Kwikspan Purlin System Pty. Ltd. v. Federal Commissioner of Taxation.Judges:
DM Campbell J
Supreme Court of Queensland
Shortly stated, the questions raised by these two appeals are whether each of the lump sum payments of $85,000, $100,000, $250,000 and $100,000 made in consideration of the grant of an exclusive licence in respect of the user of a multi-holed purlin and girt system known as the Kwikspan Purlin System in a defined geographical area of Australia, and in consideration of the giving of information and assistance to enable the system to be manufactured and sold to the best advantage, should be regarded for income tax purposes as a capital or income receipt. The questions arise under a 1980 amended assessment and under the 1981 assessment, and there is an incidental question whether a 1980 Div. 7 assessment claiming additional tax on an undistributed amount of $13,769 is correct.
The above-mentioned system has an application mainly in industrial building. Its components consist of a purlin and girt system, a system for jointing structural members called a tab-lok bridging system, a 250 KFB facia and barge system, and a range of accessories. Letters Patent were granted to the taxpayer, Kwikspan Purlin System Pty. Ltd., as patentee, for an invention entitled ``Metal purlins and girts'' and an invention entitled ``Jointing of structural members'' dated respectively 16 July 1974, and 12 February 1976, the dates on which the complete specifications were lodged. Leslie David Goleby was named in the Letters Patent as the actual inventor.
Interchangeable barges and facias were designed for use with the system, but no patent was applied for or, I imagine, could have been successfully applied for, in relation to this component.
In notes to the company's accounts attached to its income tax return for the year 1979-1980, the taxpayer disclosed that the capital profit reserve of $102,487 shown in the balance sheet for that year included a sum of $85,000 as a ``Capital receipt in respect of a licence agreement''. The agreement referred to was named an ``Agreement for Sale of Know How'' and was entered into between the taxpayer and Handford Properties Ltd. (Handford Properties) on 5 June 1980, and it related to the grant of an exclusive licence to make use of the system within New South Wales on payment of a sum of $85,000.
Similarly, in the notes to the company's accounts attached to its return for the year 1980-1981, the taxpayer disclosed that a capital profits reserve of $552,487 shown in the balance sheet for that year included a sum of $450,000 as a ``Capital receipt in respect of Licence Agreements''. The agreements there referred to were entered into between the taxpayer and other companies and related to the utilisation of the system in other areas - firstly, a ``Know How Agreement'' entered into with Osborne Metal Industries Pty. Ltd. (Osborne Industries) (the agreement is undated but was probably executed on or about 5 September 1980) granting an exclusive licence within Victoria and Tasmania in payment of a sum of $100,000; secondly, a ``Know How Agreement'' entered into with Purlins Pty. Ltd. (Purlins) on 9 September 1980, granting an exclusive licence within Queensland in payment of a sum of $250,000; and, thirdly, as a result of a variation of the agreement with Purlins, a ``Know How Agreement'' entered into with Solari Manufacturing Co. Pty. Ltd. (Solari Manufacturing) on 12 September 1980, granting an exclusive licence within Queensland north of latitude 22° in payment of a sum of $100,000.
The primary submission of the Commissioner is that the payments were properly included by him in the taxpayer's assessable income for the years in question as part of the gross income under sec. 25(1)(a) of the Act. A subsidiary submission is that the payments were profits arising from the carrying on or carrying out of a
ATC 4284profit-making undertaking or scheme and, as such, were properly included in the assessable income under sec. 26(a).
Turning now as one must to the facts, the inventor, Mr. Goleby, was appointed manager of Purlins when the company was formed in 1970. His appointment was renewed in July 1976 for a term of five years ending on 30 June 1981. Purlins was then owned by Mr. P.V. Gay and Mr. Robert Barber and members of their families. The company which carried on business of prefabricating steel and as engineers in Queensland and in northern New South Wales made it possible for Mr. Goleby to develop what became the Kwikspan Purlin System and prove its utility.
Kwikspan Purlin Pty. Ltd. was incorporated on 7 December 1976, to exploit the system throughout Australia. Mr. Goleby was made a director of the company along with Mr. Gay and Mr. Barber and the shares were held equally between them. No doubt the motivation was to provide the inventor with adequate financial recognition.
The original intention was to manufacture and market the product themselves but Mr. Goleby said, and I have no reason for doubting him, that the directors came to realise that they would run into strong opposition which made them hesitate as the initial outlay was going to be high.
So on 10 December 1976, the taxpayer entered into an agreement with a Mr. and Mrs. Sievright of Western Australia granting them a licence to manufacture and market the system in that State. The licence was determinable at the end of five years by either party and was expressed to be granted in consideration of a lump sum payment of $5,000 and specified royalty payments on net invoiced sales.
