Chapter 1 - Summary
Background
1.1 This paper reviews the income tax treatment of land-related lease payments. The review follows the recent lease inducement and lease surrender payments reforms introduced in Supplementary Order Paper No. 167 to the Taxation (Livestock Valuation, Assets Expenditure, and Remedial Matters) Bill.[1]
1.2 The review is two-fold. First, the paper considers the current tax treatment of land-related lease transfer payments in light of the recent lease surrender payments reform, and suggests making them taxable to remove current distortions.
1.3 The paper further examines the overall tax treatment of land-related lease payments. The current rules have been implemented separately for particular payments over a long period of time, and because similar payments can be treated differently, results can be inconsistent for taxpayers.
1.4 The paper suggests generic income, deduction and timing rules for all land-related lease payments. This should provide a more consistent and coherent tax treatment of these lease payments that is in line with New Zealand’s broad-base, low-rate tax framework.
Land-related lease transfer payments
1.5 A land-related lease transfer payment is generally received by an exiting tenant (transferor) from a new incoming tenant (transferee) for the transfer or assignment of a lease. For income tax purposes, the payment is generally tax deductible to the incoming tenant under the depreciation rules and non-taxable to the exiting tenant.
1.6 As part of extending the lease inducement payments reform to include lease surrender payments, a further policy problem involving the current tax treatment of lease transfer payments was identified. The current non-taxable status of lease transfer payments in tandem with the proposed lease surrender payments reform distorts the commercial decisions of the exiting tenant.
1.7 It would be more tax advantageous for the tenant to exit a lease by transferring the lease to a third party for a tax-free payment rather than surrendering it to a landlord for a taxable payment even though there is no economic difference between the two from the tenant’s perspective. Treating similar payments differently for income tax purposes distorts business decisions, resulting in economic inefficiency and unfairness.
1.8 To remove this distortion, we suggest that lease transfer payments be made taxable.
Land-related lease payments
1.9 Following the above suggestion to make lease transfer payments taxable, we consider the overall tax treatment of land-related lease payments should be reviewed for a more consistent and coherent tax treatment of these payments.
1.10 There are a number of provisions in the Income Tax Act 2007 that specifically provide for the tax treatment of certain land-related lease payments for income, deduction and timing purposes. However, these provisions are not comprehensive, and can result in inconsistent and incoherent outcomes for taxpayers.
1.11 These provisions in the Act may produce gaps, which mean that similar payments can be treated differently. Some taxpayers may treat certain payments as a revenue account item and others as a capital account item.
Suggested approach
1.12 To treat land-related lease payments consistently and coherently for income tax purposes, we suggest that generic income, deduction and timing rules for these payments be introduced.
1.13 Under these new rules, any land-related lease payment would be treated as deductible to a payer and taxable to a recipient under the Income Tax Act 2007. Note that payments derived by a tenant of residential premises would be excluded from the new rules.
1.14 The rules would apply only to a land right (leases or licences of land) if the land right has a term of less than 50 years. This way, payments made in relation to a land right that lasts 50 years or more, such as a permanent easement, would be treated similarly to payments made in relation to a freehold estate.
1.15 A separate timing rule would also be introduced to spread the income and deductions over the term of the relevant land right.
1.16 The new rules would change the tax treatment of some land-related lease payments from the status quo. Some payments that are currently non-taxable to the recipient would become taxable under new rules. For example, lease transfer payments (which are currently generally non-taxable to tenants) would become taxable, as suggested in this paper. Also, certain payments that are now generally non-deductible to the tenant would become tax deductible – such as lease modification payments.
1.17 Moreover, the new rules would rationalise the existing rules in light of the proposed changes to lease inducement and lease surrender payments. Under the current rules, income from lease premium payments may be spread over six years whereas income from lease inducement payments would be spread over the term of the lease. The suggested new rules would spread lease premium income over the term of the lease.
1.18 Rationalising the existing rules would result in a more consistent and coherent tax treatment of land-related lease payments in line with New Zealand’s broad-base, low-rate tax framework. It would also improve fairness and business efficiency.
1.19 The technical details of the suggested reforms are discussed more fully in Chapter 4.
Submissions
1.20 You are invited to make a submission on the suggested reforms raised in this issues paper, in particular:
- Should non-taxable lease transfer payments be made taxable in light of the recent lease surrender payments reform contained in the Taxation (Livestock Valuation, Assets Expenditure, and Remedial Matters) Bill?
- Are there any aspects of the suggested new income, deduction and timing rules for all land-related lease payments that do not adequately meet the objective of this review – that is, providing a more consistent and coherent tax treatment of land-related lease payments?
- Are transitional issues arising from the suggested new rules adequately addressed?
- Are there any aspects of the suggested new rules that will create unwarranted compliance costs?
1.21 Submissions will be taken into account when we make recommendations to the Government on any necessary legislative changes.
How to make a submission
1.22 Submissions should include a brief summary of major points and recommendations. Submissions should also indicate whether it would be acceptable for officials to contact the submitter to discuss the points raised, if required.
1.23 Submissions should be made by 4 June 2013 and be addressed to:
Land-related lease payments
C/- Deputy Commissioner, Policy and Strategy
Policy and Strategy
Inland Revenue
PO Box 2198
Wellington 6140
Or email to [email protected] with “Land-related lease payments” in the subject line. Electronic submissions are encouraged.
1.24 Submissions may be the subject of a request under the Official Information Act 1982, which may result in their publication. The withholding of particular submissions on the grounds of privacy, or for any other reason, will be determined in accordance with that Act. Submitters who consider that their submission or any part of it should properly be withheld under the Act should indicate this clearly.
1 The Taxation (Livestock Valuation, Assets Expenditure, and Remedial Matters) Bill was before Parliament at the time this officials’ paper was published. If implemented, these payments would be treated as taxable to the recipient and deductible to the payer under the Income Tax Act 2007 from 1 April 2013.