LEASE MAKE GOOD CLAUSES

The recent cooling in the WA economy coupled with the increased availability of commercial space has seen many of our clients considering relocating their businesses to take advantage of the favourable market conditions.  One of the multitude of things to consider when exiting and negotiating a new lease is the implications of what is commonly referred to as the “Make Good Clause”.

“Make Good” refers to the provision in a commercial lease that stipulates how a property should be left at the end of the lease term.  When negotiating a lease many other issues tend to take the precedent such as lease term, rent reviews, incentives, etc leaving make good clauses as an often forgotten generic, poorly worded afterthought.

Even if a make good clause doesn’t appear in the lease agreement, a landlord may be able to take common law action against you if you don’t return the premises in line with its original condition (except for fair wear and tear).

While it is usually accepted by the tenant that the premises be returned in the state it was given, some tenants (and landlords) fail to include adequate detail on the condition and quality of the property at the commencement of the tenancy.  This can leave an area of dispute and surprise costs at the end of a lease, consider the following:

• A business signs a lease agreement, substantially fitouts the premises and moves in.  The make good clause is a generic clause devoid of detail.  At the exit of the lease the landlord requests a refurbishment using different or superior products than was the case at the commencement of the lease. As none of this detail was included in the lease the new business owners have no point of reference to question the landlord’s request.
• Similar to the above a landlord may have purchased a property with the lease intact and have no point of comparison when undertaking final inspection.
•  Under an assignment of lease arrangement the new tenant inherits the conditions of the existing lease which can include the make good clause.  A prudent assignee can make provision for this in negotiating the assignment so that it doesn’t get burdened with any surprise make good costs.  Equally a landlord may seek to recover some of the make good prior to assignment from the assignor as part of it’s negotiations.

Cash settlements in lieu of make good are a popular way of satisfying the make good requirement at the end of the lease.  This allows a tenant to vacate the building (providing it is left clean and tidy) and not have to organise the removal of the fitout.  From a landlords point of view it gives them the option to find a tenant willing to take on the existing fitout or use the money to fit it out to the incoming tenant specifications.

With the current market place in WA being one favourable to tenants, we are seeing many incentives being offered by landlords including, but not limited to, a “no make good” clause, effectively allowing the tenant to vacate without any obligation to return it to original condition.

It is therefore important  for both parties to ensure that they agree on a detailed make good arrangement at the commencement of the lease which is well documented (including photographs) to minimise any disagreement and expense when it comes time to move on.

Should you have any questions or concerns about make good clauses in your lease agreements, please contact our office on (08) 9316 7000 and we can put you in touch with a legal expert in our network who can assist.

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THIN CAPITALISATION

Thin Capitalisation is the excessive use of debt finance compared to equity finance. For example, if an organisation were to have a debt to equity ratio 3:1 for every $3 of debt the entity is funded by $1 of equity.

The intention of Division 820 in the ITAA97 is to prevent multinational entities from shifting profits outside of Australia by funding their Australian operations with a high amount of debt finance in order to reduce their Australian tax liability.

The thin capitalisation rules act to limit the amount of debt deductions that an entity can otherwise deduct from their assessable income where the debt to equity ratios exceed the prescribed limits i.e. the entity is “thinly capitalised”.

Division 820 applies to foreign controlled Australian entities, Australian entities that operate internationally and foreign entities that operate in Australia.

Please note this Division does not apply to assets or non-debt liabilities that are held wholly or principally for private or domestic use.

A debt deduction is a cost incurred in connection with a debt that would otherwise be deductible (e.g. interest expense and borrowing costs), this specifically excludes salary or wages, rental expenses and foreign currency losses.

Debt deductions will be allowed if the total debt deductions for an entity and its associated entities does not exceed $2 million in an income year (from 1 July 2014, the previous threshold was $250,000).

The thin capitalisation rules will also not apply to outward investing Australian entities if at least 90% of their assets (including those of their associates) are Australian assets.

The application of the rules varies depending on the type of entity and whether they are inwards or outwards investors of Australia.

For a non-authorised deposit-taking institution (ADI) general entity, the following tests (among others) are available to determine the amount an entity’s debt deductions will need to be reduced by:

• Safe Harbour Debt Test

The amount of debt used to finance the Australian investments will be treated as excessive when it is greater than a debt to equity ratio of 1.5:1 or 3/5 (commencing from 1 July 2014).

•  Arm’s Length Debt Test

This is determined by analysing the entity’s activities and funding to determine the amount the entity could reasonably expect to borrow on arm’s length terms from a third party.

If you think you may be affected by the Thin Capitalisation rules and wish to discuss further, please contact our office.

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