a rent of £300 per month. She is also required to have tarmac laid on the area at the rear of the premises to be used as a new car park, and it costs her £5,000.

Colin could not have deducted the cost of laying the tarmac in his rental income computation since it is capital expenditure. He is treated as if he had received a premium equal to the extra value of his interest in the property immediately after the commencement of the lease. The increase in value is agreed to be £3,000 (not the cost of the work) to reflect the wear and tear that the improvement will have suffered by the time the lease falls in and the restating of that reduced amount to present value. Colin's rental income computation must include the following:

Deemed premium receivable £3,000
less £3,000 × (11 - 1) / 50 £600
Chargeable amount of premium £2,400
Add actual rent for three months £900

Total £3,300

If the terms of the lease also require her to redecorate the premises every three years, this does not result in a charge under this provision. Colin could have deducted the cost if he had paid it.

The definition of premium is wide and includes sums paid to persons connected with the landlord. There are also complex rules for the application of VAT and stamp duty land tax to such payments.

As with all such tax situations, advice should also be sought before proceeding. For further details call Alan Boby on 01295 250401 or email

Alan Boby

Ellacotts LLP


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