Between: FEDERAL COMMISSIONER OF TAXATION
And: UNITED AIRCRAFT CORPORATION

Judges: Latham CJ
Rich J

Williams J

Subject References:
Taxation and revenue
Income tax
Assessment
Foreign company
Income derived directly or indirectly from sources in Australia

Legislative References:
Income Tax Assessment Act 1936 No 27 - s 6; s 25(1)

SYDNEY

Judgment by:
WILLIAMS J

On 6th April 1937 an American corporation, United Aircraft Corporation (hereinafter called the American corporation), made an agreement in writing with an Australian company, Commonwealth Aircraft Corporation Pty Ltd (hereinafter called the Australian company) in America for the granting by the American corporation to the Australian company of certain contractual rights which are referred to in the agreement as a licence for the Australian company to manufacture what is called the licensed engine, which is defined to mean the single-row, air-cooled, nine cylinder, fixed radial, poppet-valve engine of 1340 cubic inch displacement equipped with carburettors for the use of gasoline and with magnetos as an ignition system, as now manufactured by Pratt & Whitney aircraft division of the American corporation under the designation of Wasp Series H-1. This agreement was supplemented by two letters written by the American corporation to the Australian company on 5th and 6th April 1937 and amended by an agreement in writing dated 13th May 1937 made between the parties.

The agreement is wide enough to include a licence for the Australian company to use any inventions relating to the licensed engine, the subject matters of letters patent owned by the American corporation in Australia, but the American corporation does not in fact own any such patents for or in respect of the licensed engine or spare parts referred to in the agreement.

On or about 22nd February 1938 the Australian company commenced the manufacture in Australia of the licensed engine as that term is defined in the agreement and it has continued so to do during the year ended 30th June 1940 and in subsequent years. During the year ended 30th June 1940 the Australian company paid to the American corporation the sum of PD5,092 in respect of the sums called royalties in article IV., s. 1 (b), of the agreement. The appellant, the Commissioner of Taxation of the Commonwealth of Australia, claimed that the American corporation was liable to pay income tax on this amount under the provisions of the Income Tax Assessment Act 1936-1940 and assessed the American corporation in the sum of PD513 16s. The American corporation appealed to this Court and my brother Starke ordered that the assessment should be quashed. The Commissioner of Taxation has now appealed to the Full Court against this order.

The agreement contains seven articles.

Article I. authorizes the Australian company to manufacture the licensed engine in the licensed territory, which means the Commonwealth of Australia, the Dominion of New Zealand and all that territory at the present time under the jurisdiction of the Commonwealth of Australia and the Dominion of New Zealand.

Article II. defines the licensed rights granted, which are expressed to be, subject to certain exceptions, the exclusive right, including the power to grant sub-licences, for the period of five years commencing 6th April 1937 and ending on 6th April 1942 (with an option to renew the term for five years) to manufacture, use, sell or lease or otherwise dispose of the licensed engine and spare and replacement parts thereof within the licensed territory but not elsewhere except as therein otherwise expressly provided. The right or licence granted is to include the right at all times during the continuance of the agreement to use within the licensed territory any inventions and designs relating to the licensed engine which may from time to time be covered by letters patent, or registered designs or applications therefor owned or controlled by the American corporation within the licensed territory.

Article III. provides that within ninety days from the date of the agreement the American corporation shall deliver to the agents of the Australian company in New York one complete set of Van Dyk prints (capable of reproduction), or, where Van Dyk prints are not available, duplicate copies of blueprints of all detail part drawings, bills of material, specifications and measurements covering the licensed engine; and that, whenever the American corporation is so requested, it will furnish to the Australian company with reasonable dispatch complete drawings and specifications in blue-print form of all special manufacturing equipment including patterns, tools, jigs, fixtures, gauges, etc, for which the drawings exist; and that on a similar request it will furnish with reasonable dispatch any or all standard or special manufacturing equipment including patterns, dies, machines, tools, jigs, fixtures, gauges, etc, any material and any and all such finished or partly finished parts as may be reasonably necessary for use in the manufacture of the licensed engine by the Australian company, to be delivered f.o.b. Port of New York at such prices and on such terms as the parties may agree from time to time. By this part the Australian company is also given the right at its own expense to send six technicians to visit the factory of the American corporation in America for the purpose of observing or studying the methods employed there in the manufacture and assembly of licensed engines, and in addition the American corporation agrees, whenever requested by the Australian company, to give to it such information and advice as might be reasonably required to enable it to manufacture the licensed engine and to use its best efforts at the request of the Australian company to lend to the Australian company at its factory, for a period of at least a year, at least one skilled engineer thoroughly familiar with the manufacture, assembling and testing of the licensed engine by the American corporation for employment at the Australian company's factory, the Australian company to bear and pay all salaries and expenses of any such engineer.

