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Can a lease surrender payment made by the lessee to terminate a lease, be included as an incidental cost that relates to the CGT event that happens to the lease, under section 110-35 of the Income Tax Assessment Act 1997 (ITAA 1997)?

No. The lease surrender payment cannot be included as an incidental cost that relates to the CGT event under section 110-35 of the ITAA 1997.

In the 2002 year of income, the taxpayer, a sole trader, entered a three year lease for a factory from which to operate a business.

During the 2003 year of income the taxpayer made a business decision to terminate the lease. The taxpayer entered into a deed of settlement for this purpose. The deed of settlement terminated the lease. The consideration for entering into this deed by the lessee was the assignment of a number of assets.

A lease is considered to be a CGT asset under section 108-5 of the ITAA 1997. The cost base of the lease is determined in accordance with section 110-25 of the ITAA 1997. The cost base of the lease includes the cost of acquiring the lease, such as any lease premium that a lessee has to pay to obtain the lease, as well as certain incidental costs that relate to the acquisition of the lease. There are five categories of incidental costs, set out in section 110-35 of the ITAA 1997. It is necessary for any particular cost to be able to be characterised under any of these five categories for it to qualify as an incidental cost.

The surrender of a lease causes a CGT event to occur under Division 104 of the ITAA 1997. Incidental costs that relate to a CGT event that happens to the lease may form part of the cost base of the lease, but they must be able to be characterised as incidental costs under section 110-35 ITAA 1997.

The amount paid by the taxpayer, represented by the value of the property assigned to the lessor, is not a cost of acquiring the lease. Nor can this payment be properly characterised as an incidental cost relating to the CGT event of surrendering the lease under any of the categories listed in section 110-35 of the ITAA 1997.