This licence was surrendered by the Sievrights on 28 November 1977, on the taxpayer undertaking to pay them $7,000. The surrender was negotiated following an unsolicited approach to the taxpayer for an exclusive licence by Osborne Industries, a large company which was involved in the purlin industry. Due to this approach it began to dawn on the directors, as Mr. Goleby explained, that they may have a more valuable asset than they imagined and that the granting of other licences is what they should be thinking about. A lump sum payment of $25,000 and a royalty on net invoiced sales were agreed to with Osborne Industries in exchange for an exclusive licence within Western Australia and South Australia for a period of 16 years. The agreement is embodied in a ``Licence Agreement'' dated 16 January 1978.
Other approaches were made shortly afterwards by several companies but they came to nothing. Then, early in 1980, Handford Properties made an offer to acquire Purlins. Negotiations eventually broke down but discussions took place on a proposal that the company be granted an exclusive licence to make and use the Kwikspan Purlin System within New South Wales and also on another proposal that it be granted a non-exclusive licence to cover Victoria, Tasmania, Northern Territory and the Australian Capital Territory. Agreement was reached on these proposals and the ``Agreement for Sale of Know How'' dated 5 June 1980, mentioned earlier providing for the lump sum payment of $85,000 was signed, together with an ``Exclusive Licence Agreement for New South Wales'' dated the same date providing for a royalty on net invoiced sales for a period of ten years with an option to extend the agreement for another five years on giving notice in writing. At the same time, an agreement headed ``Non-Exclusive Licence Agreement for Victoria, Tasmania, Northern Territory and Australian Capital Territory'' was signed. That agreement made no provision for a lump sum but provided for a royalty over a similar period and contained a covenant by the licensor that it would not grant an exclusive licence in the above places without first offering the same to the licensee.
Next, on or about 5 September 1980, the taxpayer entered into an agreement with Osborne Industries - this is the undated ``Know How Agreement'' under which $100,000 was paid to the taxpayer - granting it an exclusive licence in respect of the system within Victoria and Tasmania after first offering the licence, as it was bound to, to Handford Properties. A ``Licence Agreement'' (likewise undated) was also entered into with Osborne Industries about the same time providing for a royalty based on net invoiced sales for a ten year period with an option of a further five years. The licensee was changed into a public company but has subsequently had a downturn in sales and has not commenced manufacturing in the eastern States.
As I have said, Mr. Goleby's appointment as manager of Purlins terminated in June 1981. He had formed his own company in 1977 and it was known for some time that he intended leaving when the service agreement expired. It was against this background that the taxpayer and Purlins entered into the ``Know How Agreement'' dated 9 September 1980, whereunder the taxpayer was paid $250,000 for an exclusive licence extending to the whole of Queensland. The same procedure was followed as before and a licence agreement was executed providing for the payment of a royalty.
Up to this time there had been no formal agreement between the associated companies. There was, in Mr. Goleby's words, ``only a loose, open-ended arrangement'' whereby Purlins used the technology without any formal agreement being worked out; and this he said had been going on since the end of 1976. Mr. Goleby wanted the position clarified and after discussion with his other directors a payment of $250,000 was agreed to as equitable together with a royalty on future sales.
I should say here that although the evidence of Mr. Goleby has to be scrutinized very carefully, ``for obvious reasons'' as was said by Gibbs J. in
McCormack v. F.C. of T. 79 ATC 4111 at p. 4121; (1979) 143 C.L.R. 284 at p. 301, I found his explanations for the most part satisfactory.
In 1980 another company Solari Manufacturing, which carried on business in northern Queensland, had purchased roll-forming equipment with the intention of entering the field in which Purlins was engaged. An approach was made to see if Solari Manufacturing would tool up to use the Kwikspan Purlin System. After many months of discussion, the ``Know How Agreement'' dated 12 September 1980, was signed granting the company an exclusive licence in Queensland north of latitude 22° in consideration of the payment of $100,000. But before that could be done Purlins had to relinquish its exclusive licence over the whole State. By a ``Variation of Licence Agreement'' entered into contemporaneously with the ``Know How Agreement'', Purlins agreed to grant Solari Manufacturing an exclusive licence over the northern half of the State in consideration of the payment to it by the taxpayer of $70,000.
