Case P41

Judges: MB Hogan Ch
P Gerber M

GW Beck M

Court:
No. 3 Board of Review

Judgment date: 24 May 1982.

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Dr. G.W. Beck (Member)

The tax year involved in this case is 1979 although the deductions in dispute were claimed in two years, 1978 and 1979. In 1978 legal expenses of $1,756 were claimed and of this amount only $50 was allowed. However, 1978 was a loss year for the taxpayer and no assessment was issued against which he could object. In 1979 legal expenses of $1,484 were claimed and this amount was disallowed together with $1,706 ($1,756 less $50) of the loss brought forward. The taxpayer objected on 14 February 1980 to the disallowed legal expenses in both years and this objection was a response to his 1979 assessment which issued on 7 February 1980. He had objected on 21 March 1979 to the disallowance of the 1978 legal expenses and was advised that the objection was invalid ``as no assessment notice has issued''. I think that the objection of 14 February 1980 had to be interpreted on any reasonable reading as an objection against 1979 legal expenses and the disallowed loss forward and these reasons proceed accordingly. The Commissioner

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seems to have had no doubt that the objection covered both aspects.

2. The taxpayer carries on business as a consulting engineer and in 1974 he acquired the patent on certain equipment he had designed. He subsequently negotiated a licensing agreement with a large engineering organisation (here called XL) whereby that organisation had the exclusive rights to manufacture the equipment in Australia and royalties were to be paid in respect of each unit manufactured. The taxpayer seemed incapable of providing clear answers to questions and although I am sure he is not an obtuse man, his answers to questions sometimes made him seem very obtuse. The remainder of the factual story represents my best interpretation of his evidence.

3. The equipment needed to be built and tested and one unit was built, installed in a factory and operated. The taxpayer participated to some extent in this building and testing. After a time he became disenchanted with the way XL was promoting (or not promoting) the development and marketing of the equipment and he instituted legal proceedings primarily to get the engineering organisation to act in accordance with the way he (the taxpayer) interpreted the licensing agreement. In addition, he claimed from the company $3,000 as payment for work done on the initial unit built and tested. Some expenditure on these legal proceedings apparently was claimed and allowed in 1976 and 1977 tax years and in 1978 and 1979 the more significant sums indicated in para. I were claimed. The fate of these latter claims has already been described. Apparently while the dispute between the taxpayer and XL was in progress XL built and installed equipment in a customer's factory using the taxpayer's patent and he was entitled to royalty in respect of that transaction. The claim for this royalty payment somehow got mixed up in the legal action too, and I tried to have the taxpayer clarify the position by a series of questions as follows:

``Dr. Beck: Before you leave that point, can I ask this: in fact, as I interpret what you have been saying, you took legal action to achieve three things. One was to get what you regarded as adequate compensation for the work you had done? - Yes.

They had offered $1,500? - Yes, right.

The second was to get XL to act in accordance with the way you interpreted your original agreement, and thirdly to get royalties in respect of equipment that was installed in the factory; is that right or wrong? I am not clear. - I would say you have sized it up fairly well. There was the way I had construed the agreement. You are quite right about that, but this has all got to do with the running of the job in general terms. Okay, that is fair enough. Perhaps that was the prime issue. It was a development type effort, and there are right and wrong ways to run it.

You were endeavouring to get XL to act in accordance with the way you saw the agreement with them? - Yes.

And you are now saying that was the prime factor which caused you to take legal action? - Yes. It was a matter of getting the show on the road, and I did not see that that was happening. That was the first one. Going on from that was this matter of the work done without order, and you get the old commercial line of no order, no pay.''

4. Regardless of how one interprets these answers I do not think it will be questioned that Div. 10B, Industrial Property, has no application to the facts because no costs of devising an invention are involved. However, $50 was allowed to the taxpayer under sec. 64A in 1978 year and that section grants a deduction for up to $50 for legal expenses incurred by taxpayers carrying on business provided the expenses are not of a private or domestic nature. A deduction under sec. 64A was not granted in 1979 and I cannot discern the reasons for the Commissioner's change in treatment in the second year for it does not appear possible to claim that the legal expenses were of a private or domestic nature. I consider the taxpayer is entitled to a deduction of $50 in each year under sec. 64A, and the remaining question is therefore whether he is entitled to the balance - $1,706 in 1978 and $1,434 in 1979 - under sec. 51(1).

