The pick-up in commercial activity in Dublin has seen a resurgence in lettings involving key money especially if the property is centrally located, is under-rented or has planning permission to prepare food. There are multiple reports of food traders in particular paying large sums for leases of property in the city-centre
We have received a number of queries in recent months from landlords and advisors about the taxation treatment of key money payments.
The key issue from a taxation perspective is whether the payment is classified as a form of disposal proceeds - in which case capital gains tax ('CGT') applies - or rental income. For most people CGT treatment is more beneficial. This is because the effective rate of CGT (33%) is substantially lower than the effective aggregate rates of income tax, PRSI and universal social charges (which can be up to 55%). Furthermore, a landlord may have unutilised CGT losses which can be used to reduce the amount taxable.
The taxation of key money
Tax law distinguishes between CGT and income tax treatment by looking at the length of the lease term. A premium paid for a very long lease is treated as a part disposal of the underlying freehold interest. In this case there would be a charge to CGT.
If a premium is paid for a shorter lease it has a character more like rent (albeit rent paid in a lump sum rather than periodically).
Tax law achieves this balance by charging a proportion of the payment to tax as income. The proportion to be charged as income depends on the length of the lease. The shorter the lease, the greater the proportion to be charged.
A tenant agrees to pay key money of €200,000 for a 20 year lease in a restaurant.
Under tax rules, the payment (or lease premium) of €200,000 would be split into income of €124,000 and capital of €76,000. The income portion would simply be treated as additional rental income and be taxed along with other rental income for the landlord. The capital portion is liable to CGT.
The landlords aggregate tax liability is €93,280 (an effective rate of 46%).
The tenant's position
If the tenant is using the property for business purposes, then relief is given in computing the business profits, spread over the period of the lease. Complications arise if the payer sublets the property and in turn charges a premium.
Planning to reduce tax
There are limited options for reducing the exposures to income tax and CGT arising in respect of leases. That said, with careful drafting of the lease agreement it is possible to achieve a better outcome for the landlord - whether that is CGT or income tax treatment.
This is achieved by This is achieved by including or amending specific provisions within the lease. In doing so it is important to have regard to commercial factors and the Revenue may take into account any circumstances that could affect the lease agreement itself.
For advice on how to save tax on lease transactions contact Derek Andrews by email or at +353 (0)1 6978012.
The tax areas mentioned in this blog are income tax and capital gains tax.