There are a few different types of commercial leases in the UK. A commercial lease is a tenant/landlord agreement that describes the details and conditions of the commercial property rental.
Commercial leases, as the name suggests, are unique to commercial property and are structured differently from residential lease agreements.
Q: Who Pays Property Taxes on a Commercial Lease?
The responsibility of paying the property taxes depends on the type of commercial lease and the tenant-landlord agreement. The agreement usually involves the:
- Property maintenance
- Property insurance
- Other ongoing taxes and charges
Often, the tenants will be responsible for paying everything, leaving the landlord with very few responsibilities. This may involve a Full Repairing and Insuring (FRI) or triple net lease (NNN) that allocate costs, charges and taxes to the tenant. This hands-off approach provides freedom to both parties.
Another scenario is a gross lease that allocates all costs, charges and taxes to the landlord, thus providing a simple (but probably expensive) opportunity to shorter-term commercial tenants.
Here we’ll be breaking down commercial property tax in further detail to explore who pays property taxes and other charges on a commercial lease.
Commercial leases will include the lease agreement as well as a breakdown of other costs, which may include:
- Maintenance costs
- Property taxes
- Building insurance
These costs might be inclusive of rent (e.g. a gross lease), which means the tenants pay one flat rent to the landlord. Alternatively (and more commonly), some, or all, of these charges will be made payable to the tenant (e.g. net leases, or FRI leases).
One area that seems to lack clarity amongst existing posts online surrounding this topic is ‘property taxes’. What actually are commercial property taxes?
Firstly, there is the one-off Stamp Duty Land Tax (SDLT) as well as business rates. Many people do not realise that SDLT applies to commercial leasehold as well as freehold. Calculating SDLT is complex and uses the Net Present Value and premium value of the rent. You can find government guidance on SDLT here and a calculator here. SDLT is always the responsibility of the commercial tenant. When people talk about property taxes on a lease, they’re likely not talking about SDLT – it’s a separate consideration.
Secondly, there are business rates. These are the main property taxes that are relevant to commercial leases. Business rates are charged on most non-domestic properties, such as:
- Warehouses and industrial
- Hotel and hospitality
- Holiday rental homes or guest houses
In other words, business rates are commercial property tax. Your local council typically sends a business rates bill in either February or March, which will cover the following tax year. The government provides a self-help tool for finding and estimating these bills here. Tax relief or an exemption is also possible and might be deducted automatically.
The Valuation Office Agency (VOA) is the central government department responsible for administering these bills, and the tenant is responsible for paying them.
Business Rates in a Gross Lease Setting
So, if the tenant is responsible for paying for their business rates, how can a gross lease that is inclusive of property taxes exist in the UK?
Most Local Authorities allow the landlord to charge commercial tenants their business rates in a gross lease or other lease agreements. Brent Council explains this well here:
“Sometimes the landlord of the property charges the occupier a rent that also includes an amount for the business rates.
It remains a private matter between the landlord and occupier to decide who is responsible to make payment, however, the bill will remain in the name of the occupier, and if it is not paid, action will be taken against the occupier, not the landlord, to recover the amount due” – Brent Council.
So, it is possible for the landlord to manage everything, including all taxes and business rates (except SDLT and other initial taxes associated with the transaction itself).
Aside from property taxes, there are other charges besides rent that need to be allocated to either the tenant or the landlord. These will depend on the type of lease in question.
Gross leases, which are relatively rare in most real-estate sectors, charge rent to the tenant payable usually on a monthly basis whilst the landlord pays for everything else, e.g. maintenance, utilities, taxes, etc.
This ‘all bills and costs included’ approach is more common for shorter-term, more flexible leases or when the landlord is providing some sort of managed service for their tenants. Some of the costs will likely be factored into the lease anyway, and the landlord is exposed to more risk via the unpredictability of costs (though they’d usually be straightforward to predict).
Net leases are more common and are split into 3 subtypes; single net, double net and triple net leases.
- Single net leases pass property taxes onto the tenants, e.g. business rates, the least common form of net lease.
- Double net leases pass taxes and insurance premiums onto the tenant. The landlord will still pay maintenance costs. These are probably the most common type of commercial property lease.
- Triple net leases allocate practically all taxes, costs and risks to the tenants. The tenants will be responsible for paying maintenance, utilities, taxes and building insurance. This is the opposite of a gross lease in many ways, but often also grants more freedom to the tenants and at a lower relative cost to a managed gross lease option.
Triple net leases are usually more appropriate for experienced long-term tenants who need more flexibility over the space whilst they occupy it. The risk is often on the tenants in receipt of greater freedom to fit the building out in the way they require. They often come with longer-term fixed rents too, which can benefit the tenants if the surrounding area’s business credentials increase over the contract.
Any and all leases may include service charges.
As of 2019, mandatory RICS rules were introduced to govern the fairness and transparency of service charges charged on commercial leases. Service charges on different commercial buildings are easier to compare which helps prospective tenants compare buildings for their service charges. Landlords must give tenants annual service charge budgets with full details on what they are and the reason for inclusion.
Accounts have to be reconciled annually which makes it tougher for landlords to recover service charge costs from long ago, possibly at the detriment of the tenant’s cash flow. In short, charges on commercial leases are more transparent and easier to govern than ever.
It’s also worth mentioning percentage leases which usually applies to retail tenants renting in shopping centres or similar. These charge rent at a fixed rate plus a percentage of gross income.
In net leases, the lease will detail the costs of taxes and charges and how the tenant will pay them. Costs are usually paid at an estimated or expected value. Furthermore, they undergo a periodical assessment at which point the tenant will pay the actual value of the taxes.
Long-term leases can have provisions for increasing charges and taxes, but otherwise, the landlord can’t reassess your lease just because of an increase in charges.
This doesn’t matter to the landlord in the case of triple net leases – the tenant will pay the price of the taxes and charges regardless. Taxes, like service charges, may be fixed or variable. With that, there is often room for negotiation if the tenants object to the cost or necessity of certain charges.
SDLT is always payable by the tenant. However, business rates are the accountability of either the landlord or tenant. The arrangement of business rates depends on the lease agreement.
Gross leases ensure that the landlord accounts for business rate tax in the gross rental payment and then makes the payment to the Local Authority themselves. As Local Authorities say themselves, this is a private agreement that does not relieve the tenant from their responsibility for their own business rates.
The landlord may provide this sort of lease in a managed, short-term lease agreement where the tenant is looking for a quick and easy way to occupy and use commercial premises with little hassle.
The most common type of lease, net leases, make business rates the responsibility of the tenants. Net leases come in 3 different varieties; single-net, double-net and triple-net. Triple-net leases or FRI leases are the opposite of a gross lease. The payment of tax, utilities, maintenance/repairs and insurance is the chief responsibility of the tenant.