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Court of Appeal confirms a lease surrender payment is a revenue receipt in the hands of the landlord
Decision date: 7 August 2018
Case: Easy Park Limited v Commissioner of Inland Revenue  NZCA 296
Act(s): Income Tax Act 2007 s CB 1
Keywords: Capital revenue distinction, lease surrender payment, taxable income
In the High Court, Ellis J concluded that the lease surrender payment received by Easy Park Limited (“Easy Park”) was revenue and not a capital receipt in Easy Park’s hands upholding the Commissioner of Inland Revenue’s (“the Commissioner”) classification of the lease surrender payment as taxable income. Easy Park appealed to the Court of Appeal.
The Court of Appeal agreed with the Commissioner and Ellis J in holding that the lease surrender payment in the hands of Easy Park was revenue and therefore taxable income. The appeal was dismissed.
This decision confirms that a lease surrender payment received by a landlord that is in the business of leasing commercial properties is considered revenue and not capital meaning it is taxable income in the hands of the landlord.
Easy Park was a company that was formed for the sole purpose of undertaking commercial rental property investments.
In 2003 Easy Park acquired two commercial buildings in Wellington one of which was a four-storey building situated in 312 Lambton Quay (“the Whitcoulls Building”).
Easy Park purchased the Whitcoulls Building subject to a lease to Whitcoulls Group Limited (“WGL”). The lease was for a term of 12 years and three months commencing on 1 June 2003.
On 17 February 2011 WGL was placed into voluntary administration. The administrators of WGL sold its business and assets to Whitcoulls 2011 Ltd (“W2011”). W2011 took occupation of the Whitcoulls Building without an assignment of the lease to WGL.
In June 2011 W2011 publicly announced that it would be vacating the Whitcoulls Building.
In August 2011 WGL assigned its lease to W2011 with effect from 21 June 2011. At that stage there was three years and three months remaining on the lease.
In November 2011 Easy Park and W2011 entered into negotiations for early termination of the lease. Easy Park and W2011 agreed to an amount of $1.1 million to be paid by W2011 for early surrender (“the lease surrender payment”).
On 7 February 2012 Easy Park and W2011 entered into a deed of surrender of lease providing for a surrender date of 30 June 2012.
In its income tax return for the year ended 31 March 2012, Easy Park treated the receipt of the lease surrender payment as a non-taxable capital amount.
The Commissioner disagreed and assessed the surrender payment as being business income subject to income tax of $308,000. The Commissioner also imposed a shortfall penalty of 10%.
Ellis J upheld the Commissioner’s classification of the lease surrender payment as taxable income but quashed the imposition of a shortfall penalty finding that the tax position taken by Easy Park was not unacceptable.
Easy Park appealed.
Appellant’s argument that the lease was part of the capital asset
The Court rejected the appellant’s argument that the lease to WGL was part of the capital asset acquired by Easy Park when it purchased the freehold in the Whitcoulls Building.
The Court agreed that Easy Park purchased the freehold in the Whitcoulls building under its sale and purchase agreement and that this was clearly a capital asset.
The Court did not accept that the lease to the Whitcoulls Building can be “tacked on” to the capital asset by virtue of the lease being in place when the property was purchased.
Easy Park did not acquire a leasehold interest in land. Easy Park acquired a freehold estate that was subject to a lease that belonged to WGL and later W2011.
Characterisation of lease surrender payment as revenue
The Court agreed with Ellis J and the Commissioner that the lease surrender payment was revenue and subsequently taxable income.
The Court proceeded on the basis of the principle outlined by Richardson J in AA Finance Ltd v Commissioner of Inland Revenue (1994) 16 NZTC 11,383 (CA) at 11,391, that the nature of a receipt for income tax purposes depends on what the amount received was calculated to effect from a practical business point of view.
The Court held that Easy Park’s sole business was in leasing commercial properties. It generated income in the form of rent for those properties. That rent is indisputably income. The lease surrender payment essentially had the same character as the payment of rents that Easy Park generated as income when leasing those commercial properties. It was a lump sum made on account of the rent forgone by the landlord meaning from a practical business point of view, the lease surrender payment was income.
The court recognised that early surrender payment may have been determined by reference to rent lost, it was necessarily received as revenue. The authorities are clear that character of a receipt is not to be determined by the measure or method used to quantify the payment.
The Court accepted the termination of the lease and associated receipt, although unwelcome, constituted part of the ordinary business activities of Easy Park as a commercial lessor. The Court agreed with Ellis J that the lease surrender was simply an ordinary if unwanted incident of Easy Park’s core and only business of commercial leasing.
The Court rejected the appellant’s alternative arguments
The Court rejected the appellants submissions based on Regent Oil Co Ltd v Strick (Inspector of Taxes)  AC 295 (HL), Commissioner of Inland Revenue v McKenzies (NZ) Ltd  2 NZLR 736 (CA), and Commissioner of Inland Revenue v Wattie  1 NZLR 529 (PC), distinguishing those cases from this case primarily on the basis that Easy Park was a commercial lessor. The lease surrender payment received by Easy Park was in course of its ordinary business operations and the lease was held on revenue account.
The Court rejected the appellant’s argument that the financial impact of the termination affected the structure and core of Easy Park’s business. It was noted that:
- In March 2011 the Wellington City Council gave Easy Park notice that the Whitcoulls Building was earthquake prone and required strengthening by 29 March 2015.
- Easy Park surrendered their lease with Lifestyle Gym before commencing strengthening work.
- While it was sensible for Easy Park to do it this way in order to secure a new tenant, however it did not follow that the lease surrender was the cause of the cost of the earthquake strengthening work.
- Apart from having to pay insurance on the building (which was previously borne by WGL and then W2011) Easy Park’s business continued after the earthquake work as before.