Make-good obligations are a common feature in commercial leases, requiring tenants to restore leased premises to their original condition at the end of the tenancy. This often includes removing fit-outs, repairing damage, and repainting. The tax treatment of make-good expenses is a critical consideration for businesses, as it affects both current cash flow and future deductions.
Under a commercial lease, make-good provisions are legally binding and can vary significantly between leases. These obligations may include removing partitions, repainting walls, or even replacing floor coverings. The costs associated with fulfilling these obligations can be substantial, and understanding their tax implications is essential.
From a tax perspective, make-good costs are treated differently depending on their nature. The ATO allows certain costs to be capitalised, meaning they are added to the asset's cost base and can be depreciated over time. Under Division 40 of ITAA 1997, costs related to plant and equipment, such as removing and disposing of fittings, may be depreciated. In contrast, Division 43 covers capital works deductions for structural improvements or repairs.
To see how this plays out, consider a business leasing a 500 square metre retail space in Melbourne. At the end of the lease, the tenant is required to remove internal partitions and repaint the premises. The total make-good cost is $50,000. If $20,000 is attributed to plant and equipment removal, these can be depreciated under Division 40 over the asset's effective life. The remaining $30,000 for repainting falls under Division 43 and can be claimed over a 40-year period. At a 30% corporate tax rate, the immediate deduction impact for the first year could reduce the tax liability by $6,000.
In our experience reviewing thousands of properties across Australia, we often see business owners underestimating make-good costs. Many are unaware that these expenses can significantly affect their capital gains tax cost base or that failing to comply with make-good obligations can result in hefty penalties. Additionally, many business owners miss out on available depreciation deductions due to improper categorisation of expenses.
The answer can differ depending on your situation. For example, if the lease commenced before 9 May 2017, some second-hand plant and equipment costs might not be claimable under Division 40 due to legislative changes. For businesses operating within SMSFs, different tax treatments may apply, and joint tenancy situations could affect the distribution of make-good obligations. Furthermore, the nature of the lease, whether it is retail, office, or industrial, can influence the specific requirements and associated costs.
When it comes to make-good obligations, getting professional advice is crucial. A Chartered Quantity Surveyor can accurately assess the costs and potential tax deductions associated with your lease. Coupled with guidance from an accountant, you can maximise your tax benefits while ensuring compliance with lease terms.