How to Properly Assign the Obligation of Property Tax Payment to a Lessee

In legal practice, it is common to encounter real estate lease agreements where the lessor requires the lessee to pay property tax in addition to the rent. While the law does not explicitly prohibit this arrangement, due to a lack of knowledge or prior consultation with tax attorneys, such agreements often fail to specify how this obligation should be properly fulfilled.

We have frequently observed errors in fulfilling this obligation, leading to the following negative consequences:

1. Financial burden on the lessee.

The lessee pays property tax during the lease term, which can be substantial. The tax amount depends on factors such as the property's type, intended use, and area, potentially representing a significant expense for the lessee.

2. Issues for the lessor during audits.

Over time, tax authorities at the property's location may notice the lack of tax payments by lessor during a desk audit. Consequently, the lessor is assessed additional tax for the entire period, along with penalties and sanctions.

Bottom line: Both parties – the lessee and the lessor – incur financial losses.

In this article, we aim to explore the reasons for such outcomes from a tax law perspective. We will also provide a universal guide on how to correctly assign the responsibility of paying property tax to a lessee to prevent such situations.

The primary cause of the aforementioned issues stems from an incorrect identification of the property taxpayer. While lease agreements may designate the lessee as responsible for property tax – a practice not explicitly prohibited – it's crucial to consult the legislation, which clearly defines the taxpayer.

According to Article 373 Part I paragraph 1 of the Tax Code of the Kyrgyz Republic (hereinafter – the Tax Code), the property taxpayer in our case is an organization, individual entrepreneur, or individual with respect to an item of property registered or used in the Kyrgyz Republic that:

a) is owned by them, unless otherwise specified by law;

b) is under temporary land use rights, i.e., the lessee of the land plot;

c) is acquired under a financial lease or mortgage agreement, i.e. in case of mortgage the user of the property is equated to the owner, which he/she will become when repaying his/her obligations to the bank;

d) is a structure in use, i.e., a lessee of a room, building, or other structure.

This raises the question: if the Tax Code recognizes the lessee as a taxpayer, where does the problem lie?

Per Article 542 of the Civil Code of the Kyrgyz Republic (hereinafter – the Civil Code), under a property lease agreement, the lessor agrees to provide the lessee with property for a fee for temporary possession and use or temporary use.

In accordance with Article 545 of the Civil Code, a property lease agreement must be executed in writing. For immovable property, such an agreement is subject to mandatory state registration if the lease term is three years or more.

Therefore, while ownership rights are always subject to state registration, usage rights, such as those arising from a lease, require mandatory registration only if the lease duration is three years or longer.

In practice, lease agreements frequently specify terms shorter than three years to avoid mandatory state registration. Consequently, the state register of rights to immovable property reflects only the property owner, leaving leaseholder rights unrecorded in such cases.

According to Article 117, Part 6 of the Tax Code, a desk audit to verify the correctness of tax calculations is conducted by tax authorities in their respective location based on the taxpayer's submitted documentation and additional information obtained from other sources.

This means that during a desk audit, the tax inspector determines the taxpayer for the property in question by referencing the state register of immovable property rights. The inspector reviews the registry to identify the party listed as holding rights to the property.

If the lease agreement is registered with the state, the lessee is recognized as the taxpayer. However, if the agreement is not registered, the owner, as recorded in the registry, is considered the taxpayer.

Guide on the correct imposition of the tax payment duty on a lessee:

Option 1: State registration of the lease agreement

Ensure that the lease agreement is registered with the state, so the lessee is officially recorded in the register as the user of the property.

Option 2: No registration of the lease agreement

If the parties choose not to register the agreement, the tax payment should be made via the property owner:

• The lessee must provide the Tax Identification Number (TIN), name, or full name of the owner when making the tax payment.
• The payment will be credited to the owner's personal account in the tax system.
  This way, the formal taxpayer remains the property owner, but the tax payment is effectively handled by the lessee.

Errors in defining the taxpayer in lease agreements often result in financial losses and disputes with tax authorities. A clear understanding of legislative norms and proper organization of the tax payment process helps avoid additional charges and penalties, safeguarding the interests of both parties.

Legal practice demonstrates that each situation requires an individual approach. With our expertise in tax and civil law, we help find effective solutions even in the most complex cases, ensuring reliable protection and stability for your business.