Mr. Fryberg for the Commissioner made much of this payment. It shows up as part of the taxpayer's expenses in the Trading and Profit and Loss Account for the year ended 30 June 1981 in the item ``Franchise expense... $70,000''. It was put to Mr. Goleby that the reason behind the payment was to generate a revenue deduction, but I find this difficult to accept. The agreements were entered into about the same time, and no doubt it would have been simpler for the taxpayer to have granted Purlins an exclusive licence over southern Queensland and Solari Manufacturing an exclusive licence over the northern part. But Purlins had been operating throughout Queensland for some time and the ``Know How Agreement'' signed by it was drawn up in recognition of that fact. I think it can be accepted that what was done so far as Purlins is concerned was to carry out what had been planned before Solari Manufacturing came on the scene. It was conceded by Mr. Davies for the taxpayer that the sum of $70,000 was wrongly treated as an expense item in the Profit and Loss Account.
The effect of the option in the licence agreements is that they can continue for the life of the patents i.e. 16 years from the dates of the Letters Patent. However, Mr. Fryberg drew attention to the fact that the licences could be terminated by the licensor in the event of breach by a licensee. But under the ``know how'' agreements the lump sums are payable ``once for all''. There is therefore some justification for the taxpayer comparing the agreements with assignments.
Murray (Inspector of Taxes) v. Imperial Chemical Industries Ltd. (1967) 1 Ch. 1038, I.C.I., which had an exclusive licence to exploit certain patents for the manufacture of terylene polymers, entered into agreements with a number of foreign companies granting them sub-licences to manufacture equivalents of terylene in their respective countries. The agreements with the companies included a ``keep-out'' covenant in which I.C.I. covenanted not to compete in those countries in the manufacture or selling of products of a terylene texture. I.C.I. received royalties for the grant of the sub-licences and lump sums expressed as capital sums for the ``keep-out'' covenants. It was held that as the lump sums were payable irrespective of user they were capital receipts. The ``keep-out'' covenants were regarded by the licensees as important in case some method of making terylene without infringing the patents was discovered or in case
ATC 4286the patents themselves were held to be invalid. After stating that he saw no difference between the assignment of patent rights and the grant of an exclusive licence for the period of the patent, Lord Denning M.R. had this to say about how the money received for the disposal of the rights should be assessed under the Income Tax Act (at p. 1052):
``... it seems to me fairly clear that if, and in so far as, a man disposes of patent rights outright (for example, by an assignment of his patent, or by the grant of an exclusive licence) and receives in return royalties calculated by reference to the actual user, the royalties are clearly revenue receipts. If, and in so far as, he disposes of them for annual payments over the period, which can fairly be regarded as compensation for the user during the period, then those also are revenue receipts (such as the payment of £2,500 a year over 10 years in I.R. Commrs. v. British Salmson Aero Engines Ltd., and, of course, the royalties of £10,000 a year in the present case). If, and in so far as, he disposes of the patent rights outright for a lump sum, which is arrived at by reference to some anticipated quantum of user, it will normally be income in the hands of the recipient (see the judgment of Lord Greene M.R. in Withers v. Nethersole; approved by Lord Simon in the House of Lords). But if, and in so far as, he disposes of them outright for a lump sum which has no reference to anticipated user, it will normally be capital (such as the payment of £25,000 in the British Salmson case). It is different when a man does not dispose of his patent rights, but retains them and grants a non-exclusive licence. He does not then dispose of a capital asset. He retains the asset and he uses it to bring in money for him. A lump sum may in those cases be a revenue receipt: see
Rustproof Metal Window Co. Ltd. v. I.R. Commrs. (1947) 2 All E.R. 454, 459, per Lord Greene M.R., who emphasised that it was a non-exclusive licence there. Similarly a lump sum for `know-how' may be a revenue receipt. The capital asset remains with the owner. All he does is to put it to use.''
The ``know how'' agreements in the present case do not contain a clause directed to preventing the taxpayer from competing with the licensee in the places over which the licences extend. But I do not think that the absence of such a clause is significant and I think that such a clause is to be implied. The ``exclusiveness'' of the licences granted was not disputed by the Commissioner.
Most reliance was placed by Mr. Fryberg on the decision of the House of Lords in
Ducker v. Rees Roturbo Development Syndicate, Limited (1928) A.C. 133. This was a case where the taxpayer company was formed for the purpose of acquiring patents and dealing in them and, in particular, rights over a patented invention related to centrifugal pumps. The sum whose character was in dispute was the net sum paid by the licensee, an American company, to the taxpayer for being excused from paying royalties under an agreement which was converted into one of purchase (see the judgment of Scrutton L.J. in the Court of Appeal reported in (1928) 1 K.B. 506). The view taken was that the disposition was in the course of the taxpayer's business and that the profit on sale was chargeable to tax. It seems to me that the decision does not have an application beyond the facts of the case.
