Duty and leases - When may a leasing transaction attract duty?

In brief:

It remains important for both landlords and tenants alike to continue to consider when a leasing transaction may attract duty, as this could significantly impact on the financial viability of a transaction. 

Background

• In May 2022, amendments to the Duties Act 1997 (NSW) (Act) expanded the application of duty to include a change in beneficial ownership of dutiable property as a dutiable transaction. This means that certain commercial leasing transactions are now dutiable.

• In November 2022, the Commissioner of State Revenue published two practice notes, CPN 025 (Change in Beneficial Ownership) and CPN 027 (Leases and change in beneficial ownership) which provide further information about how the Act and its regulations apply to leases.

• During 2023 to date, practitioners and parties alike have undertaken certain leasing transactions with the above new framework in mind. The above practice notes continue to be current.

What is a change in beneficial ownership and how may leasing transactions be impacted by this? 

A 'change in beneficial ownership' is defined in the Act to include: 

• the creation of dutiable property; 

• the extinguishment of dutiable property; and 

• a change in equitable interests in dutiable property. 

Accordingly, the grant of a lease may attract duty unless one of the exclusions set out in the Act or the Duties Regulation 2022 (NSW) (Regulation) applies. 

What are the express exclusions from duty for leasing transactions? 

The Act and the Regulation identify a number of transactions which are 'excluded' from the broadened application of stamp duty. The excluded transactions which are relevant to leasing include:

1. the grant, renewal or variation of a lease for no consideration;

2. the creation, variation or surrender, for no consideration, of a tenant’s interest in fixtures that are fit-out for commercial premises;

3. a change in tenancy under a lease for no consideration; and

4. the expiry, extinguishment or merger of one or more leases for no consideration.

As a general rule, a lease granted, renewed or varied without consideration will not attract duty. If, on the other hand, the tenant pays a premium or other consideration for the grant, renewal or variation of the lease, the amount of the consideration will be dutiable.

What is consideration in the context of a leasing transaction?

Consideration is money or value paid that "moves the conveyance or transfer" and may be monetary or non-monetary. It is important to note that rent is not a consideration for the grant of the lease itself, as it is a payment for the right to use the land.

If, for example, Company A as a tenant enters into a ten-year lease of commercial premises for rent of $1,000 per month and makes no other upfront payment, Company A will not have to pay duty. The rent of $1,000 per month is payment for the right to use the land and not consideration for the grant of the lease.

Further, outgoings such as rates, charges or taxes are also not treated as consideration under the Act.

Will all lump sum payments be considered monetary consideration for the grant of a lease? 

Whether a lump sum paid by a tenant is rent or a premium depends upon whether the sum is paid: 

• as consideration for the granting of the lease itself (in which case it would be considered a premium and attract duty); or 

• for the use and enjoyment of the land (this would be considered rent). 

As a general rule, if a lump sum payment is non-refundable on early termination of the lease in an amount proportionate to the period of the unexpired term of the lease, Revenue NSW will treat the sum as a premium even if the parties have described the amount as rent in advance.

The Commissioner of State Revenue has provided several examples to illustrate how Revenue NSW will treat lump sum payments, which include the following: 

• Example 1 - Company B as a tenant enters into a ten-year lease of commercial premises for rent of $500 per week. 
  
  At the commencement of the lease, Company B makes a non-refundable upfront payment of $160,000 for the grant of the lease. Duty will be payable on the $160,000 under section 8(1)(b)(viii) of the Act, as the $160,000 is a premium paid for the grant of the lease; and

• Example 2 - Company C as a tenant enters into a 6-year lease of commercial premises for rent of $500 per week. At the commencement of the lease, Company C makes an upfront payment of $160,000.
  
  The $160,000 is characterised in the lease documents as a combination of prepayment of rent, the unused portion of which is refundable if the lease is terminated early, and a "guarantee payment" of $4,000. In this case, the $156,000 ($500 x 52 x 6) attributable to the prepayment of rent will not be dutiable, but the amount of $4,000 as a guarantee payment will attract duty as a premium.

​What is non-monetary consideration, and how may improvements and fit out attract duty? 

One of the more significant changes resulting from the 2022 amendments to the Act is the scope for duty to be imposed on non-monetary consideration under leases. Now, non-monetary consideration such as improvements to the property may also be dutiable under the Act. 

Again, whether improvements to the property are dutiable depends upon whether the improvements: 

• Are made as an incentive to the landlord for the grant, renewal or variation of the lease (which will attract duty); or 

• Take the character of prepaid rent (which will not attract duty).

