On Whose Part Does Gratuitous Income Arise When the Lease and Sub-Lease Agreements are Terminated at the Same Time?
In cases in which the property owner enables the lessee to perform technical improvement on the property and to subsequently depreciate the improvement made, while no compensation is provided upon the lease agreement’s termination, the property owner generates gratuitous income. The property owner is obliged to tax such income as part of his/her tax base. Pursuant to the amendment to the relevant legislation effective from 1 July 2017 it was possible to perform and depreciate such technical improvements both for lessees and any authorised property users (such as sub-lessees). However, the legislation did not provide any guidance on how to treat technical improvement upon the termination of sub-lease agreements.
Pursuant to Section 28 (7) of the Income Taxes Act, under which the depreciation of technical improvements was also made possible for sub-lessees, the applicable treatment shall be similar to situations where the technical improvement is depreciated by the lessee. As such, taking into account the purely grammatical interpretation of this provision, it can be inferred that upon the termination of the lease agreement or when there is an option to depreciate technical improvement for which no compensation was provided, both the property owner and the lessee should generate non-cash income.
The issue involving simultaneous termination of the lease and sub-lease agreements was addressed by the Coordination Committee of the Chamber of Tax Advisors of the Czech Republic. They argued that the purpose of the Income Taxes Act was not to tax the same income twice, due to which it was not possible to adhere to the literal interpretation. This view has been also supported by court rulings. In addition, according to this view, in cases like this an actual increase in the tax payer’s assets which he/she may dispose of needs to occur.
In the event that the lease and sub-lease agreements are terminated at the same time, the relevant property is not available for use to the lessee at all. Therefore, it is the property owner for whom the technical improvement is available. Moreover, the statement of reasons accompanying the relevant legal amendment shows that non-cash income is always generated by those tax payers for whom the entitlement to utilise the given property newly arises after the original tax payer ceases to utilise the property.
The General Financial Directorate (“GFD”) expressed its agreement with the fact that the Income Taxes Act does not provide any guidance on this issue. Also, the GFD agreed that taxing the gratuitous income both on the part of the lessee and the property owner would violate both the legislative purpose and the economic substance of contractual relationships. Therefore, as long as no explicit legislative guidance is set out in the Income Taxes Act, there is no need for the lessee to tax this type of income it shall be taxed solely by the property owner.
Unfortunately, the discussion did not extend to other situations. A much more common situation is when the sub-lease agreement is terminated without the lease relationship being simultaneously ended. The GFD’s indicates that the purpose of the relevant legal provision is not to tax income both on the part of the property owner and the lessee. By contrast, the purpose is to tax this type of income at least on one side. Nevertheless, the GFD’s opinion did not directly state on which part, that is, either on the property owner’s or the lessee’s part, this contribution should be taxed. As a result, similar cases will need to be thoroughly assessed on an individual basis as they occur.
We will continuously monitor the developments in this issue.