Both Viscount Simon in
Withers (H.M. Inspector of Taxes) v. Nethersole (1948) 1 All E.R. 400 at p. 403 and Davies L.J. in the Imperial Chemical Industries case at p. 1053 adopted the observations of Lord Greene M.R. in
Nethersole (1946) 1 All E.R. 716. Referring to the general principles he had previously discussed in
I.R. Commrs. v. British Salmson Aero Engines Ltd. (1938) 2 K.B. 482, the Master of the Rolls said:
``This decision is a clear authority, so far as this court is concerned, that a lump sum payment received for the grant of a patent licence for a term of years may be a capital and not a revenue receipt; whether or not it is so must depend on any particular facts, which, in the particular case, may throw light upon its real character, including, of course, the terms of the agreement under which the licence is granted.''
The main contention of the Commissioner is that the challenged receipts are proceeds of a business and not proceeds from the realisation of an asset. But the taxpayer was not in the business of dealing in patents. It was the owner of an invention which was sold under a trade name and the fact that several licences were granted for different places in Australia is the same as if one licence had been granted for the
ATC 4287whole of Australia. No element of repetitiveness was present in a real sense:
Hope v. The Council of the City of Bathurst 80 ATC 4386 at pp. 4389-4390; (1980) 144 C.L.R. 1 at p. 8.
Of course, if a company puts its assets to a ``gainful use'', to use the descriptive phrase of Lord Diplock in the Privy Council in
American Leaf Blending Co. Snd. Bhd. v. Director-General of Inland Revenue (1978) 3 All E.R. 1185 at p. 1189, as distinct from realizing them, that will generally amount to carrying on a business. It might be noticed, as the case was cited by Mr. Fryberg, that the situation was of a company granting licences to other companies to use and occupy its factory and warehouse in return for a monthly rental. Lord Diplock found it convenient to refer to the ``licences'' as ``lettings'', and had little difficulty in coming to the conclusion that the prima facie inference that the taxpayer was carrying on a business was not displaced.
There were some other submissions in support of the assessments which should be looked at briefly. The point was made that the taxpayer had no business premises of its own or staff of its own. But I do not think that advanced the argument that it was carrying on a business. It was stressed that the objects clause of the memorandum of association of the taxpayer was widely drawn. But that fact is not decisive and a widely drawn objects clause is typical of most companies. Finally, attention was drawn to the fact that there was no apportionment of the lump sums between the various components which made up the Kwikspan Purlin System. But as I understand the two patents really form the whole basis of the system.
It has often been remarked before that these cases can stand on a knife-edge. This case is not as finely balanced as that, as I see it. In my opinion, the payments in question were wrongly included in the taxpayer's assessable income under sec. 25(1)(a).
The alternative submission that the payments were assessable under the second limb of sec. 26(a) remains to be considered. In my view it is not a case which calls for the making of fine distinctions; and it is not unfair to remark that the limb was simply resorted to in argument as a backstop. The interrelation of sec. 25(1)(a) and the second limb of sec. 26(a) was considered again recently in
F.C. of T. v. Whitfords Beach Pty. Ltd. 82 ATC 4031; (1982) 56 A.L.J.R. 240 when another attempt was made to draw a dividing line between them. In the course of his judgment Gibbs C.J. said (at ATC p. 4037; A.L.J.R. p. 244):
``... I consider that the second limb of sec. 26(a) includes profits which would not otherwise have fallen within sec. 25, because they could not be described as income in the ordinary sense... However, I should make it clear that I regard it as established that profit yielded by the mere realisation of a capital asset not acquired for the purpose of profit-making by sale would not be either assessable income within sec. 25(1) or the profit arising from the carrying on or carrying out of a profit-making undertaking or scheme within sec. 26(a)...''
After referring to the passage in the judgment of the Lord Justice Clerk in
Californian Copper Syndicate v. Harris (1904) 5 T.C. 159 at pp. 165-166, which always seems to rate a mention on this subject, Mason J. said (at ATC p. 4047; A.L.J.R. p. 251):
``The principal, if not the essential, question under the second limb of sec. 26(a), as under sec. 25(1), is whether more is involved than the mere realisation of an asset... To bring this case within the second limb the Commissioner does not need to show that the respondent was carrying on a business. As we have seen, it is enough to answer the statutory description that there was a profit-making undertaking or scheme which exhibited the characteristics of a business deal, even though it did not amount to the carrying on of a business. If what has happened amounted to no more than the mere realisation of an asset then it was not a profit-making undertaking or scheme.''
I think I have said sufficient to indicate my reasons for concluding that the granting of the licences was not part of a ``scheme''.
I would allow the appeals and in the circumstances remit the cases to the Commissioner for re-assessment.