Question

Gary owns a commercial building and leased his premises to John to conduct a bakery business. Under the lease contract, John is obliged to repair any modified or damaged parts of the building after the lease term. However, John fails to repair Gary’s building, which was damaged due to machinery and fixtures’ instalments. John agreed to pay Gary $3,100 to cover the repair expenses.

Required: With reference to relevant legislation and case law discuss the tax treatment of this payment for Gary. (10 marks, maximum 300 words)

Answer 1

It is purely an example of expense reimbursement. Hence Gary is not required to report the payment as Income

Points to note:

Reimbursement of expenses does not have any tax treatment. As per the lease agreement, John is obligated to repair any parts of the building that underwent modification or suffered damages. However John agreed to reimburse Gary the expenses that he will incurr while doing the necessary repairs.

Therefore, there is no business relationship exists between Gary and John besides reimbursement of costs aimed at satisfying the agreement between them. There will not be any tax treatment for the money Gary receives to do the repairs.

Full amount of rent earned on leased commerical premises is inculded in income tax return. Lessor can claim deduction for related expenses for the period the property is rented or is available for rent.

• deduction of expenses relating to the management and maintenance of the property, including interest on loans
• some expenses are claimed over a number of years, including depreciation costs (decline in value of depreciating assets such as carpet, furniture) and certain consturction expenditure.

However the following expenses cannot be claimed as deduction:

• acquisition and disposal costs fo the property
• expenses not actually paid by lessor, such as water or electricity charges paid by lessee
• expenses not related to the rental of the property.

In the given scenario while repairs were to be carried out by the lessee, John who in turn agreed to pay $ 3100 to cover the repair expenses. Technically Gary has not incurred any repair expenses hence he cannot claim any deduction for the same.

Additional amount received by Gary would tantamount to lease income and would be taxable for Gary.