When a corporation's lease requires only a flat lump-sum rent payment, with the landlord separately responsible for utilities, taxes, maintenance, and repairs, can the corporation deduct anything from that rent when computing the value of rented property for Tennessee franchise tax purposes?

Subject

Whether a corporation may deduct lessor-paid expenses from lump-sum lease rent when computing net annual rent for franchise tax purposes.

Plain-English summary

The Tennessee Department of Revenue ruled that a corporation renting its office space from two individual shareholders for a flat $120,000 annual rent could not deduct anything from that amount when computing the value of rented real property for Tennessee franchise tax purposes — even though the lease made the landlord (not the corporation) responsible for utilities, taxes, janitorial services, maintenance, and interest charges.

Tennessee's franchise tax has a minimum measure based partly on the value of real property "used in Tennessee," which for rented property equals "net annual rental" multiplied by 8. Net annual rental starts with the actual rent paid under the lease and generally only adds to that figure — it doesn't subtract from it. Specifically, Tenn. Code Ann. § 67-4-2108(a)(6)(D) says if the lease requires the tenant to pay extra amounts that would otherwise have been the landlord's responsibility (interest, taxes, insurance, repairs), those get added to rent — but the statute provides no mechanism to deduct anything.

The taxpayer's argument centered on one sentence in the implementing regulation (Rule 28) suggesting that if a payment mixes "rent and other charges unsegregated," the rent amount is determined by "consideration of the relative values of the rent and the other items" — which the taxpayer read as implying the value of lessor-paid utilities/janitorial services embedded in the lump-sum rent could be backed out. The Department rejected that reading: that sentence, read in the full context of the rule (per the interpretive principle that a statute's meaning comes from the whole document, not an isolated sentence, citing McLane Co., Inc. v. State), only explains how to handle additional required lessee payments that are unsegregated from base rent when it's unclear how much relates to excludible service charges — it doesn't create a general deduction. Because this lease required only a single flat rental payment with no additional lessee-paid charges at all, there was nothing unsegregated to apportion, and the full $120,000 stood as net annual rent with no reduction.

What this means for you

Corporations leasing property, especially from related parties

A flat lump-sum lease rent is fully counted as "net annual rent" for franchise tax purposes, with no implicit discount for expenses the landlord happens to be responsible for. The service-charge exclusion in Rule 28 only becomes relevant if your lease requires you (the tenant) to make additional payments beyond base rent that are bundled together with excludible service charges (utilities, janitorial) in a way that's hard to separate — it doesn't let you argue that the landlord's costs are "baked into" your flat rent and should be backed out.

Accountants and tax professionals

This ruling is a useful statutory-construction example — reading an isolated regulatory sentence in the context of the whole rule rather than in isolation, following McLane Co., Inc. v. State (quoting Tidwell v. Servomation-Willoughby Co.). It's also a good illustration of the mechanical process: (1) start with rent payable under the lease, (2) add any lessee-paid amounts that substitute for what would otherwise be lessor obligations, (3) if those additional amounts are unsegregated from base rent, apportion by relative value — but there's no step that ever subtracts from net annual rent. Also note the parallel rule for the apportionment property factor at Tenn. Code Ann. § 67-4-2111(c)(1), which uses identical language.

Common questions

Q: Can a corporation reduce its net annual rent for franchise tax purposes because the landlord pays for utilities, taxes, or maintenance?
A: No. Net annual rent has no deduction mechanism — it only adds lessee-paid substitute-for-rent expenses to the base rent figure, and even that only applies when the lease requires the lessee to make such payments.

Q: When does the "relative value" apportionment in Rule 28 actually apply?
A: Only when the lease requires the tenant to pay some additional, unsegregated amount beyond base rent that mixes required additional-rent items (like taxes or interest) with excludible service charges (like utilities), and it's unclear how much of that additional payment relates to each.

Q: Does a flat, single-payment lease with no other tenant obligations trigger any adjustment to net annual rent?
A: No. If the tenant pays only a lump-sum rent with no additional required payments, net annual rent simply equals that lump sum, multiplied by 8 for the franchise tax property valuation.

Q: Does this ruling apply to other corporate leases, including related-party leases?
A: No. A Tennessee letter ruling binds the Department only for the specific taxpayer and facts addressed and cannot be relied on by others, though the net-annual-rent computation mechanics it describes apply generally under the statute.

