Tax relief for rent-free periods

You’ve signed a new lease on your premises and negotiated a rent-free period with your landlord. How will this affect the timing of tax relief over the term of the lease?

Tax timing

The timing of a tax deduction can affect your company’s cash flow, especially if it’s for a major cost like renting your business premises. Ask most people in business when they think you can claim a tax deduction for an expense and they’ll probably say when you spend the money, or maybe when you receive an invoice. Ask an accountant or HMRC the same question and you’ll probably be asleep before they’ve finished their answer. But don’t be too hard on them, it really isn’t that simple.

Nothing to report

Two years ago Acom leased a factory. It had been vacant for a while and as an incentive the landlord offered the first year rent free and lower than current market rate for rents over the next two years. Acom’s bookkeeper listed no rents in the company’s records for the first financial year under the new lease, and only the rent actually paid in the following year’s accounts. No adjustment to these figures was made before the accounts were submitted to HMRC. But should there have been one?

Accounting and tax standards

Over recent years HMRC has come around to the accountancy profession’s way of thinking, that expenditure should be set against the income it generates. This means that where you incur a cost for something which is going to be used in your business over a period of time, it should be spread over the life expectancy of whatever it is that you’ve purchased. But in the case of rent on your business premises doesn’t one month’s rent simply pay for one month’s occupation?

Lease or no lease

The answer to the question above is “yes”, but only for short-term (a year or less) occupation. Where the rent is payable under a lease or other type of rental agreement over a longer period, the money you pay is in instalments against the cost of the lease as a whole. Accountancy/tax rules say you should spread this cost evenly over the tax years which the lease covers.

Tip. Where you don’t know the total cost of the lease, because the rent is only set for, say, three years of a ten-year lease, spread the rental payments equally over the period for which the rents are known.

Example. Acom signs a lease on the factory on 1 January 2015. The lease is for ten years, and the first year is rent free. The annual rent for the second and third years is £21,360 and is then subject to review. The company should include an expense in its accounts for the year of £14,720. This is worked out by adding together the rent from the start of the lease to the first review point and then dividing it equally between each year up to the rent review date, i.e. £0+£21,360+ £21,360÷3=£14,720. HMRC is happy to follow suit and allow a tax deduction of £14,720 in its 2014/15 accounts, even though it paid nothing in rent during that year.

Conclusion. This is good news for Acom; it corrected the earlier accounts and claimed corporation tax relief on an extra £14,720. In the long run it would have got the same tax relief, but in the short term it has extra money in the bank.

Please give us a call if you have any further information or advice.

Tax relief for rent-free periods

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