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HMRC internal manual

Capital Gains Manual

Leases: sum paid to procure surrender of lease

Sum paid by landlord

If a landlord makes a payment to a tenant to procure the surrender of a lease, that payment will qualify as allowable expenditure under TCGA92/S38 (1)(b), provided that it is reflected in the state or nature of the property at the date of its disposal by the landlord.

An example of such expenditure which would not be reflected in the state or nature of the property at the date of disposal would be where, following the surrender of the old lease, the landlord granted a new lease on essentially the same terms.

No allowance should be given to the landlord for any amount which has become chargeable on the tenant in accordance with CG71260.

 

Sum paid by tenant

Where a tenant no longer wishes to retain a lease of particular premises, he or she may be prepared to make a payment, either to the landlord in order to effect a surrender of the lease, or to a third party to accept an assignment of the lease. Any such payment will not be allowable expenditure in computing the loss arising on the disposal of the lease. It does not ‘enhance’ the value of the asset, see TCGA92/S38 (1)(b), nor is it within any of the categories of incidental costs of disposal listed in TCGA92/S38 (2), see CG15250 onwards.

This type of payment may be described as a ‘reverse premium’. However, it is not a reverse premium of the kind described in CG70830 onwards.

 

Sum received by landlord

TCGA92/Sch 8/Para 3 (2), (4) & (6)

A landlord may receive a capital sum from a tenant in return for accepting a surrender of a lease. The way in which the gain accruing to the landlord is calculated depends principally on whether the terms of the lease provided for such a payment.

  • If the terms of the lease did provide for such a payment, the capital sum is not treated as a part-disposal of the landlord’s interest in the land. Rather, it is treated as being a disposal of the landlord’s interest in a separate asset, that is the lease.
  • If the terms of the lease did not provide for such a payment, the capital sum is chargeable under TCGA92/S22 (1), see CG12940P, and will amount to a part disposal of the landlord’s interest in the land.

The way in which these rules work in practice is illustrated in the following examples.

Example 1

On 1 June 2003, Mrs S acquired the freehold of a property for £300,000. On 31 October 2012, she granted a 21 year lease of the property in return for a premium of £100,000. Under the terms of the lease, the tenant was entitled to surrender the lease after six years on payment of £50,000. The tenant exercised this right on 31 October 2017.

The Valuation Office Agency reported that the value of Mrs S’s interest in the property, on 31 October 2012, after the granting of the lease, was £400,000.

The computation of the gain arising to Mrs S, as a result of the surrender of the lease, is as follows:

i) Amount chargeable as income of a UK property business:

= £50,000 - [ (£50,000 x (6-1)) / 50 ]

= £45,000

Note: the lease is treated as having a duration of only six years.

 

ii) Chargeable gain:

= Premium received - Amount chargeable as property income

= £50,000 - £45,000

= £5,000

Note: no deduction is made of any part of the cost of the freehold interest. This is because the receipt of the capital sum is treated as the disposal of a separate asset, that is Mrs S’s interest in the lease.

Example 2

The facts are the same as those used in example 1, except that the terms of the lease did not specifically provide for its early surrender. However, on 31 October 2017, Mrs S agreed with her tenant that she would accept a surrender of the lease in return for a payment of £50,000.

The Valuation Office Agency reported that the value of Mrs S’s freehold interest, after accepting the surrender of the lease, was £700,000.

In these circumstances, in order to calculate the gain on the surrender payment, you need to know the allowable expenditure remaining after the grant of the original lease. You therefore first need to calculate the gain arising on the grant of the lease. You can then calculate the gain arising on the surrender payment.

The gains accruing to Mrs S are as follows:

1. Gain arising on grant of lease.

i) Amount chargeable as income of a UK property business:

= £100,000 - [ (£100,000 x (21-1) ) / 50 ]

= £60,000

 

ii) Allowable expenditure:

= £300,000 x [ £400,000 / (£400,000 + £100,000) ]

= £24,000

 

iii) Chargeable gain:

= Premium received - Amount chargeable as property income - Allowable expenditure

= £100,000 - £60,000 - £24,000

= £16,000

Note: in this case the lease is treated as having a duration of 21 years as it contained no provision for early surrender.

 

2. Gain arising on surrender of lease:

i) Allowable expenditure:

= (£300,000 - £24,000) x [ £50,000 / (£50,000 + £700,000) ]

= £18,400

 

ii) Chargeable gain:

= Capital sum - allowable expenditure

= £50,000 - £18,400

= £31,600