In Mussalli & Ors v FC of T [2021] FCAFC 71, the taxpayer entered into lease and licence agreements to operate several McDonald’s fast-food restaurants. The agreements included an option to make a fixed upfront annual payment that, if made, would reduce the amount of rent payable over the term of the arrangement. The taxpayer made the upfront payments and treated the outgoings as ‘prepaid rent’ on revenue account. Deductions were claimed by the taxpayer on the basis that the amounts were deductible under section 82KZM of the Income Tax Assessment Act 1936. The ATO disagreed and treated the upfront payments as a capital outgoing.
The Federal Court held that certain fixed upfront payments labelled prepayments of rent that were made by the taxpayer on entering the franchise agreements were capital in nature, as they secured an enduring advantage for the term of the agreements. The payments were not for rent but to alter an obligation that otherwise would have existed to pay the higher percentage rent. The payments secured the acquisition of a better business structure and were not for the carrying on of the business. The non-refundable nature of the payments further suggested that they were not for occupying the premises.
The taxpayer appealed to Full Federal Court. However, the Full Federal Court upheld the Federal Court decision and observed that there was no principle that a payment that substituted for future revenue outgoings or which more accurately in this case obviated or removed the need for them, must itself be revenue. There was no principle of general application that a lump sum paid to reduce or eliminate future revenue expenses was always to be characterised in the same way as the expenses for which it was substituted.
The Court decision emphasises that when considering the characteristics of capital and revenue expenses, the focus is on the substance of the payment. The label the taxpayer chooses to attach to a transaction is not determinative.
To discuss or for more information, please contact:
Neil Brydges
Principal Lawyer | Accredited Specialist in Tax Law
M +61 407 821 157 | T +61 3 9611 0176
E nbrydges@sladen.com.au
Lucy Liang
Lawyer
T +61 9611 0131
E lliang@sladen.com.au