Article IV. provides for the payments to be made by the Australian company to the American corporation. Section 1 provides that in consideration of the rights granted to the Australian company by the agreement as set forth in article II. thereof (i.e., the exclusive licence) and of the design data to be furnished by the American corporation as set forth in s. 1 of article III. thereof (i.e., the delivery to the Australian company of the Van Dyk prints and other documents containing the drawings and specifications of the licensed engine) the Australian company agrees to make the following payments in New York funds to the American corporation:(a) an initial payment of 50,000 dollars, and (b) as and for royalties to pay on each licensed engine and parts thereof manufactured by the Australian company or its sub-licensees (regardless of whether or not the licensed engine or part is or shall be sold, leased, used or otherwise disposed of), the following amounts:for each licensed engine 500 dollars and for all extra or spare parts, seven and one half per cent (71/2%) of the American corporation's list price current at the time of manufacture.

Article V. provides that whenever during the agreement the American corporation shall make any improvements in the design or construction of the licensed engine, it will furnish without cost to the Australian company f.o.b. Port of New York full particulars of such improvements together with drawings and specifications disclosing the same, that the licence granted by the agreement shall for all purposes be deemed to extend to cover all such improvements, and that if the American corporation shall apply for or receive any patents on any such improvements it will take all steps necessary to obtain patents thereon within the licensed territory and the licence granted to the licensee in the agreement shall be deemed to embrace any such patents.

Article VI. contains what are called the special agreements of the licensee, and includes an agreement that whenever the Australian company or any of its sub-licensees shall make any improvement in the design or construction of the licensed engine, the Australian company shall without cost to the American corporation furnish to it full particulars of such improvement together with drawings and specifications disclosing the same and that all rights in and to such improvements shall, subject to the licence granted by the agreement, vest in the American corporation to the same extent and for all intents and purposes as if it had made such improvements. By s. 5 the Australian company agrees not to manufacture, license, sell or otherwise dispose of during the term of the licence granted by the agreement or at any time after its termination, any aeronautical engine embodying the same or substantially similar design as the licensed engine other than such engines or parts thereof as may be manufactured pursuant to the licence granted by the agreement. By s. 6 the Australian company agrees that it shall not at any time disclose or permit its sub-licensees to disclose to any person outside the licensed territory any design, data, technical or other information of any character relating to the design or manufacture of licensed engines, whether such information be received from the American corporation or any of its officers, agents or employees, or shall be derived from any experience gained by the Australian company in manufacturing licensed engines, and that the Australian company shall not at any time disclose or permit its sub-licensees to disclose any such information to any person within the licensed territory other than any person or persons at the time exercising rights under a sub-licence from the licensee, with a proviso that the licensee shall not be liable for any unauthorized disclosure of any such information made by any of its employees or any other person without the consent or approval of the licensee.

Article VII. authorizes the American corporation to terminate the agreement, inter alia, if the Australian company shall either default in any payment or if it shall fail to make at least one licensed engine during the twelve months period ending on 1st October 1938 or during any other twelve months period ending on any 1st October thereafter.

The Income Tax Assessment Act 1936-1940 defines what is comprised in "income from personal exertion" in considerable detail, and then defines "income from property" or "income derived from property" to mean all income not being income from personal exertion. In these definitions no attempt is made at technical legal accuracies. In Visbord v Federal Commissioner of Taxation, ^[F19] my brother Starke said:

"Subject to any express direction contained in the Acts the ascertainment of income must be `dealt with on business lines,' and the method pursued must depend upon the circumstances of the particular case; See Federal Commissioner of Taxation v Thorogood, ^[F20] at p. 457; Commissioner of Taxes (S.A.) v Executor Trustee and Agency Company of South Australia Ltd, ^[F21] at p. 154."