Citations and references

Statutes, rules, and cases:

• Tenn. Code Ann. § 67-4-2108(a)(1) (minimum franchise tax measure includes real/tangible property used in Tennessee)
• Tenn. Code Ann. § 67-4-2108(a)(3) (value of rented property = net annual rental × 8)
• Tenn. Code Ann. § 67-4-2108(a)(6)(D) (definition of "net annual rental"; lessee-paid substitute-for-rent expenses included, no deduction provided)
• Tenn. Code Ann. § 67-4-2111(c)(1) (identical net annual rent definition for the apportionment property factor)
• TENN. COMP. R. & REGS. 1320-6-1-.28(2)(c) ("Rule 28") (annual rent computation; excludible service charges; unsegregated-charge apportionment)
• McLane Co., Inc. v. State, 115 S.W.3d 925 (Tenn. Ct. App. 2002) (quoting Tidwell v. Servomation-Willoughby Co., 483 S.W.2d 98 (Tenn. 1972)) (statutory meaning determined from the whole text, not an isolated sentence)

Source

• Landing page: https://www.tn.gov/revenue/tax-resources/legal-resources/tax-rulings.html
• Original PDF: https://www.tn.gov/content/dam/tn/revenue/documents/rulings/fae/06-08fe.pdf

Original ruling text

TENNESSEE DEPARTMENT OF REVENUE
LETTER RULING # 06-08

WARNING
Letter rulings are binding on the Department only with respect to the individual
taxpayer being addressed in the ruling. This presentation of the ruling in a redacted
form is informational only. Rulings are made in response to particular facts
presented and are not intended necessarily as statements of Department policy.

SUBJECT
The deductibility from annual rent of certain expenses in the computation of the value of
rented real property for franchise tax purposes.
SCOPE
This letter ruling is an interpretation and application of the tax law as it relates to a
specific set of existing facts furnished to the Department by the taxpayer. The rulings
herein are binding upon the Department, and are applicable only to the individual
taxpayer being addressed.
This letter ruling may be revoked or modified by the Commissioner at any time. Such
revocation or modification shall be effective retroactively unless the following conditions
are met, in which case the revocation shall be prospective only:
(A) The taxpayer must not have misstated or omitted material facts
involved in the transaction;
(B) Facts that develop later must not be materially different from the facts
upon which the ruling was based;
(C) The applicable law must not have been changed or amended;
(D) The ruling must have been issued originally with respect to a
prospective or proposed transaction; and
(E) The taxpayer directly involved must have acted in good faith in
relying upon the ruling and a retroactive revocation of the ruling must
inure to his detriment.

FACTS
[TAXPAYER] is a corporation engaged in [A BUSINESS]. The Taxpayer rents
substantially all of its office space from two individual shareholders pursuant to a lease
agreement (the “Lease”). The rental rate is $10,000 monthly or $120,000 annually. The
Lease specifies that the lessor is responsible for payment of utilities, taxes, janitorial
services, maintenance and interest charges. The Taxpayer’s only responsibility is for the
annual rental payment of $120,000.
QUESTION
In the computation of the value of rented real property for franchise tax purposes, may
the Taxpayer deduct from net annual rent the expenses described under the facts
presented?
RULING
The Taxpayer may not deduct from net annual rent the expenses described under the facts
presented.
ANALYSIS
Tenn. Code Ann. § 67-4-2108(a)(1) provides that the minimum measure of the franchise
tax shall in no case be less than the actual value of the real or tangible property owned or
used in Tennessee. Real property “used in Tennessee” includes real property that is
rented by the taxpayer; in the case of rented real property, the value of the rented property
is determined by multiplying the “net annual rental” times eight (8). Tenn. Code Ann. §
67-4-2108(a)(3). “Net annual rental” means the gross annual rental paid by the taxpayer,
less the gross rental received by the taxpayer for sub-rental. Tenn. Code Ann. § 67-42108(a)(6)(D). Payments to a lessor “as part of rent, or in lieu of rent” are considered
rent. Id. Tenn. Code Ann. § 67-4-2108(a)(6)(D) does not define the term “rent,” but
payments such as interest, taxes, insurance and repairs shall be treated as rent if such
items “would have been paid by the lessor if the lease contract or other agreement had not
specifically provided that they be paid by the lessee.”1 Id.
Tenn. Comp. R. and Regs. 1320-6-1-.28(2)(c) (“Rule 28”) provides that “annual rent” is
the actual sum of money or other consideration payable, directly or indirectly, by the
taxpayer for the use of the property. Annual rent includes any amount payable for the use
of the property, whether designated as a fixed sum of money or as a percentage of sales,
profits or otherwise. Additionally, Rule 28, Section (2)(c)(.2), provides that annual rent
also includes “[a]ny amount payable as additional rent or in lieu of rents, such as interest,
taxes, insurance, repairs or any other items which are required to be paid by the terms of
the lease or other arrangement, not including amounts paid as service charges, such as
utilities, janitor services, etc. If a payment includes rent and other charges unsegregated,
1

Identical language is used in Tenn. Code Ann. § 67-4-2111(c)(1) with respect to the computation of net
annual rent for purposes of determining the apportionment formula property factor.

