Leases — Income Tax and CGT Implications


Simon Misiewicz

18th April 2016

Do you own a freehold property and wish to split the property into more than one leasehold property?

Or perhaps you are granting lease extensions or premiums?

If you’re involved in this type of investment you’ll be aware there are tax liabilities.  However, the complexity of tax calculations in this area can be overwhelming.

The problem — two types of tax for leases

We will get into the details of how to calculate the types of tax later. Let’s first look at the types of tax that will be incurred:

  • Income tax based on money you have earned
  • Capital gains tax (CGT) on investments you’ve seen an increase in the value of

You’ll know when you receive money from someone it needs to be accounted for in terms of tax. It would be easy to assume that if you’ve received money for an asset on a lease then surely the money received is a capital gain that’s therefore subject to CGT, right? Well, not exactly. As it depends on the amount of money that you have received and the length of the lease granted.

Before you enter any transactions into your bookkeeping schedule you will need to go through a rather complex formula. This formula which unfortunately is likely to give you a headache.

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More or less than 50 years?

If you are granting a lease of more than 50 years, the money received will be treated as liable to capital gains tax only. But lump sums received upfront for the grant of a lease of 50 years or less are liable to tax on a special basis. Such receipts are generally called “premiums“, which are subject to income tax.

A distinction is made between:

  • a premium paid for the grant of a lease, and
  • rent due under the lease.

There is an additional distinction to be made in regards to the premium:

  • a premium paid for the grant of a lease, and
  • a capital sum paid on the sale of a lease.

A person holding property freehold (a landlord) may grant a lease under which another person (the tenant) occupies the property for a certain time. When the lease expires, the property reverts to the landlord.

The tenant might in turn grant a sub-lease under which he allows another person (a sub-tenant) to occupy the property for part of the term of the lease. At the end of the sub-lease the property reverts to the intermediate landlord (the head tenant) until the original lease (the head lease) expires.

If the sub-tenant pays a lump sum to the intermediate landlord, that is a lease premium.

Working out the tax on premiums 

Below are a couple of worked examples provided by HMRC to explain exactly how it works.

Example 1

Jeremy pays a premium of £10,000 to his landlord to obtain the grant of a lease of 21 years at a rent of £5,000 a year. The £10,000 is within the premium rules. Ten years later Jeremy sells the remaining eleven years of his lease to Robert for £8,000. That £8,000 is not a premium for the grant of a lease but the sale price of the lease and any gain or loss is dealt with under the CGT rules (unless Jeremy is a property dealer).

Example 2

Paul grants a 25-year lease to Peter on 5 June, 2004. The lease agreement requires Peter to pay Paul a premium of £30,000 on 30 June, 2004 in addition to rent of £400 a month. Paul must include in his rental business accounts for 2004-05 both the rent due for the period from 5 June, 2004 (when the lease started) to 5 April, 2005 and the taxable amount of the premium. That is, the premium is taxed in the year in which the lease is granted. The amount which Paul is treated as receiving as part of his rental business is calculated as follows:

£30,000 Premium receivable

£14,400 Less: (2% of £30,000) x 24 years
£15,600 chargeable to income tax in the tax year received

£4,000 Add: rent for period 5/6/04 – 5/4/05 (10 months at £400 per mont)

£19,600 charged to income tax on the year

Next steps — Understanding the tax implications of leases

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