It is not contended that the American corporation is resident in Australia within the meaning of the Act, so that the corporation is taxable, if at all, as a non-resident. The Act, s. 25 (1), provides that the assessable income of a taxpayer shall include (b) where the taxpayer is non-resident the gross income derived directly or indirectly from all sources in Australia, which is not exempt income.

It is not contested that the royalties are income within the meaning of s. 26 (f) of the Act, so that, if they are derived from a source in Australia, the amount of PD5,092 is assessable income of the appellant.

It has been held by this Court in several cases, commencing with Nathan v Federal Commissioner of Taxation ^[F22] and concluding with Tariff Reinsurances Ltd v Commissioner of Taxes (Vict.), ^[F23] and this view has now been upheld by the Privy Council in Liquidator Rhodesia Metals Ltd v Commissioner of Taxes, ^[F24] that the determination of the source of income is a "practical hard matter of fact." In the present case the agreement was made in America, all the information and equipment which the American corporation agreed to supply are to be supplied in America, and all the payments which the Australian company agreed to make are to be paid in America, so that it is contended that every part of the source of the right of the American corporation to payment of royalties is in fact in America. This contention was upheld by my brother Starke.

In ascertaining source account must be taken of the fact that at the present day the element of contract is involved in most receipts by way of income unless they are derived from public or private bounty and the royalties now in question are no exception from this general rule. The importance of the contract element in the derivation of any particular set of receipts depends upon the circumstances. In some cases it may be the only important element, so that the locus of the making of the contract is the locus of the source of the receipts. In others it may be relatively unimportant, so that the place where the contract was made is negligible in determining the locus of the source. In others again the facts may be such as to necessitate attribution of part of the receipts to the locus of the making of the contract and of part of them to some other locus as a source (Federal Commissioner of Taxation v W. Angliss & Co Pty Ltd; ^[F25] Commissioner of Taxation (N.S.W.) v Hillsdon Watts Ltd ^[F26] ). A decision as to the locus of the source upon one set of facts, although it may be authoritative for any principles of law which may be laid down, is no authority for determining the fact of source upon other and different facts. To adopt the words of the Chief Justice in Tariff Reinsurances Ltd v Commissioner of Taxes (Vict.): ^[F27]

"It is a question of fact whether income (or profits) is derived from a particular country. In Federal Commissioner of Taxation v W. Angliss & Co Pty Ltd: ^[F28] See especially at p. 423 my brother Starke sets out and examines a number of cases which have dealt with this subject. It is there shown that the question which arises is really a question of fact and that no absolute rule of law can be stated the application of which will make it possible to determine all cases."

This must be determined in every case by what "a practical man would regard as a real source of income" (Nathan v Federal Commissioner of Taxation ^[F29] ), and, as Higgins J. pointed out in Mount Morgan Gold Mining Co Ltd v Commissioner of Income Tax (Q.), ^[F30] at pp. 93, 94, the source from which income is derived or the place where it is earned is not necessarily identical with the place where the business is carried on.

The agreement provides for two kinds of payment to the American corporation: (1) the payment of a lump sum of 50,000 dollars, 25,000 dollars upon the execution of the agreement and 25,000 dollars upon the disclosure of the information how to manufacture the licensed engine, and (2) payment of royalties of 500 dollars every time that the information is used by the Australian company or its sub-licensees to manufacture an engine, and of 7 per cent on the price of all extra or spare parts charged by the American corporation at the time of manufacture by the Australian company.

