Mussalli – Full Federal Court of Australia finds that “rent prepayments” made by new franchisees to reduce percentage rent payments on leases were capital expenditures

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, Mckerracher and Stewart JJ stated:

There is no principle that a payment that substitutes for future revenue outgoings or which compensates for them, or which more accurately in this case obviates or removes the need for them, must itself be revenue. …

[I]f the term … of the lease was irrelevant to the method of calculation of the payment [as was the case here], then any argument that the payment was in truth … a computation of prepayment of rent is extremely difficult to mount. …

The taxpayer has, in effect, purchased the right to have the better lease with the lower rent. …

Neal Armstrong. Summary of Mussalli v Commissioner of Taxation [2021] FCAFC 71 under s. 18(1)(b) – Capital expenditure v. expense – Contract purchases or prepayments.