Mussalli – Federal Court of Australia finds that a partial rent prepayment was a capital expenditure

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 relatively minor 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:

[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.

Neal Armstrong. Summary of Mussalli v Commissioner of Taxation [2020] FCA 544 under s. 18(1)(b) – Capital expenditure v. expense – Contract purchases or prepayments.