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Leasing pitfalls

Entering into a Lease is a long term financial commitment. You need to consider all the rights and obligations it imposes on you for the entire duration of the Lease. Some Leases are straight forward, but most are drafted to protect and favour the Lessor’s interests. You need to ensure your interests are protected and what you negotiated is accurately reflected in the documents.

What constitutes a Lease?

A Lease is a contract by which the Lessor transfers rights to enjoy a property to the Lessee for a specific length of time in return for payment of rent and outgoings.

Are preliminary agreements a waste of time?

Preliminary Agreements can be used to fine tune negotiations and form a basis for the Lease to be drafted.

Whilst they are not binding unless they specifically state they are, they can be an important tool in getting each party to the same understanding on key issues.

Non-Standard Lease provisions

Some Leases impose specific rights and obligations on the parties for the duration of the Lease.

These can include the obligation for the Lessee to behave in a certain manner whilst conducting their business from particular premises. Large Commercial premises Leases can impose:

  • “Green Lease” obligations
  • Fire Safety obligations
  • Limited access hours to building;
  • Prohibited acts
  • Make Good obligations

Assignments and Sub-Leases

Assignments of Lease can cause a number of difficulties, especially if the Lessee has caused damage to a strata premises.

Any good Lease will have a requirement for no assignment to be consented to if the Lessee is in breach of the Lease.

The Retail Leases Act sets out the procedure for obtaining consent to assignment in section 41. This includes:

  • Request must be made in writing;
  • The proposed Assignee must be furnished with a copy of any disclosure statement prior to requesting consent;
  • The Lessor must deal with the request expeditiously.

Sub-leases are when a Lessee lets part of the premises they have leased to a third party. This could be used in instances where a company down sizes due to outsourcing or technological impacts where staff are able to work remotely. This reduces the overheads and is usually a commercial decision.

Options and Incentives

Options to renew allow a Lessee to have the option to enter into a fresh Lease on the same or similar terms for an additional period of duration.

Options to buy are used when the Lessor agrees to grant an option to sell the premises to the Lessee at the end of a specified rental period.

Usually the Lessee pays an option fee. This is usually non-refundable. The option only binds the Lessor to sell to the Lessee, it does not bind the Lessee to buy the premises.

Lease Incentives are enticements to enter into a Lease. They need to be considered carefully, especially in relation to Tax implications as they could be deemed income in nature.

The most common types of Lease Incentives and their taxable status are as follows:

  1. Rent-free periods – effectively tax-free.
  2. Interest-free loans – effectively tax-free, provided they are genuine business loans and not disguised cash payments.
  3. Free fit-outs –
    • If owned by landlord – effectively tax-free.
    • If owned by tenant – assessable but a deduction will be allowed for depreciation to the extent that the fit-out qualifies as depreciable plant or articles.
  4. Free holidays – complete holiday packages comprising travel, accommodation, meals and recreation will be effectively tax-free to the tenant, as the cost will not be deductible to the lessor.
  5. Free equipment such as computers – assessable but a deduction will be allowed for depreciation.
  6. Payment of removal costs – fully taxable except to the extent that the costs relate to revenue items such as trading stock.
  7. Payment of surrender value of existing lease – fully taxable. [1]

The most common issues that should be considered while negotiating lease incentives include:

  • Drafting Incentive Deeds in relation to fit-outs so that they achieve the desired outcome and Taxation status.
  • Identifying which assets that make up the fit-out that should be owned by which party as the depreciation rates for different assets may vary. For example the depreciation rate for equipment is usually higher that the depreciation rate for a premises.
  • Difference between timing of tax payable on fit-out contributions and tax deduction for depreciation in relation to them. The value of fit-out is generally assessable at the time it is received, however the depreciation deduction will be claimed over the effective life of the fit-out.

[1] Taxation Ruling No. IT 2631