• Florida: Are Your Leasehold Improvements Subject To Sales Tax?
  • March 12, 2014 | Authors: David M. Kall; Susan Millradt McGlone
  • Law Firm: McDonald Hopkins LLC - Cleveland Office
  • The Florida Department of Revenue (the “Department”) recently issued guidance on a topic that has been the subject of a longstanding debate and various litigation matters in Florida. That topic is whether leasehold improvements relating to commercial leases are subject to sales tax. For example, if your business leased vacant and unfinished commercial space, you might plan to finish such space to your specifications. One question you may have not considered is whether such leasehold improvements are subject to sales tax.

    Introduction and Background

    In most commercial leases, there are provisions relating to leasehold improvements that will be made to the property in order to make it suitable for the tenant. These leasehold improvements generally revert back to the lessor at the end of the lease due to their inherent nature - such improvements either become part of the property or are treated as fixtures.

    In many situations, the lessor is arguably enriched by the leasehold improvements to its property whether by design or happenstance. Nonetheless, there are many variations in the lease terms through which the landlord and tenant reach agreement on the topic of leasehold improvements. Often, the tenant is responsible for reimbursing the lessor for such leasehold improvements and the lessor may give the lessee a break on rent for such payments. In other situations, the tenant’s planned improvements would be unsuitable to another lessee (think about distinctive interior designs or specific uses of space) and are therefore, of little or no value to the lessor. While these motives may come into play, what is most important from a sales tax perspective is the substance of the negotiation and the terms of the lease.

    Florida Statutes § 212.031(1)(a) and (c) impose a tax on the total rent or license fee charged for the renting, leasing, or letting of any real property. Furthermore, under Florida Statutes § 212.031, when the rental fee is paid by way of property or “other thing of value,” this is also a taxable element of rent. Under the Florida Administrative Code, all consideration due and payable by the tenant for the right or privilege required by the lease is “rent.” The full amount of such benefits flowing to the landlord is included for sales tax purposes. The landlord is responsible for collecting sales tax on any amount received that is determined to be “rent” from the tenant or will be personally responsible for such payment.

    The problem many taxpayers have struggled with is when are leasehold improvements not subject to sales tax and how could the arrangements be structured to substantiate that the leasehold improvements are not subject to sales tax.

    Fortunately, the Department has provided guidance on this issue.

    Technical Assistance Advisement 13A-023

    In the Department’s Technical Assistance Advisement 13A-023 (the “Advisement”), the taxpayer requested advice based on the following scenario:

    Are a “tenant’s reimbursement of funds [to the landlord] expended on the tenant’s behalf . . . not subject to the tax imposed in section 212.031, F.S., when the funds are for improvements solely to make the premises suitable for the tenant’s intended operation, are not mandatory, and are not in lieu of rent[?]”

    In support of its conclusion in the Advisement, the Department relied in part on the Florida First District Court of Appeals’ decision in Department of Revenue v. Ruehl No. 925, LLC, 76 So.3d 389 (Fla. 1st DCA 2011) (“Ruehl”). In Ruehl, the Court upheld the decision that certain improvements were not "rent" subject to sales on commercial rentals, notwithstanding the fact the improvements became the property of the landlord. Based on the Ruehl decision, the Department considered the following factors in making its determination of the whether leasehold improvements were not taxable as “rent”:

    • The improvements are made in order to put the premises in a condition suitable for the operation of the tenant’s business;
    • There is no requirement to spend a specific or minimum amount of money on the improvements;
    • No credit is given against rental payments with respect to the amount of the improvements;
    • The improvements are not explicitly classified as rent, additional rent, rent-in-kind, or in lieu of rent; and
    • There is no evidence that there was an attempt to reclassify rental payments to avoid the tax.

    The Department ultimately found in favor of the taxpayer in the Advisement after reviewing the lease agreement and the facts and circumstances surrounding the lease, holding that the leasehold improvements were not subject to sales tax. On a going forward basis, please note that any such determination by the Department will be heavily dependent on the particular facts and circumstances.

    The Advisement demonstrates the importance of the express terms of the commercial lease, the facts surrounding the leasehold improvements, and the ultimate structure of the commercial lease. When the leasehold improvements are significant, professional guidance could potentially reduce the lessee’s sales tax burden significantly or at a minimum, ensure that the entire amount expended on such leasehold improvements is not subject to sales tax.