Mussalli v Commissioner of Taxation, [2020] FCA 544, aff'd [2021] FCAFC 71

Two family trusts (MFT and MIT) agreed to lease restaurant premises from McDonald’s Australia Limited (MAL). The agreements-to lease (FLLs) had a term of 20 years (where MAL owned the premises) or of one day less than the headlease (where MAL leased the premises), and provided for a monthly base rent plus percentage rents calculated based on monthly sales. At the same time as the trusts agreed to enter into the leases, they agreed to make a lump sum payment described as “prepayment of rent” so as to reduce the percentage rent payable. Apart from one store, which had a shorter lease and less certain prospects of renewal, the FLLs did not provide for any refund of the payment.

The trusts deducted the rent prepayments over a 10-year period. In finding that the rent prepayments were capital expenditures, so that such deduction was not permitted, Jagot J stated (at paras 115, 119 and 125):

…[T]he payments in dispute are of capital or are of a capital nature. They were … a one off, lump sum, non-refundable payment made to secure an enduring advantage (the right to pay the lesser percentage rent) for the term of the FLL and most likely the term of any renewal of the FLL. The payments negated or extinguished any obligation to pay the higher percentage rent and did not thereby relate to any future obligation to pay rent. As a matter of substance the payments, although called the prepayment of rent, did not involve the payment of rent at all.

… What MFT acquired through the payments was a business with a different structure, a business in which the percentage rent payable was permanently reduced from what it otherwise would have been. …

… The non-refundable nature of the payments suggests that they were not made to secure the right to occupy the premises under the lease and, rather, were capital in nature.

Two Australian trusts that were to be the franchisees for seven McDonald’s restaurants agreed, at the same time as they agreed to enter into leases of the premises for base rents plus sales-based percentage rents, to make a lump sum “prepayment of rent” so as to reduce the percentage rent payable. With one exception, the leases did not provide for any refund of the prepaid rent in the event of early lease termination.

The trusts deducted the rent prepayments over a 10-year period. In finding that the rent prepayments were capital expenditures, so that such deduction was not permitted, Jagot J stated (at paras 115, 119 and 125):

[T]he payments … were … a one off, lump sum, non-refundable payment made to secure an enduring advantage (the right to pay the lesser percentage rent) for the term of the [leases] and most likely the term of any renewal of the [leases]. The payments negated or extinguished any obligation to pay the higher percentage rent and did not thereby relate to any future obligation to pay rent. As a matter of substance the payments, although called the prepayment of rent, did not involve the payment of rent at all. …

… What [the trust] acquired through the payments was a business with a different structure, a business in which the percentage rent payable was permanently reduced … .

… The non-refundable nature of the payments suggests that they were not made to secure the right to occupy the premises under the lease and, rather, were capital in nature.