Lease reinstatement cost tax deduction is now under consideration of IRD 

More aggressive depreciation allowance claim expected for large-scale construction / renovation projects 

The Hong Kong Inland Revenue Department (IRD) has always considered any lease that grants exclusive use of a property to be a capital asset. Consequently, costs incurred by lessees to restore premises to their original state at the end of a lease were deemed part of the lease acquisition cost and, therefore, non-deductible under Section 16 of the Inland Revenue Ordinance (IRO).

According to Hong Kong Financial Reporting Standard 16 (HKFRS 16), lessees are required to accrue reinstatement costs as an additional expense during the initial renovation based on an estimate of the future costs needed to restore the property. Since this estimate is considered a provision rather than an actual expenditure, it does not qualify for a commercial building allowance. Even if the lessee incurs actual reinstatement costs before the lease ends, these costs are still not eligible for the allowance.

However, in the 2024-25 Budget, the Financial Secretary proposed to allow tax deductions on lease reinstatement costs starting from the year of assessment 2024/25. This proposal will require legislative amendments to the IRO, with further details to be announced.

Recognizing that businesses often incur reinstatement costs due to evolving needs, the government now acknowledges that these expenses may be considered ordinary business costs. Tax deductions are available under certain conditions.

With reference to the tax treatment of lease reinstatement costs in Singapore and stakeholder feedback, the government proposes the following conditions for profits tax deductibility:

•    Actual Costs Incurred: Only costs that have actually been incurred or paid by the lessee will be deductible. No deductions will be allowed for provisions made under accounting standards (e.g., amortization of capitalized reinstatement costs under HKFRS 16).

•    Obligatory Reinstatement: The IRD must be satisfied that the lessee is obligated to restore the leased premises to their original condition either at the end of the lease term or upon early termination. This obligation can be stipulated in the tenancy agreement or other arrangements between the lessee and the lessor.

The proposed deduction will cover both the lessee's costs and any payments made to the lessor to fulfill the reinstatement obligation, provided that the amount paid is reasonable.

Subject to Legislative Council approval, these amendments are expected to take effect from year 2024/25.

Points to note:

We welcome the new approach on lease reinstatement costs proposed by the IRD to follow the latest global tax development. In our opinion, it has always been unfair to taxpayers that no tax deduction / allowance is given to a business expense obviously directly related to the principal activities even it is actually incurred. 

Nevertheless, even with the new rule, taxpayers should make sure that they fulfill all the requirements of the new legislation in order to claim tax deduction. It is also worthwhile to mention that there is considerable timing difference between accounting costs and tax deduction. In the Profits Tax computation, it is important to keep detailed track changes of the movement of provision of reinstatement costs per property in order to claim tax deduction. 

For large-scale construction projects, we always recommend our client to adopt the Speed-up Tax Depreciation Approach rather than Normal Depreciation Approach on construction costs or leasehold improvements. 

Normal Tax Depreciation Method – Table 1

Speed-Up Tax Depreciation Method – Table 2

As you can see from the above table, Speed-up Tax Depreciation Method will significantly expedite the capital allowance claim, and thus reduce the tax liabilities of the taxpayer in the short-term period. This could significantly help companies with heavy capital expenditure and tight cashflow to reduce their tax burden.