5. The Commissioner's representative said in argument:

``The evidence in the present case shows that the expenditure was incurred for two

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purposes; firstly to secure payment of moneys which the taxpayer considered were due to him under the original license agreement for work he performed.

The second was to secure a new license agreement more favourable to the taxpayer to allow further exploitation of his patents. In the Commissioner's view the license agreement and patent from which they are derived are the tree from which revenue is derived.''

The taxpayer certainly ended up with a new licensing agreement with XL, but the agreement was in the form of a schedule to a settlement agreement dated 30 June 1978 whereby XL paid the taxpayer $5,540 and he agreed to ``forthwith discontinue the said (legal) action''. The taxpayer's evidence was clear that he had taken the action to cause XL to operate the initial licensing agreement and it was only when he was making no headway with this that he agreed to accept a settlement and a new agreement. When the Chairman put to him that he had ``sought to terminate the license, the exclusive license'' he responded ``That only came in the second round. My first attempt was to try to keep the agreement going as it was''. I consider this taxpayer truthful and I accept that the purpose of the legal action was to have XL meet the obligations, both as to money payments and to the manner of promoting the invention, that the taxpayer believed they had under the original exclusive licensing agreement. I therefore reject the above contention of the Commissioner's representative that the second purpose was to secure a new agreement. The new agreement was an unavoidable eventuality but the taxpayer's legal expenses were aimed at a different target altogether.

6. The settlement agreement of 30 June 1978 provided for the payment of $5,540 to the taxpayer ``in full satisfaction of all (his) rights under the license agreement'' but it is clear from his evidence that this amount was agreed between him and XL on the basis of $1,500 for work done by him on the test equipment, and the balance for royalties in respect of the equipment installed at M factory. It was, he said, ``a two-part deal... a straight out royalty on M, which was a bit over $4,000, plus the $1,500 which was the development work earlier on''. The legal costs of obtaining payment for work done surely fall squarely under sec. 51 and the same can be said of costs of obtaining payment of royalties due and the costs of having a party comply with the terms of an operating contract. These are not costs of preserving a capital asset and thus of a capital nature (see
Pye v. F.C. of T. (1959) 12 A.T.D. 118 ) but are costs necessarily incurred by the taxpayer in carrying on his business with a view to earning assessable income.
F.C. of T. v. Snowden & Willson Pty. Ltd. (1958) 99 C.L.R. 431 seems to me to put deductibility beyond doubt, and some of the reasoning in the recent case of
Magna Alloys & Research Pty. Ltd. v. F.C. of T. 80 ATC 4542 also seems to me to fit the facts in the case under consideration.

7. At the hearing some observations were made by the Board that might have led the taxpayer to believe that the amount received from XL which he had returned as income in a subsequent year was, in fact, not assessable. Although this matter is not germane to the decision to be made here it is appropriate to comment on what I now consider misleading statements. The basis for the comments at the hearing was apparently the decision in
McLaurin v. F.C. of T. (1961) 104 C.L.R. 381 and the decision in
Allsop v. F.C. of T. (1965) 113 C.L.R. 341 . However, McLaurin's case related to unliquidated damages which was not the factual situation in the instant case and Allsop's case also has a fundamentally different factual situation. Allsop had paid large sums as road transport fees and had suffered significant costs due to what might be termed ``hassling'' by officers policing transportation legislation. These officers had part unloaded his trucks on occasions and refused to assist with reloading, and as a result deliveries were late and contracts were lost. Allsop instituted legal action to recover fees paid (and only fees paid) between April 1951 and the end of June 1954. In July 1958 he received a lump sum in settlement and signed a release in favour of the Government of the State of N.S.W. to the effect that the sum was in full satisfaction of claims for transport fees paid, and for any present or future claims in respect of other moneys and for claims that might be made ``arising out of anything done... by any person under the Act''. It was held that the lump sum was not assessable ``as

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neither the whole nor any part of it could be attributed solely to a refund of the permit fees''. In the case under review here there was not the slightest doubt in the minds of the taxpayer or the other party as to the composition of the sum he received and it is my view that the decision in Allsop's case has no bearing on this decision.

8. I direct that the taxpayer's assessment for 1979 year be amended to allow a deduction of $1,484 in respect of legal expenses and to increase the loss brought forward by $1,706.

Claim allowed in part