COVID-19: Renegotiating commercial lease agreements may trigger tax costs
Spain Tax Commentary
The COVID-19 crisis and resulting halt in economic activity in certain sectors is leading in a few cases to the renegotiation of commercial lease agreements on the ground of force majeure.
The requests made by lessees may vary greatly in scope, but they usually relate to rent reductions or discounts or to arranging grace periods in relation to due date for rent in the months while the current situation is in place.
Apart from the purely legal elements raised in these types of renegotiations, it is important to consider the potential tax implications:
a. A lease is a service of an ongoing nature, which means that VAT becomes chargeable, as a general rule, when the rent is payable.
So the obligation to charge and pay over VAT will exist even if the rent has not been paid, including where nonpayment is for force majeure reasons.
It may be taken from the interpretation provided by the Directorate General for Taxes (in binding resolution V1117-16, of March 21, 2016, for example) that “only if the lease contractual relationship is formally and expressly cancelled, or the date payment becomes due is changed, by reason of an injunctive remedy closing the premises which prevents their use, will VAT stop becoming chargeable”.
In short, only if before the rent falls due an express agreement is reached between lessor and lessee delaying that due date for the rent or reducing its amount, can the VAT charge on the originally stipulated rent be avoided on the date initially specified for payment. It should not be forgotten, in any event, that if only the due date is changed, this will delay the charging of VAT, although it will not change the amount of rent on which the amount of VAT to be charged must be calculated when the rent falls due.
b. Otherwise, if an agreement of that type has not been reached before the rent falls due and, therefore, VAT has been charged on the original amount of rent, the taxable amount will subsequently have to be changed in two scenarios:
- If discounts or reductions are offered after the rent fell due and VAT was charged on it.
- If rent that has already been billed is not paid.
In both cases, the relevant correction invoices must be issued; in the second, additionally, the procedure specifically defined for nonpayment scenarios must be implemented, which implies making the appropriate notification to the tax authorities.
c. In the specific case of nonpayment of rent, it must be recalled that, under instruction 1/2017, of January 18, 2017 by the head of the Collection Department at the State Tax Agency, on management of split and deferred payments, an application could be made for deferred payment of the VAT if a guarantee is provided (for debts higher than €30,000).
For small and medium-sized companies and the self-employed, it is added to this that Royal Decree-Law 7/2020, of March 12, 2020 allows deferred payment without guarantees for debts below €30,000 (see our alert), even if nonpayment has not occurred.
2. Corporate Income Tax:
There are no particular rules in the corporate income tax legislation specifically defining the treatment of these types of renegotiations, and therefore, as determined in article 10 of the Corporate Income Tax Law, the provisions in the accounting legislation must be applied.
In this regard, the Spanish National Chart of Accounts (Recognition and Measurement Standard 8) and the criteria issued by the Spanish Accounting and Audit Institute on this subject could lead to understand (considering the principal of materiality as regards the incentives in every particular case and company) that the effect of lease incentives must be distributed over the lease period, for which a distribution system on a straight line basis must generally be used over the remaining lease term.
In other words, in case this criterion is applied, the lower income for lessors (and lower expense for lessees) resulting from covenanted reductions or grace periods in relation to rent under leases does not have to be recognized only and fully in the periods affected by the covenanted discounts or grace periods, instead their effects must be spread for accounting purpose, on a straight line basis, over the remaining term of the lease agreement.
This accounting treatment may contribute to distributing the adverse impact of the current crisis over the whole period the lease agreement is in force (which may be important for many leasing companies, so they do not see too much harm to their 2020 income statements), but this will have an impact on the taxable amount, which will be out of step (in timing terms) with the rent payments actually billed.
In relation to any billed rent that lessors have not received, it should be recalled that, subject to certain requirements specified in the corporate income tax legislation, provisions for bad debts may be deductible; although, as a general rule, they will not be so until six months after the due date for the debt.
3. Personal Income Tax:
In this case, if we stick to scenarios where rent is treated as income from movable capital, personal income tax arises on these rent payments when they become payable.
Besides, the personal income tax legislation presumes to be taxable, unless proved otherwise, all supplies of goods, rights or services able to generate salary income or income from capital.
Therefore, in a similar way to VAT, to avoid tax arising on the rent in this way, it is necessary to stipulate expressly a deferral of the due date for the rent, or a temporary or permanent reduction; additionally, the option exists, if this renegotiation has not been done expressly, to deduct any provisions for bad debts, which, as a general rule, will also require six months to have run from when the step for collection was performed until the end of the year.
This express renegotiation of time periods and amounts will be necessary, also, to avoid the obligation arising to withhold all or part of the tax liability. In relation to this, the Directorate General for Taxes (in binding resolution V0166-16, of January 19, 2016, for example) concluded that the obligation to withhold tax will not arise until the rent payments under the lease are made, if a grace period or deferred payment is specified in the agreement.