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HMRC internal manual

Property Income Manual

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HM Revenue & Customs
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Premiums: how the charge is calculated

Taxation of premiums received - details

Premiums and similar receipts related to the grant of a lease are taxable wholly or partly as income where the taxpayer gets them for granting a lease of fifty years or less. The part of the premium taxable as income is treated as a receipt of the rental business for the year of assessment in which the lease is granted. If the taxpayer receives a lump sum for selling their existing lease these special rules don’t apply: see PIM1204.

The amount, which is a receipt of the rental business, is calculated on a sliding scale that depends on the length of the lease for which the taxpayer got the payment. The longer the lease, the smaller the amount charged to IT as property income but the larger the amount potentially chargeable to IT as trading income (in a property dealing trade) or, if there is no trade, to CGT, (ICTA88/S34 and ITTOIA05/S277).

The rule is that the amount taxable as income of the rental business is reduced by 2% of the premium for each complete year of the lease after the first. Thus:

  • the full amount of a premium is taxable as income where the lease is for less than two years,
  • 98% of the premium is taxable as income if the lease is for two years or more but less than three years,
  • 96% of the premium is taxable as income if the lease is for three years or more but less than four years,
  • and so on until the lease is for 49 years or more but less than 50 years; here 4% of the premium is taxable as income; the deduction from the taxable premium is 49 complete years less one year = 48 years x 2% = 96%, thus, for example, 4% is taxable if the lease is for 49 years and one month or 49 years and 11 months,
  • when the lease is for exactly 50 years 2% of the premium is taxable as income; the deduction is 50 complete years less one year = 49 years x 2% = 98%,
  • none of the premium is taxable as income when the lease is for over 50 years; for example, where the lease is for 50 years and one day.

Example illustrating basic premium case

Paul grants a 25-year lease to Peter on 5 June 2004. The lease agreement requires Peter to pay Paul a premium of £30,000 on 30 June 2004 in addition to rent of £400 a month. Paul must include in his rental business accounts for 2004-05 both the rent due for the period from 5 June 2004 (when the lease started) to 5 April 2005 and the taxable amount of the premium. That is, the premium is taxed in the year in which the lease is granted. The amount which Paul is treated as receiving as part of his rental business is calculated as follows:

Premium receivable £30,000
   
Less: (2% of £30,000) x 24 years £14,400
  £15,600
Plus: rent for period 5/6/04 - 5/4/05* £ 4,000
Amount to include in rental business £19,600
*This is ten months at £400 a month.  

Length of lease and premiums

Normally, in a straightforward case, the length of a lease is the period for which it is granted. For example, if the lease says it lasts for 60 years the duration will be taken as 60 years. But there are special rules aimed at attempts to make a lease appear to be:

  • long when, in substance, it is short, or
  • short when, in substance, it is long.

The law aims to work on the true length of the lease.

For example, a lease might be granted for 60 years at a premium but the facts known at the time the lease was granted could make it unlikely that the lease will last more than 10 years. A simple case might be a lease that provides that the rent due shoots up 100 times from year 11. Assuming that the amount of the premium reflects the 10-year period, the lease is treated as a 10-year lease.

The rules for deciding the length of a lease are complicated and depend on when the lease was granted - see ‘duration of lease’ below.

The method of calculation

The method of calculation is prescribed in ICTA88/S34 (1) and ITTOIA05/S277 (4).

ICTA88/S34 (1) expresses the amount of the premium to be treated as rent in the formula:

P - (P x Y)
   
  50

where P = the premium and Y = the number of complete years in the term of the lease apart from the first.

ITTOIA05/S277 (4) expresses the amount of the premium to be treated as rent in the formula:

P x (50 - Y)
   
  50

where P = the premium and Y = the number of complete years in the term of the lease apart from the first.

Although the formula has changed, the chargeable amount of the premium has not changed. These two formulae give the same result.

The landlord is treated for tax purposes as becoming entitled to rent of this amount when the lease is granted, in addition to any actual rent.

Duration of lease

Determining the length of a lease may be straightforward. But there are rules designed to deal with cases where there may be an attempt to obtain a tax advantage from the premium provisions. These provide that in certain circumstances some period other than the stated term of the lease is to be used for the purposes of the charge on premiums.

The rules have changed several times, and which rules to use depends on when the lease was granted. Here are details of where you can find more guidance in this manual.

  • Lease granted on or after 25 August 1971 - see PIM1206 - PIM1207.
  • Lease granted after 12 June 1969 but before 25 August 1971 - see PIM1208.
  • Lease granted on or before 12 June 1969 - see PIM1209.