Nov 252014

In a previous article, we saw how the tax legislation allows a business tenant to deduct the income element of the premium paid under a short lease. In particular, we found that the deduction is spread over the term of the lease.

This makes sense and has symmetry, though this symmetry is due to the legislation. Under the lease premium rules the landlord is treated as receiving part of the premium as income, so the tenant is treated as having incurred this same amount as an income expense. However, this statement isn’t quite true as we shall find out.

The problem – the tenant exits the lease early

The following scenario is taken from a question poised on one of the message boards on the accounting website AccountingWEB.

We have a tenant who intends to trade from the property, paying the landlord a premium of £15,000 for a 15 year lease. This is a short lease, since the term is for less than 50 years. The lease premium rules apply so that the landlord is treated as receiving an income receipt A, given by the formula1:

A = P x [(50 – Y)/50]

Where P is the premium and Y is the number of years in the lease apart from the first year. Thus P = £15,000 and Y = 14, so that the income element A amounts to £10,800. The tenant is entitled to yearly deductions of £10,800/15 = £720.

After three years, the tenant stops trading and exits the lease by exercising a break clause. (We shall assume that the existence of this break clause doesn’t turn it into a three year lease2).

At this stage, the tenant has obtained three years worth of tax relief amounting to £2,160. What happens to the balance of £8,640? Can it be claimed as a trading loss in the final year?

Tenant tax deduction on premium

No he can’t!

The question presupposes that the £10,800 is the tenant’s income expense, on the basis that this amount is also an income receipt for the landlord. But that’s not what the legislation actually says.

This is what the legislation says3:

“The tenant…is treated as incurring an expense of a revenue nature in respect of the land…for each qualifying day.”

In our previous article we found that a qualifying day is defined as being4:

  • A day that falls within the receipt period of the taxed receipt – which is simply any day of the lease5; and
  • It must also be a day on which the tenant occupies the whole or part of the land for the purpose of carrying out the trade.

So the tenant can only claim a revenue deduction for each day that he occupies the property for trading purposes. So if the tenant stops trading after three years, he is only entitled to three years worth of tax relief.

But how much is this tax relief worth? Is the daily calculation adjusted to take into account the time that the tenant occupied the property? Unfortunately not. The daily amount that can be deducted is fixed at the outset by the formula6:



  • A is the income element that the landlord is treated as having received7; and
  • TRP is the number of days in the lease8.

Ideally the denominator – “TRP” – would be recalculated to take into account the fact that the tenant only stayed in the property for three years. But there is no such provision in the legislation.

Accordingly, the three years worth of tax relief that our tenant has already obtained, is all he is entitled to as a revenue deduction. The balance cannot be claimed because there is no balance – for the tenant was never entitled to treat the whole of the landlord’s income receipt as a deductible expense in the first place. The only way in which this could have come about was for the tenant to carry on trading in the property for the full term of the lease.

But all is not lost.

What is the capital gains treatment?

By exercising the break clause, the tenant has disposed of the lease. In order to calculate his CGT computation he is permitted to deduct his base cost together with any incidental expenses incurred in entering the lease9.

Normally the base cost will be the premium. But since the tenant has already claimed part of this amount as tax relief against his trading profits, that part is left out of the equation10.

So what is the tenant’s net base cost?

 Lease premium - tenant's capital gains-001

The tenant’s base cost is £12,840. This sum includes the balance of £8,640 that the tenant was unable to set against his trading profits. Had the tenant been able to claim this amount as a revenue deduction, the capital gains base cost would have been only £4,200 – which exactly matches the amount that the landlord can claim as a capital receipt. This latter scenario would only have come about had the tenant carried on trading for the whole term of the lease.

So the tenant can in fact deduct the £8,640 balance – not against trading profits, but against his capital gains calculation on exiting the lease. Whether this will be of any use to him is another matter.

For example, assume that the disposal of the lease results in a capital loss – which will be the case as there are no “sale proceeds”. This loss can be set against any gains made on selling off any of the trading assets if there are any (but these must be capital assets). On the other hand, claiming the balance as a revenue deduction is no use if there aren’t any profits available to set against in the final three years of trading11.

Side note on wasting assets

The base cost will actually be lower than £12,840, due to the rules on wasting assets. The lease is a wasting asset since it has less than 50 years to run, and so the base cost is adjusted downwards12. Nevertheless, at least some of the £8,640 balance can be recovered.


We started with the proposition that when a tenant is granted a short lease, part of the premium can be deducted as a revenue expense, with the deduction being spread over the length of the lease. We also assumed that the total deduction must match the landlord’s income receipt under the lease premium rules.

But it turns out that this isn’t a completely accurate state of affairs. Both these propositions hold, but only if the tenant trades from the property for the entire duration of the lease. However, if the tenant exits the lease before the end of the term, the amount of tax relief is reduced. This is simply a consequence of the fact that the tenant’s deduction is calculated at a fixed daily rate and only lasts for as long as he continues to trade from the property.

However, the loss of tax relief is illusory. For while the revenue deduction is reduced, his capital gains base cost is increased. Depending on the circumstances, this may prove to be more valuable than the lost tax relief against income profits.


  1. ITTOIA 2005 s 277(4); CTA 2009 s 217(4).
  2. ITTOIA 2005 s 303(1); CTA 2009 s 243(1).
  3. ITTOIA 2005 s 61(1); CTA 2009 s 63(1).
  4. ITTOIA 2005 s 61(3); CTA 2009 s 63(3).
  5. The receipt period is the effective duration of the lease – ITTOIA 2005 ss 60(4), 288(6); CTA 2009 ss 62(4), 228(6). The taxed receipt is the premium paid to the landlord – ITTOIA 2005 ss 60(4), 287(4); CTA 2009 ss 62(4), 227(4).
  6. ITTOIA 2005 s 61(4); CTA 2009 s 63(4).
  7. ITTOIA 2005 ss 60(4); 290(2); CTA 2009 ss 62(4), 230(2).
  8. ITTOIA 2005 s 61(4); CTA 2009 s 63(4).
  9. TCGA 1992 s 38(1)(a).
  10. TCGA 1992 s 39(1).
  11. ITA 2007 s 89; CTA 2010 s 39.
  12. TCGA 1992 Schedule 8, paragraph 1.
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Satwaki Chanda

Satwaki Chanda

Satwaki Chanda is a tax lawyer with a First Class degree in Mathematics. Called to the Bar in 1992, he is the Editor of Tax Notes.
Satwaki Chanda

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  4 Responses to “Property Tax and the Lease Premium Rules – What happens when the tenant exits the lease?”

  1. In today’s economic climate, the scenario is more often that not that a landlord offers the tenant incentives to take a lease, either as rent free, half rent or capital contirubtion to fit out. What is the tax situation for the tenant in this scenario?

    • Thank you for your question Victoria. This is actually the second time someone has asked me this today, the other being on one of the linkedin Property Boards.

      The answer to your question is actually the subject of another article I have planned on reverse premiums. However, this is what I replied on the linkedin board about what the position is if the landlord simply makes a cash payment;

      “The tenant is specifically treated as receiving an income receipt by the legislation. But there are no mirror provisions which say that the landlord is treated as incurring a (deductible) revenue expense. Landlord’s inducement is generally capital, but it doesn’t mean he can necessarily deduct it in his CGT calculation.”

      Which is (partly) why one tries other options such as rent free periods and fit out contributions.

      Strangely enough I first wrote about reverse premiums two recessions ago, when it was very much relevant then as it is today.

  2. Very helpful article.

  3. Excellent post. Thanks!

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