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Tax matters in sale and leaseback

Tax has always been an important consideration in property transactions, and sale and leasebacks are no exception.

While non-tax factors will drive the process, addressing tax matters from the outset will ensure you minimise the overall tax cost of the process, and maximise the overall value from a sale and leaseback.

If you currently own commercial property, the idea of a sale and leaseback holds some attraction. The opportunity to sell and free up cash, or repay debt is compelling where cashflow is tight, or where the bank is reluctant to renew lending.

As ever, when dealing with property matters, tax implications and opportunities should always be considered, and not left until after the event.

In its simplest terms, the transaction will involve a sale of the existing land and buildings to a third party, who will then lease the premises back. The following areas should be considered to help avoid surprises and maximise tax efficiency when contemplating a sale and leaseback.

Sale of land

Generally, proceeds from the sale of land will not be taxable. However, proceeds may be taxable in some circumstances, including where:

· The vendor purchased the land with a purpose or intention of sale or disposal;

· The vendor carries on business as a dealer, developer, sub-divider or builder, or is associated with someone operating in this area – note that important new rules around ‘association’ are proposed, but have not yet come into force;

· Gains arise from improvements made in some situations;

· Gains arise from rezoning or the likelihood of rezoning in some situations.

This is a complex area, and it generally pays to obtain advice on your specific situation.

Sale of buildings & fittings

Tax depreciation will have been claimed on buildings and fittings. The tax implications on disposal depend on how the sale price compares to the original cost and the tax depreciation claimed to date.

· Proceeds in excess of original cost will often constitute a tax-free capital gain;

· Proceeds in excess of Adjusted Tax Value (ATV) will result in taxable depreciation recovered (clawed back);

· Proceeds below ATV will result in a deductible tax loss on fittings, but not for buildings.

The net after-tax cost of the sale can be significantly altered depending on relative values allocated to different asset types. Negotiate with the purchaser and seek an allocation for your specific circumstances. The best time to arrive at the allocation is during the sale negotiation process, and the allocation should be documented in the sale and purchase agreement. This approach should minimise the likelihood of arguing the matter with the IRD at a later time, as compared to the approach of a single lump sum being disclosed in the documentation and each party adopting their own (differing) allocation. In any event, ensure that any allocation is reasonable and is preferably based on an independent valuation.

In the examples below, by allocating more of the sale price to land, and less to buildings and fittings, $1.8m in tax is saved.

Allocating a lower amount to buildings is not always beneficial. For example, if the building is relatively new, not much tax depreciation will have been claimed. This means only a limited claw back of depreciation in the event that proceeds exceed the ATV, with the rest likely to represent capital gain.

Note that the purchaser will often (but not always) have the competing objective to maximise the value attributed to a building and fittings, so working out the tax implications in advance will help achieve the best outcome from negotiations.

Deductibility of lease payments

Because the building has been sold, you will no longer be entitled to claim tax depreciation on the building. However, a tax deduction will instead be claimed for the lease payments, providing a faster tax deduction.

GST

GST is likely to apply to the sale. Take care in relation to the time of supply – receipt of a deposit will trigger the time of supply with respect to the whole sale price, unless paid into an independent stakeholder account.

Other issues

In some situations, the parties could negotiate terms which provide for an inducement by either party to enter into the transactions. Such inducements could include a rent subsidy, rent holiday, fit-out contribution, lease inducement or lease premium. The tax consequences of these arrangements need to be carefully considered in the light of each party’s particular tax circumstances.

• Ben Willems is a Partner at Ernst & Young. If you require any assistance with any of the issues discussed above, please do not hesitate to contact Ben on 03 353 8098 or email ben.willems@nz.ey.com; ww.ey.com/nz.

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