Courts have produced contradictory rulings on when gross-up obligations are triggered, what "subject to tax" means in a lease context, and whether a gross-up payment itself generates another gross-up obligation. For asset managers and leasing teams, the inconsistency has direct operational consequences.
The year-end reconciliation came in clean until page four. A commercial tenant in a net lease, accustomed to predictable operating expense true-ups, found a line item they had not modeled: a gross-up adjustment that added $47,000 to their bill. The clause had been in the lease since signing. No one flagged it during abstraction. The landlord called it a tax pass-through. The tenant called it a windfall. Both found lawyers who agreed with them.
That scenario plays out more often than the industry tracks. Gross-up provisions appear in commercial leases for legitimate reasons: they allocate tax risk, protect a party's net economic position, and account for the reality that tax consequences at the time of payment rarely match what the contract assumed. But the drafting assumptions that make gross-up clauses sensible in theory become litigation fuel the moment a dispute requires a court to decide what the clause actually means.
What exactly is at stake. A gross-up provision requires one party to pay the other enough that the recipient ends up with a specified net amount after taxes, withholding, or other deductions are applied. In commercial real estate, gross-up clauses appear most commonly in cross-border leasing arrangements, lease termination and buy-out structures, settlement agreements that include real property, and REIT-related financing transactions where withholding tax on rent triggers a pass-through obligation. They also surface in operating expense provisions where variable costs are adjusted to reflect full-occupancy conditions — a related but legally distinct mechanism that carries its own body of dispute precedent.
The core question a court must answer is straightforward: did the recipient receive the net benefit the parties intended? The answer depends entirely on which court is asked.
What Does "Subject to Tax" Actually Mean?
The phrase appears in thousands of commercial leases. It generates disproportionate litigation because it can mean at least two different things, and courts in the UK and the US have gone in opposite directions.
In AXA SA v. Genworth Financial International Holdings LLC, AXA argued that a payment was "subject to tax" because it fell within the scope of the tax system, regardless of whether any tax was actually payable due to an available exemption. Genworth disagreed. The court sided with Genworth: a gross-up obligation should apply only where tax is actually owed, not merely theoretically possible. The rationale was economic. An obligation triggered by a hypothetical tax burden does not compensate — it creates a windfall.
That logic resonates with textualist courts in the US: if the clause does not say what it means with precision, ambiguity cuts against expansion.
But the Third Circuit reached a different destination in Eshelman v. Agere Systems, Inc. [554 F.3d 426 (3d Cir. 2009)]. The court approved an additional gross-up to offset the tax consequence of receiving multiple years of back pay in a single lump sum. The circuit did not demand proof of a specific tax liability calculated to the dollar. It applied a make-whole standard: did the recipient end up in the position the parties intended? The answer to that question turned on economic reality, not contractual precision.
Two courts, two philosophies, the same type of clause. The gap between them is not a technical legal nuance. It determines whether a gross-up obligation exists at all.
The Recursive Problem Most Lease Reviews Miss
Here is the angle that standard lease abstractions almost never capture: if a gross-up payment is itself taxable, the recipient's net position after the gross-up may still fall short of the intended amount. That creates the legal question of whether a gross-up on the gross-up is owed.
The mathematics are not complicated. A $100 payment subject to a $30 tax creates a $30 gross-up obligation. But if that $30 gross-up is itself taxable at the same rate, the recipient nets $121 instead of the intended $130. That implies another $9 gross-up is owed — which is also taxable, and so on. The recursive calculation compounds meaningfully on large lease transactions.
Courts have not resolved this consistently. Some accept the recursive calculation. Others stop at a single gross-up. In Sonoma Apartment Associates v. United States [939 F.3d 1293 (Fed. Cir. 2019)], the Federal Circuit confronted the difficulty of projecting future tax consequences for a gross-up calculation and distinguished cases like Eshelman on the grounds that Sonoma required estimating future tax rates and future income. Courts are generally reluctant to make those predictions.
The practical problem for commercial real estate teams: most leases are drafted at a single point in time. Tax law changes. Exemptions expire. Rates shift. A gross-up clause negotiated in 2018 operates in a materially different tax environment in 2026. The clause typically does not account for that drift, which means the parties end up litigating what was intended rather than what was written.
Why This Pattern Repeats Across Real Estate Portfolios
Commercial leases are long-term contracts negotiated by lawyers who are expert in real property but often not in tax law. The reverse is also true: tax counsel reviewing the same transaction may not anticipate how the clause will perform over a fifteen-year lease term as property tax rates, withholding rules, and REIT structures evolve.
The result is a clause that passes legal review at execution but contains several latent failure points. No one flags the "subject to tax" ambiguity because it looks obvious. No one models the recursive gross-up scenario because it seems unlikely. No one annotates what happens if the underlying tax changes before the clause is triggered.
Years pass. A termination payment or a restructuring event activates the clause. The parties discover they understood it differently, and the inconsistency in judicial interpretation gives both sides a reasonable legal theory. This is not a drafting problem confined to smaller operators. The same gap appears in institutional portfolios with sophisticated legal teams, because the commercial real estate transaction and the underlying tax treatment are typically handled by different counsel who review in sequence rather than together.
What Lease and Asset Management Teams Can Do Differently
Audit gross-up clauses at abstraction, not at dispute. Most commercial lease abstracts capture the existence of a gross-up provision without flagging the trigger language, the scope of covered taxes, and whether the clause is silent on recursive obligations. That incomplete abstraction sits dormant until an event activates it. The review should happen at lease execution and again at any major lease event — termination negotiation, refinancing, REIT restructuring — when the clause is most likely to be invoked.
Flag jurisdictional ambiguity explicitly. The same "subject to tax" language has been interpreted in contradictory directions by courts in different jurisdictions. If a lease involves a cross-border counterparty or a multi-state portfolio, the governing law provision matters as much as the gross-up clause itself. That analysis is not always conducted together.
Draft the recursive scenario into the clause. A lease that explicitly states whether a gross-up is itself subject to another gross-up obligation eliminates the most litigated uncertainty before it becomes one. Most leases are silent on this. The fix is a single sentence negotiated at execution. Platforms like QTREN help centralize and extract key information from lease documents, making lease data more accessible and easier to review as part of broader portfolio management and analysis workflows.
The Broader Lesson
Gross-up provisions look like a narrow, technical drafting question until a court tells you that two lawyers reading the same clause can reach opposite legal conclusions, and both find precedent to support them. The judicial inconsistency documented in cases from Philadelphia to London is not a flaw in the system. It reflects genuine interpretive disagreement about what these clauses are for.
The real estate question is simpler: does your lease abstract capture what triggers the obligation, what taxes are covered, whether recursive gross-ups are addressed, and which jurisdiction's courts will be deciding? If those questions do not have clear answers, the clause is a liability, not a protection.
Which of your leases would survive that review?
Disclaimer: This article is provided for informational and educational purposes only and does not constitute legal, financial, or compliance advice. Real estate professionals should consult qualified counsel regarding gross-up provisions, lease tax obligations, and jurisdiction-specific requirements.