2

the amount of rent shall be determined by consideration of the relative values of the rent
and the other items.”
More precisely, Tenn. Code Ann. § 67-4-2108(a)(6)(D) provides for the inclusion in
annual rent of certain expenses such as interest, taxes, insurance and repairs, when paid
by the lessee under the terms of the lease agreement. Importantly, Tenn. Code Ann. § 674-2108(a)(6)(D) does not allow the deduction from annual rent of such expenses.
Similarly, Rule 28 discusses in greater detail the inclusion of certain expenses in the
computation of annual rent, but does not allow any deduction of expenses.
As noted above, Rule 28, Section (2)(c)(.2), states that annual rent includes “any amount
payable as additional rent or in lieu of rents, such as interest, taxes, insurance, repairs or
any other items which are required to be paid by the terms of the lease or other
arrangement, not including amounts paid as service charges, such as utilities, janitor
services, etc. If a payment includes rent and other charges unsegregated, the amount of
rent shall be determined by consideration of the relative values of the rent and the other
items.” (Emphasis added.) In other words, Rule 28, Section (2)(c)(.2), requires the
inclusion in annual rent of amounts payable as additional rent, unless the amount was
actually paid as a service charge.
Read in isolation, the final sentence of Rule 28, Section (2)(c)(.2), may appear to indicate
that the lessee is permitted to deduct from annual rent the value of expenses such utilities
or janitor services, even when such expenses are the sole responsibility of the lessor and
are not specifically charged to the lessee. The reasoning is ostensibly that the lump sum
rental amount due under the lease reflects the cost of such expenses to the lessor, even
though the lease obligates the lessor to pay the expenses.
The final sentence must, however, be read in conjunction with the rest of Rule 28,
Section (2)(c)(.2). See McLane Co., Inc. v. State, 115 S.W.3d 925, 928 (Tenn.Ct.App.
2002) (quoting Tidwell v. Servomation-Willoughby Co., 483 S.W.2d 98 (Tenn.1972))
(emphasizing that the meaning of a statute is to be determined not from the special words
in a single sentence but from the statute taken as a whole).
Read in context, the final sentence simply functions to clarify the exception to the
requirement that certain additional payments must be included in annual rent. Rule 28,
Section (2)(c)(.1), provides that, in the computation of annual rent, the lessee must first
include the amount of rent payable under the lease agreement. Rule 28, Section (2)(c)(.2),
requires the lessee to then add to annual rent any amount “payable as additional rent or
in lieu of rents.” (Emphasis added.) Such amounts include interest, taxes, insurance,
repairs or any other items that are required to be paid by the terms of the lease. Rule 28,
Section (2)(c)(.2), goes on to state, however, the lessee must not include in this additional
amount any amounts “paid as service charges, such as utilities, janitor services, etc.”
(Emphasis added.) The final sentence of Rule 28, Section (2)(c)(.2) (“If a payment
includes rent and other charges unsegregated, the amount of rent shall be determined by
consideration of the relative values of the rent and the other items”), simply serves to
explain how the lessee is to proceed if the lessee is specifically required by the lease

3

agreement to pay additional amounts, but it is unclear what portion of the additional
amounts relate to excludible service charges.
To illustrate, assume that a lease requires the lessee to pay a monthly set base rental
amount, as well as the lessee’s proportionate share of monthly utility charges and real
estate tax increases, both as additional rent. Each month, the lessor determines the
lessee’s proportionate share of these additional items, and sends the lessee an invoice that
does not separately list the amount of each additional item. Assume further that the lessor
fails to keep adequate records. The lessee would be required by the terms of the lease to
pay an amount as additional rent, but the charges would be unsegregated. The lessee
would be unable to separate the charges, due to the lessor’s lack of records. In this case,
the lessee would determine the amount to exclude from the addition to annual rent by
taking into consideration the relative value of the rent and each of the additional charges.
In the Taxpayer’s case, the Lease simply requires the Taxpayer to pay a lump sum rental
amount. The Lease does not require the Taxpayer to pay any amounts as additional rent
or in lieu of rent, nor is the Taxpayer required to pay any service charges. Accordingly,
the Taxpayer will compute its annual rent by including the amount payable as rent under
the terms of the Lease, or $120,000. The Taxpayer has paid no additional amounts, so no
further additions are made to annual rent. Because the Taxpayer has no additional
amounts to include in annual rent, the final sentence of Rule 28, Section (2)(c)(.2), does
not function to exclude any expenses from the computation. The Taxpayer’s annual rent
for franchise tax purposes is therefore $120,000.

Kristin Solomon
Tax Counsel

APPROVED: Loren L. Chumley
Commissioner of Revenue

DATE: 4/7/06

4