New York City office-sharing agreements and commercial rent tax

Editor: Jeffrey N. Bilsky, CPA

On Sept. 20, 2022, New York City’s Department of Finance (DOF) issued Finance Letter Ruling (FLR) 22-5018, which highlighted that businesses engaging in office-sharing agreements may be subject to the city’s commercial rent tax (CRT). The CRT is a tax imposed on commercial tenants in Manhattan that pay annual rent of at least $250,000.

Although FLR 22-5018’s specific focus was on whether a taxpayer could claim a subtenant deduction, it has ramifications for unsuspecting businesses engaged in office-sharing activities that may be subject to New York City’s CRT. As discussed below, a business does not necessarily have to have exclusive control of premises to be subject to the CRT. Further, the concept of rent may be fluid in office-sharing arrangements because it is sometimes unclear what services provided under them pertain to building services rather than business services.

The facts

The taxpayer in FLR 22-5018 operated a members-only workspace that provided offices, desks, meeting rooms, and collaborative spaces. Members used the workspace, which was equipped with various tools, technology, furniture, and equipment, to carry on or exercise a trade, business, profession, vocation, or commercial activity.

The taxpayer offered several levels of daily and monthly memberships that provided access to shared office spaces, lockable storage, phone areas, videoconferencing, and bookable meeting rooms, among other things. The membership agreement expressly provided that a property interest would not be created.

The issue was whether the membership fees were subtenant payments that the taxpayer could deduct from base rent for CRT purposes.

The DOF first determined that the membership agreements did “not create a tenancy, lease, or other real property interest in the member’s favor.” However, it found that the taxpayer was still allowed a subtenant deduction because the agreements were licenses: “Licensees are persons given permission to enter and use the taxpayer’s premises,” the DOF stated. “Here, the members are paying for permission to enter and use the taxpayer’s premises for trade, business, professional, or commercial activity.”

CRT overview

The CRT is imposed on tenants who occupy or use for commercial activity taxable premises in Manhattan south of 96th St. whose annual or annualized gross rent is at least $250,000. It is applied on base rent at a 6% rate. Base rent is computed by applying a 35% reduction to the gross rent paid, which reduces the effective tax rate to 3.9%.

Generally, the CRT applies to rent paid between parties so long as there is a landlord-tenant relationship and consideration is paid for the use of taxable premises.

The New York City Administrative Code Section 11-701 defines a “tenant” as a “person paying or required to pay rent for premises as a lessee, sublessee, licensee or concessionaire” and a “landlord” as a “person who grants the right to use or occupy premises to any lessee, sublessee, licensee or concessionaire, whether or not such person is the owner of the premises.” It defines “rent” as the “consideration paid or required to be paid by a tenant for the use or occupancy of premises.” Taxable premises are any real property or structure or space thereon “used or intended to be occupied or used for the purpose of carrying on or exercising any trade, business, profession, vocation or commercial activity.”

The ruling

In FLR 22-5018, the DOF concluded that for purposes of the CRT, the taxpayer was entitled to reduce its base rent by the portion of membership fees paid by its members for the use or occupancy of the space. In reaching this conclusion, the DOF indicated that exclusive control is not necessary for the subtenant deduction in the context of an office space. Although the issue was not directly raised here, the ruling suggests that subtenants can be subject to the CRT for shared space that is not necessarily delineated.

Based on FLR 22-5018, taxpayers should be aware that they may still be subject to the CRT even when they do not necessarily have exclusive control over any portion of taxable premises in New York City.

Building services versus business services

As noted, the taxpayer in FLR 22-5018 provided its members numerous services — in addition to the use of office space — based on membership level, and the DOF found that members made payments to the taxpayer based on those features.

However, the ruling does not discuss which services are considered building services rather than business services. That distinction could be important, as the ruling recognized, in determining the amount of a particular membership fee that should be allowed as a subtenant deduction or, conversely, considered rent paid by a member.

For instance, in The Little Shop Co., No. FHD(380) (N.Y.C. Dep’t of Fin. Hearings 8/22/91), a theatrical production company made payments under a theater license agreement to the licensor in exchange for services of box office staff, a house manager, a porter, and an electrician and stagehand.

The Commissioner of Finance concluded that these did not constitute rent subject to the CRT. The Commissioner of Finance characterized the services as business services rather than building services because they involved the conduct of the theatrical production and not the operation of the theater building. In addition, the amounts for those services were set forth in the lease separately from the rent consideration, and the Commissioner of Finance found those charges reasonable.

Takeaways

FLR 22-5018 may subject to the CRT unsuspecting businesses that share office space even when they lack exclusive control of any part of the premises. Also, it is important for both tenants and subtenants to know whether the services provided in an office-sharing arrangement are business or building services because this can affect the amount of CRT owed or even whether a business is exempt from the tax.

Editor notes

Jeffrey N. Bilsky, CPA, is managing principal, National Tax Office, with BDO USA LLP in Atlanta. Contributors are members of or associated with BDO USA LLP. For additional information about these items, contact Bilsky at jbilsky@bdo.com.