Deductions were claimed for payments identified as "prepaid rent" paid to McDonald's Australia Limited upon entering into lease and licence agreements to operate seven McDonald's Family Restaurants. The deductions were claimed by the franchisee, the trustee of the Mussalli Family Trust, on the basis that the amounts were deductible in accordance with s 82KZM of the Income Tax Assessment Act 1936 (Cth). The applicants to the proceedings were the beneficiaries of the trust to whom the net income of the trust was paid in the relevant years and who thereby benefited from the deduction claimed.

The Federal Court found that the payments were one off, lump sum, non-refundable payments made to secure an enduring advantage (being the right to pay a lesser percentage rent) for the term of the lease and licence agreements and most likely the term of any renewal of the lease and licence agreements. 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. Accordingly, as a matter of substance the payments, although called “prepayment of rent”, did not involve the payment of rent at all.

The decision confirmed that the focus is on the substance of the payment

Her Honour accepted the evidence of the Commissioner’s expert accountant in respect to the calculation of the “prepaid rent” amount, as being calculated by subtracting the value of the equipment from the agreed price of the restaurant and not, as the applicants’ expert accountant submitted, the net present value of the rental differential.

The Federal Court also confirmed that the nature of an advantage sought by the taxpayer is to be determined objectively and held that the applicants’ approach to confine determination of the nature of the advantage to Mr Mussalli’s subjective state of awareness was contrary to principle.

This matter is the latest in a string of decisions handed down by the Federal Court involving consideration of the characteristics of capital and revenue expenses. The decision confirmed that the focus is on the substance of the payment and that the label of the payment is not determinative. The Court also confirmed that the subjective knowledge of the taxpayer will not have any weight to the character of the expense.

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