If a manufacturer has ascertained the manner in which an intricate chattel, such as an aeronautical engine, comprising many component parts and requiring special plant and machinery, can be manufactured, he has acquired with respect to a particular subject matter a special knowledge that can have great value. If that knowledge is to be made available to others for manufacturing purposes, it must be described and illustrated in many specifications and drawings. If it is a new manner of manufacture within the meaning of the Statute of Monopolies, it is an invention which can be made the subject matter of letters patent. As consideration for the disclosure the manufacturer can then acquire a monopoly for sixteen years under the Patents Act. But, supposing that the knowledge is not such that it is patentable, or that, although the knowledge or some of it is patentable, it is such that it would have to be made the subject matter of numerous patents, and the manufacturer is not prepared to go to the trouble and expense of applying for letters patent all over the world, he can still retain a monopoly in fact in his knowledge by only disclosing the manner of manufacture under such circumstances that those to whom it is disclosed are under an obligation, express or implied, only to use the knowledge for the purposes for which it has been disclosed to them: See the judgment of Romer L.J. in Handley Page v Butterworth, ^[F31] at pp. 359, 360.

If the party to whom the disclosure is made, in breach of the contract, threatens and intends to disclose the information, equity will restrain the threatened wrong by an injunction. If he has disclosed the information, the other party can sue the wrongdoer and the person to whom the disclosure was made for an injunction to prevent any use being made of the disclosure, or he can sue the wrongdoer for damages for breach of contract at common law.

If the disclosure relates to an invention that is patentable, and the person to whom the disclosure has been made wrongly uses the information to acquire letters patent for the invention, equity will declare that he is a trustee of the letters patent for the person who has made the disclosure, and, subject to the plaintiff recouping the defendant for the expenses which he has incurred in acquiring the letters patent, will order the defendant to assign the patent to the plaintiff. If a third party, knowing that a person is under an obligation not to disclose confidential information, is seeking wilfully to induce such a disclosure, equity will restrain the threatened disclosure by an injunction; or, if the third party has wilfully induced him so to do, the person who disclosed the information can sue the third party for an injunction to prevent him using the knowledge or for damages for wilfully procuring a breach of contract. It is immaterial for the purpose of this judgment finally to decide the extent of the right against third parties, but it would appear that they would be liable except where they could prove that they had come by the knowledge honestly (Tipping v Clarke, ^[F32] at p. 161]; Albert (Prince) v Strange; ^[F33] Summers (William) & Co Ltd v Boyce & Kinmond & Co; ^[F34] Robb v Green, ^[F35] at pp 15, 16; Rex Co v Muirhead, ^[F36] at p. 46; Kerr on Injunctions, 6th ed. (1927), p. 487).

As between the party who makes the disclosure and the party to whom the disclosure is made the rights are in general contractual, but third parties are placed in effect in an analogous position to other third parties in equity where contracts create rights of a proprietary nature in that they can only acquire a better title than the party recognized by the contract to be the owner of the proprietary rights if they can establish that they are bona fide purchasers for value without notice. In Rex Co v Muirhead ^[F37] Clauson J. (as he then was) went even further when he said:"The case of Albert (Prince) v Strange ^[F38] established this proposition to my mind quite fully: that a stranger, who quite innocently and properly finds himself in possession of information which the plaintiff is entitled as matter of property to protect from disclosure to the public, will be restrained by this Court from disclosing that information, notwithstanding it may have come to him perfectly properly." In several cases the ownership of such knowledge has been referred to as property. For instance, see Morison v Moat, ^[F39] at p. 498]; Green v Church ^[F40] (where a secret process was settled); Lamb v Evans, ^[F41] at p. 226; Robb v Green; ^[F42] In re Keene ^[F43] (where a secret process was held to be the property of a bankrupt); Reid & Sigrist Ltd v Moss & Mechanism Ltd, ^[F44] at p. 480; Triplex Safety Glass Co Ltd v Scorah, ^[F45] at pp. 28, 29; British Industrial Plastics Ltd v Ferguson, ^[F46] at p. 7 (H.L.). In Handley Page v Butterworth ^[F47] in the House of Lords Lord Tomlin, in referring to designs for certain types of bomber aeroplanes which were not capable of being registered or being the subject of letters patent, said:"In such a design there is no legal monopoly or property. There is property, no doubt, in the drawings and plans in which it is embodied, and if the design is kept secret it may be protected by those remedies which are available against breaches of confidence." But, as Hawkins J. pointed out in Robb v Green ^[F48] it is the information that is valuable and the mere property in the documents (apart from the information they contain) is nothing.

