ATO probing McDonald’s franchises

SUSANNAH MORAN
March 11, 2013
The Australian

FAST-FOOD giant McDonald’s is being investigated by the Australian Taxation Office over a controversial practice that has allowed its franchisees to enjoy lucrative tax deductions over a number of years.

With tens of millions of dollars at stake, franchisees of McDonald’s Australia have set up a fighting fund to deal with a potentially costly and lengthy legal battle, hiring tax lawyer Graeme Halperin of Halperin & Co for advice.

McDonald’s Australia, part of the global McDonald’s empire, has also been seeking external legal advice, engaging with top Sydney lawyer Richard Gelski from Johnson Winter Slattery.

There are more than 780 McDonald’s restaurants in Australia. The company owns and operates fewer than one-third of these, with the rest franchised. The franchisees pay rent to McDonald’s, whose business model includes owning, where possible, the land on which a restaurant is located.

The tax office is looking into how deals are structured when existing McDonald’s stores are traded between franchisees.

“In particular, the ATO wanted to better understand transactions in which a payment received by an outgoing licensee for surrender of a restaurant licence was characterised as a capital gain on capital account by the outgoing licensee, whereas an incoming licensee in relation to the same restaurant transaction treated its payment to McDonald’s as a tax deduction on revenue account,” McDonald’s general counsel Craig Cawood said in an email last November to Australian licensees, obtained by The Australian.

Mr Cawood said in the email that the tax office “stressed that this was only a very preliminary review” and it was “far from drawing any adverse conclusion about these matters”.

The Australian can reveal that a senior McDonald’s employee raised concerns more than a year ago about the way the company was structuring the deals.

Of particular concern was the issue of pre-paid rent, which can be claimed as a tax deduction by an incoming licensee.

Long before the tax office began making inquiries, McDonald’s launched a review into how the sales of existing restaurants were being structured, and documented and sought advice on what it had been doing.

“As part of that review we took the difficult decision to put a hold on all transactions,” former chief financial officer Marty McLysaght wrote in an email to licensees in January last year, which was copied to the Australian board. Mr McLysaght said McDonald’s was “seeking the advice and assistance from some of the best tax minds in Australia”.

Licensees were concerned that if the pre-paid rent option — and subsequent tax deduction — was no longer available the value of their stores would drop and they could lose hundreds of thousands of dollars in cash flow every year.

They were also worried that banks could reassess their borrowing levels, based on the anticipated reduced cash flow.

By March last year, a licensee working group had retained its own tax lawyer to get legal advice.

While not all licensees are affected by the ATO investigation, they have all been asked to contribute financially to the legal fund. Franchisees across Australia were recently asked to contribute $500 each to pay for legal advice.

Last May, McDonald’s chief executive Catriona Noble held a meeting with the group of licensees where it was agreed McDonald’s and the licensees would “work collaboratively” and the views of a QC would be sought.

“Cat expressed her intention for all parties to understand that neither would act independently without seeking and reviewing joint advice,” said an email sent on behalf of Ms Noble to licensees and senior McDonald’s management the following day.

McDonald’s Australia declined to discuss the issue of pre-paid rent and the ATO investigation.

“As you would appreciate, any discussions with the ATO and our commercial arrangements with our franchisees are confidential, however, we are happy to clarify that we are very comfortable that our commercial dealings are consistent with all applicable Australian standards and regulations,” a McDonald’s spokeswoman said.