Re:locate magazine, summer 2006

Premium Leases: Advantages and Disadvantages

Rental-property legal expert Marveen Smith assesses the pros and cons of premium leases, explaining when and why they can work to a company’s advantage.

Premium Leases are becoming an increasingly popular option because of the corporate tax benefits they can offer, and — as such — they’re worth investigating in more detail. The term ‘premium lease’ may be an expression used by letting agents and relocation companies, but it’s one that has no distinct legal meaning. The term is taken to mean a tenancy or lease for which a premium is paid to the Lessor. This is, in effect, the purchase price of the premises for the period of that lease —commonly for a length of time between one and three years. The Lessee becomes the purchaser or owner of the property for that period of time, and has the option of registering this interest at the Land Registry. Premium leases are usually tax-driven to the advantage of the Lessee, but they’re not always tax advantageous for the Lessor.

What’s what with premium leases

Premium leases are granted for a fixed period with no break clause. Legally, there is no minimum or maximum term for their duration, but this factor may be determined by tax considerations dictated by the Lessee’s accountants. Instead of the words ‘landlord’ and ‘tenant’ the words ‘Lessor’ and ‘Lessee’ are used. The premium is paid up-front, and this is effectively the purchase price of the property for the period of the Lease, this figure being based upon the notional rent for the period of the Lease. There is no break clause in favour of either the Lessor or the Lessee during the term. In addition to the premium, there is a ground rent to be paid — this is usually set at a nominal ‘peppercorn’ rate of, say, a £1 per annum.

Advantages for the Lessor

• The Lessor need not worry about the Lessee defaulting on the ‘rent’ since, by definition, he has received the benefit of the tenancy by collecting the premium –the rent itself is just a nominal amount. Also, the whole sum, which effectively forms the rent, is paid at the start of the Lease.

• The lessor need not be concerned about the possibility of the Lessee operating a break clause and leaving the property at, for example, the end of six months. No right exists for the agreement to be broken, although the company or Lessee could – and may – demand the right to replace the occupier. This requires the Lessor’s written consent, which cannot unreasonably be withheld. Disadvantages for the Lessor

• The Lessor will receive a large sum in Year One, all of which is taxable in that year, and he will be able to off-set the expenses in Year One against this money. But he will have expenses in Years Two and Three for a three-year tenancy, and no income against which to offset them. The loss will have to be carried forward to future years if he does not own other property.

• Because the whole sum is taxed in Year One, the Lessor may end up paying tax at a higher rate — there is no option to spread the money across tax years to attract only basic-rate tax. The agreement is usually provided by the Lessee company. It may therefore contain clauses that are disadvantageous for the Lessor.

• Any lender or superior landlord, providing he understands the legal significance of a Premium Lease, may refuse consent to let. This does not often happen in practice as few lenders or superior landlords understand this type of agreement.

Advantages for the Lessee

• The Lessee company is able to claim the rental payment as a capital sum paid by them. They may be able to claim that the benefit in kind to the Lessee is considerably less than the rental payment if converted into an annual amount. There may therefore be a considerable tax saving, both to the company and the employee.

Disadvantages to the Lessee

• The Lessee has less flexibility if the employee were to leave the employment of the company as no break clause can be exercised. It should be possible, however, to negotiate the substitution of an alternative employee for the original one, were the latter to leave.

• The Lessee should pay the stamp duty land tax for the tenancy and register the lease at the Land Registry. This could constitute a considerable sum of money, as the transaction is taxed as a purchase. Stamp Duty Land Tax could be payable at a rate of between 1% and 4% on the whole premium. This may not be the case in practice, as many Lessees neglect to declare the premium to the Inland Revenue and instead pay the tax. This is a breach of their legal obligation and one that could lead to higher charges in the future, given that the Inland Revenue can claim money retrospectively for up to six years and charge interest and penalties on outstanding sums.

• If the Lessor fails to comply with his repairing obligations the Lessee cannot retain compensation from the rent as they have received only a nominal sum, and the agent may not hold enough funds to keep the property in repair. This problem should be addressed in the tenancy agreement by retaining a set sum until the end of the tenancy that can be put aside to cover the cost of repairs.

• If the property is no longer needed by the Lessee, he cannot exercise a break clause and give notice. He remains liable for the security of the property for the whole of the fixed term. The obligations only cease if he negotiates surrender of the Lease, which could be done. A term of the surrender could be that the Lessor retains the whole premium in exchange for releasing the Lessee early.