In the present case the knowledge that the American corporation agreed to disclose to the Australian company was in the main embodied in the specifications and drawings referred to in the agreement, and the agreement states specifically that it was for the use of this information embodied in the specifications and drawings coupled with the exclusive manufacturing rights in Australia that the Australian company agreed to pay the sums set out in article IV., s. 1, thereof, so that, having regard to the provisions of the agreement, the information contained in such specifications and drawings would be property as defined by Lord Tomlin and protected in the manner which he described.

These considerations all show that, although the rights arise out of contractual or fiduciary relations between individuals, the consequences which flow from that relationship both with respect to the parties to the contract and third parties are such that they may fairly be described, if not in a technical sense, at least in a business sense, as proprietary rights. They have been described as property in a business sense in tax cases: Delage v Nugget Polish Co Ltd; ^[F49] British Dyestuffs Corporation (Blackley) Ltd v Inland Revenue Commissioners. ^[F50]

Provisions of the agreement which show that the source of the income is the exclusive use of what the parties regard as the property of the American corporation in Australia are (1) that the parties agree that a licence to manufacture in Australia is necessary; (2) that the licence granted is, subject to exceptions, an exclusive licence for Australia and New Zealand: as there could be in a practical sense no other competition except from the American corporation this was in fact as exclusive a licence as the American corporation could have conferred by the exercise of patent rights; (3) that the Australian company agrees that any manufacturing improvements which it may discover in the course of using that knowledge are to be, like the original information, the property of the American corporation, and that it is only to have the same limited rights to use the improvements that it has to use the original information; and (4) that the Australian company agrees that on the termination of the licence it will not continue to manufacture the licensed engine. Provisions which show that the disclosure of the information is confidential are those clauses which show that the information is only to be used by the Australian company for a limited time, namely, the period of the contract or of its extension, and that any design, data, technical information or other information of any character relating to the design or manufacture of the licensed engine, whether such information is received from the American corporation or is derived from experience gained by the Australian company in manufacturing the licensed engine, shall not be disclosed to any persons outside the licensed territory, and that the Australian company shall not disclose (which must mean by its agents or employees) or permit its sub-licensees to disclose any information to any persons within the licensed territory other than a person or persons at the time exercising rights under sub-licences, with a proviso that the licensee shall not be liable for any unauthorized disclosure made by any of its employees or any other person without the consent or approval of the licensee.

The agreement provides, therefore, for the communication of the knowledge to the Australian company on the basis that the information is to remain the property of the American corporation and is only to be used by the Australian company in the area, to the extent, and for the period allowed by the American corporation. The American corporation can restrain the manufacture of the engines by the Australian company except pursuant to the terms of the agreement (Lamb v Evans ^[F51] ). It can put an end to the agreement if the Australian company fails to make at least one licensed engine during each annual period of twelve months ending 1st October, or if the Australian company makes default in the quarterly payments of royalties.

The question is whether, in these circumstances, the source of the payment of the royalties to the American corporation is, in a practical business sense, the making of the agreement in America and the acts done by the American corporation in the performance of the agreement in America, or the manufacture of the engines in Australia in the manner contemplated by the agreement, or partly the one source and partly the other. On each occasion that the Australian company manufactures an engine, it uses in Australia information supplied to it by the American corporation for use in Australia subject to the payment of a royalty for the use of the information on that occasion.

It is more than a case of a company carrying on business in Australia becoming liable, each time that an event happens, to make a payment to a corporation carrying on business in America under a contract made in America.

