When a landlord grants a lease on a property, they might receive two types of payment: regular rent and a lump sum paid upfront, known as a premium. While rent is clearly income, a premium appears more like a capital receipt. However, UK tax law treats premiums in a special way that sits somewhere between income and capital, depending largely on how long the lease lasts.
This guide explains how HMRC approaches the taxation of lease premiums. If you’re a landlord granting a lease, a tenant paying a premium, or simply trying to work out the tax position on an existing arrangement let’s understand these provisions.
What Is a Lease Premium?
A premium is a lump sum payment made when a lease is created. It represents an upfront payment for the right to occupy property, separate from the regular rent that follows. Some leases require both a premium and ongoing rent, while others might involve rent alone.
The key characteristic of a premium is that it's paid at the point when an interest in property is created. Under normal tax principles, this would make it a capital sum. Indeed, landlords historically sought premiums instead of rent precisely to avoid income tax. To counter this practice, legislation was introduced requiring certain premiums to be treated, wholly or partly, as taxable income.
Note
It's important not to confuse a premium with rent paid in advance. The distinction lies in what the payment represents: a premium is paid for the grant of the lease itself, whereas rent is due under the terms of that lease once it exists.
How are Lease Extensions Premiums Calculated?
When a landlord receives a premium for granting a lease, the tax treatment depends entirely on the length of that lease. HMRC views the duration of a lease as a primary indicator of whether a payment is more like "income" or more like "capital."
The 50-Year Threshold
The most important rule in premium taxation is the 50-year limit.
Leases of 50 years or less: These are subject to a special tax basis where a portion of the premium is treated as property business income.
Leases over 50 years: These are viewed as purely capital transactions. No part of the premium is treated as property income, though Capital Gains Tax (CGT) may still apply.
The logic behind this distinction is that a premium for a very short lease is effectively "rent in a lump sum." The shorter the lease, the more the premium resembles regular income. As the lease term increases, the payment becomes more like a capital sum paid for a long-term asset.
How the Income Portion is Calculated?
For leases of 50 years or less, the amount of the premium that must be reported as property income is determined by a sliding scale. The longer the lease, the smaller the percentage of the premium that is taxed as income.
The formula used to calculate the taxable income portion is P × (50 - Y) / 50
In this formula:
P represents the total amount of the premium received.
Y is the number of complete periods of 12 months (other than the first) comprised in the effective duration of the lease.
Calculation Example If a landlord grants a 25-year lease and receives a £30,000 premium:
The remaining balance (£14,400) is treated as a capital receipt and may be subject to Capital Gains Tax (unless you are a property dealer, in which case trading income rules apply. |
How the taxable percentage changes with lease length?
10-year lease: 82% taxable as income (18% capital)
20-year lease: 62% taxable as income (38% capital)
25-year lease: 52% taxable as income (48% capital)
30-year lease: 42% taxable as income (58% capital)
40-year lease: 22% taxable as income (78% capital)
50-year lease: 2% taxable as income (98% capital)
Over 50 years: 0% taxable as income (100% capital)
As you can see, the shorter the lease, the more of your premium is treated as rental income rather than a capital gain.
When Is the Premium Taxed?
The part of the premium taxable as income is treated as a receipt of the property business for the year of assessment (for Income Tax) or accounting period (for Corporation Tax) in which the lease is granted. This is true even if the premium covers a period that spans many years. The landlord must include the taxable portion of the premium, alongside any regular rent received during that year, in their tax return for that period.
Practical Note
This means if you grant a lease in March 2025, you must include the taxable premium in your 2024-25 tax return, even though the lease will run for many years. The premium is taxed "up front" in one go, not spread over the lease term. Any regular rent is then taxed annually as you receive it.
When Premium Rules Apply? Granting Versus Assigning
A distinction exists between granting a new lease and selling an existing one. The premium rules only apply when a lease is granted, not when it's assigned or sold. This difference has significant tax consequences, so understanding which category a transaction falls into is essential.
How This Works?
Consider a landlord who holds property freehold. They grant a lease to a tenant, who then occupies the property for a specified term. When that lease expires, the property reverts to the landlord.
Now imagine the tenant wants to allow someone else to use the property. They have two options, each with different tax consequences:
Option 1: Granting a Sublease
The tenant creates a new lease arrangement, allowing another person (a subtenant) to occupy the property for part of the remaining term. At the end of the sublease, possession returns to the original tenant, who remains responsible under the head lease until it expires. If the subtenant pays a lump sum for this arrangement, that payment is a premium subject to the special tax rules.
Option 2: Assigning the Lease
The original tenant wants someone else to take over their lease completely. Rather than creating a sublease, they assign their entire interest in the lease. The new person becomes the tenant under the original lease terms, and the original tenant exits the arrangement entirely. If they receive a lump sum for this assignment, that payment is not a premium under the tax rules. Instead, it represents the sale price of the lease, dealt with under Capital Gains Tax provisions unless the person is a property dealer.
Granting a Lease (or Sublease) | Assigning a Lease |
|---|---|
Creating a new lease arrangement | Transferring an existing lease |
Landlord remains the ultimate owner | Original tenant exits completely |
Property eventually reverts to the landlord | New person steps into tenant's shoes |
Lump sum payment = Premium (special tax rules apply) | Lump sum payment = Sale proceeds (Capital Gains Tax rules apply) |
New lease must be shorter than any head lease | Entire remaining term is transferred |
EXAMPLE: Sarah pays a £15,000 premium to obtain a 30-year lease at £6,000/year rent. Fifteen years later, Sarah wants to exit the arrangement and transfers her remaining 15 years to James for £12,000. Is the £12,000 a premium? No. Sarah assigned (sold) her entire remaining lease interest. The £12,000 is a sale price dealt with under Capital Gains Tax rules, not premium rules. If instead Sarah had granted James a 12-year sublease (keeping 3 years for herself), then any lump sum payment from James would be a premium subject to these special rules. |
Determining the Length of a Lease
For most straightforward leases granted after 25 August 1971, the duration is simply what the lease document states - a 20-year lease is 20 years. However, HMRC has special rules to prevent people from manipulating lease terms for tax advantages. These rules determine the 'effective duration' based on what's actually likely to happen, not just what's written down.
NOTE FOR MOST LANDLORDS
If you're granting a lease in 2026 or later, focus on the section "Leases Granted on or After 25 August 1971" below. The historical provisions (pre-1971 leases) are included for completeness but likely don't apply to you. Skip to that section if preferred.