Non-monetary consideration may take the character of prepaid rent if: 

1. The landlord has credited the value of the improvements against the tenant's obligation to pay rent; and 

2. The tenant is entitled to a proportionate refund if the lease is terminated early.

Again, the Commissioner of State Revenue has provided several examples that illustrate when the value of improvements to a premises will be dutiable. We have adapted several of these examples below:

• Example 1 - Improvements as prepaid rent: A landlord grants Company D a 15-year lease of an industrial building. The consideration for the use of the premises under the lease is a prepaid rent of $15 million. There is no separate consideration for the grant of the lease. Company D can satisfy the obligation to pay rent by either the payment of cash, or by the construction of improvements with an agreed value of $20 million. In either case, if there is an early termination of the lease (other than through the default of Company D), Company D is entitled to a proportionate refund. No duty is payable even if Company D constructs the improvements, as it takes the character of prepaid rent.

• Example 2 - Improvements as consideration for the grant of a lease: A landlord grants Company E a lease of NSW premises for a period of 10 years. Rent is $1.00 per annum. There is no premium payable, but the lease documents provide that Company E must fit out the premises. The lease documents also provide that these improvements will become the landlord's property when the lease ends. Duty will be payable on the value of the improvements. This is because the value of the improvements is the non-monetary consideration for the grant of the lease.

• Example 3 - Improvements as consideration for the grant of a lease: A landlord grants Company F a 15-year lease of an industrial building. The lease is granted for $1 per annum. The lease is conditional on Company F making improvements to the currently dilapidated industrial estate. The improvements cost $20 million. A valuation is prepared showing that the evidence of value of the improvements after 15 years is $12 million. Company F submits a valuation on this basis and after analysis of the valuation, this is accepted by the Chief Commissioner and duty will be calculated and payable on $12 million. 

• Example 4 - Fit out on expiration of a lease: A landlord grants Company G a lease of 3 floors of a commercial office tower in NSW for a term of 10 years. The lease includes a provision that requires Company G to remove all fit out and fixtures when the lease expires. At the end of the lease, the landlord allows Company G to leave without removing the carpet and office partitions. No duty will be payable on the expiration of the lease because Company G has surrendered its interest in the fixtures for no consideration.

• Example 5 - Improvements as consideration for release of a debt: A landlord grants Company H a lease for a term of 5 years. Company H defaults on the rental payments. At the end of the 5-year term, Company H surrenders its rights in some fixtures and fit out of the leased premises in exchange for the release of a debt equivalent in value to the surrendered items. The surrender of the fixtures and fit out will be liable for duty based on the value of the fixtures and fit out. 

Installing improvements to the premises is going to attract duty, so how is the value of that non-monetary consideration calculated? 

Revenue NSW takes the dutiable value of any non-monetary consideration to be the percentage of the total value of the improvements that will revert to the landlord once the lease comes to an end. 

As a general rule, the longer the lease the lower the percentage of the initial cost of the improvements that will be dutiable, so as to account for depreciation. If the lease is for a period of more than 50 years, Revenue NSW will treat the improvements as having no value and no duty will be payable on the cost of the improvements.

There are two options for calculating the value of the improvements: 

1. Obtaining a valuation for the value of the improvements; or 

2. Relying on the construction costs of the improvements. 

Parties should carefully consider and seek advice as to which method of valuation may result in a better outcome. 

Obtaining a valuation 

If a tenant choses to go down the valuation path, the tenant or developer must provide Revenue NSW with evidence of the value of the improvements at the time of stamping of the lease or agreement for lease. If a valuation is not provided, the Chief Commissioner may assess duty on the basis of another valuation or other evidence. 
If it is the case that you choose to obtain a valuation to calculate the value of the improvements, we recommend contacting a suitably qualified quantity surveyor to provide a valuation for the purposes of duty assessment. 

Construction costs 

The second method for calculating the value of non-monetary consideration is to rely on the construction costs of the improvements.
 
Revenue NSW is prepared to accept evidence of the actual cost of improvements and to use the methodology set out in the below table to calculate the proportion of the value attributable to the improvements as the dutiable value. Namely, the dutiable value of the improvements will be the cost of construction activities including GST. 

 

Term of Lease	% of cost of improvement
10 years or less	100
Greater than 10 but not more than 20 years	75
Greater than 20 but not more than 30 years	50
Greater than 30 but not more than 50 years	25
Greater than 50 years	nil
Periodic lease or lease for a term that cannot be ascertained when the lease is made	100

The impact for landlords and tenants 

Given the abolition of duty being assessed and payable on most leases as was the case up to 2008, for many years now landlords and tenants have not for the most part had to consider duty in their transactions (aside from for example lease surrenders and the payment of lease premiums). The 2022 changes to the Act changed that position. 

Lease premiums are becoming less common in commercial leasing. However, the imposition of duty on non-monetary consideration (which includes improvements to premises) could significantly change the commercial feasibility of a particular lease transaction. 

If you are considering entering into a leasing transaction which involves non-monetary consideration for the grant of the lease, we recommend you continue to assess the scope for duty to be imposed on that consideration and seek advice including as to the best method to calculate the value of that consideration.