The whole conventional basis of the agreement is that the American corporation has made the Australian company the usufructuary in Australia for a limited period of knowledge which is capable of being regarded, at least in a business sense, as the property of the American corporation. It is this valuable knowledge "which represents, so to speak, the capital fund which produces the income" (Nathan v Federal Commissioner of Taxation ^[F52] ). To adopt the words of Rowlatt J. (as he then was) in British Dyestuffs Corporation (Blackley) Ltd v Inland Revenue Commissioners, ^[F53] the American corporation "is really using the property ... and taking an annual return for it." This profitable use is in Australia. If royalties have to be paid from Australia in respect of the exercise in Australia of a licence to use a process here, it is difficult to understand why, in a practical business sense, the royalties should be regarded as derived from a source in Australia if the process is patented, but as not so derived if it is not. If a process has been patented it is clear that the source would be the right to the exclusive future use of the information in Australia: See the cases referred to in the judgment of Macnaghten J. in Beare v Carter, ^[F54] at pp. 191-193. In Rees Roturbo Development Syndicate Ltd v Inland Revenue Commissioners, ^[F55] at p. 515 (when that case was in the Court of Appeal), Scrutton L.J. said: "The licensor cannot, having granted an exclusive licence, make any money out of the patent in the district of the licence, except from the licensee under the licence." In British Dyestuffs Corporation (Blackley) Ltd v Inland Revenue Commissioners ^[F56] Rowlatt J. (as he then was) treated the patents and the secret processes as being on the same footing. He said: "The real essence of it is this, that you have got here patented and secret processes; you can use them in this territory and in that territory ... and all that has been done here is to use this American company practically as a licensee." In each case, as was pointed out by Phillimore J. (as he then was) in Delage v Nugget Polish Co Ltd, ^[F57] the recipients are receiving a sum of money "which they only gain because profitable work has been done in this country or because work has been done in this country."

It is also not altogether irrelevant to point out that in Inland Revenue Commissioners v Muller & Co 's Margarine Ltd, ^[F58] at p. 238, where the House of Lords held that intangible rights regarded as property, such as goodwill, are capable of having a local situation, Lord Halsbury, who only dissented from the majority of the House in that he took a narrower view, said:"It may be very probable that in such a case there would be no goodwill of the business, or very little, but the mere fact that the business was practically, or altogether, local would not make the goodwill of the business simply local, unless by the contract of sale it was confined to a particular spot."

If it were possible to manufacture an engine from its component parts by putting them into a mechanical device in the same way as the battery box described in Palmer v Dunlop Perdriau Rubber Co Ltd, ^[F59] and if such a device were hired by the American corporation to the Australian company to be used to manufacture engines in Australia in consideration of the payment of a lump sum and of a royalty each time the device was used to manufacture an engine, it could hardly be said that the source of the royalty was not in Australia. In a practical business sense I am unable to see any distinction between the hire of such a mechanical device and the disclosure of information how to manufacture the engine.

It is true that the agreement provides that, until 40,000 dollars should have been paid in royalties, the Australian company will pay to the American corporation on account of the royalty not less than 500 dollars for each period of six months, but such a clause, which is a guarantee that the income shall be so much, is a common clause in licence agreements. For instance, in Wild v Ionides, ^[F60] at p. 424, Rowlatt J., in referring to a similar clause in a licence to exercise a patent, said:"It seems to me as clear as possible that this was guaranteed income in respect of the ownership of this patent" (in the present case I would substitute "information" for "patent") "which of course so far as it was used under licence took effect out of the interest of the licensor." Moreover, the American corporation is not claiming the royalties under this provision. It is claiming them under article VI., s. 1, of the agreement. The present case is distinguishable on its facts from any of the cases that were cited to us. The closest case on its facts is the Tariff Reinsurances Case. ^[F61] In that case it appeared that an Australian company carrying on the business of insurance in Australia took out a policy in England with an English company insuring itself against part of its risks. It was held that the premiums paid to the English company were not derived by it from a source in Australia, and that the facts that the Australian company's business was an insurance business and that the premiums paid to the English company were measured by the premiums received by the Australian company did not alter the position. The fact that in that case the locus of the making of the contract of insurance with the English company was regarded as the source of the premiums does not, in my opinion, throw any light upon the source of the royalties paid to the American corporation in the present case as a consideration for allowing its manner of manufacture to be worked in Australia. Furthermore, especially since a separate consideration was paid to the American corporation for entering into the contract, I can see no reason why the whole of the royalties should not be attributed to an Australian source.

The royalties payable on extra or spare parts are, of course, in a similar position to the royalties payable on the manufacture of the engines.

For these reasons I would allow the appeal.