Pech and Commissioner of Taxation - [2001] AATA 573

DECISION AND REASONS FOR DECISION [2001] AATA 573

ADMINISTRATIVE APPEALS TRIBUNAL ) No NT2000/474 and

) NT2000/475

TAXATION APPEALS TRIBUNAL )

Re          JIRI THOMAS PECH
Applicant
  And        COMMISSIONER OF TAXATION
  Respondent

Re          GLENDA HELEN PECH
  Applicant
  And        COMMISSIONER OF TAXATION
  Respondent

DECISION

Tribunal Senior Member M D Allen
Date 22 June 2001

Place Sydney

Decision      The decisions under review are set aside and the matters are remitted to the Respondent with the DIRECTION THAT: the legal expenses incurred by the Applicants are allowable deductions.
  (Sgd)                  M D ALLEN
  ..............................................
  Senior Member
CATCHWORDS
TAXATION – Action brought against partnership for alleged infringement of trademark. Whether legal expenses incurred in fighting the claim and setting up counter defence of having been granted a licence to use were outgoings of a capital or revenue nature.

Income Tax Assessment Act 1997 – section 8-1

Smithkline Beecham Laboratories (Australia) Ltd v Federal Commissioner of Taxation 93 ATC 4629
Case 21 11 C.T.B.R. (N.S.) Case 21

REASONS FOR DECISION

22 June 2001 Senior Member M D Allen

By applications lodged 13 November 2000 the Applicants sought review of a decision by the Respondent rejecting their objection to amended assessments which disallowed their claims to deduct legal expenses in the sum of $18,871.00.
The said objection decision remitted a shortfall penalty in the sum of $1,538.21 but affirmed the rejection of the said legal expenses as a deduction.
The legal expenses were incurred by the Applicants in defending a claim made against them by one David Machon in the Federal Court, alleging that the Applicants had infringed his trademark "nockAbout Campers".
Although it was not in the materials provided to me at the hearing of this matter I requested, and obtained from the Applicants' solicitor, a copy of the original proceedings brought against them in the Federal Court by Machon. That document has now been taken in and marked as Exhibit A2.
Apart from alleging a breach of trademark, the Statement of Claim also alleges breaches of the Trade Practices Act 1974 (Cth) and the Fair Trading Act 1987 (NSW) as a result of the Applicants using the trademark "nockAbout Campers" and claimed that, as a result, the plaintiff in the action had suffered loss and damage.
Mr Jiri Thomas Pech, the Applicant in matter NT2000/474, gave evidence before me. The genesis of the dispute lies in an agreement between Mr Pech, as the manufacturer of trailers.
The evidence was that in or about October 1994, discussions were held with David Machon whereby it was agreed that the Applicants would manufacture trailers and Machon would build a canvass top for the trailer.
As a result of the agreement trailers were manufactured by Mr Pech and Machon supplied canvass tops for them. The name "nockAbout" was stencilled to the tailgate of the said trailers.
It was the evidence of Mr Pech that his wife thought up the name "nockAbout" and he discussed with Machon the registering the name as a trademark.
In November 1995 the partnership of J and G Pech applied for the registration of the business name "nockAbout Trailers" and trailers were manufactured bearing the name "nockAbout". Signs were also created using the word "nockAbout".
Contrary to an agreement between the Applicants and Machon, Machon applied for the registration of the words '"nockAbout Campers" as a trademark on his own account and, after being granted registration of that trademark, informed the Applicants of that fact. He stated to Mr Pech words to the effect "You know I will never stop you from using it", which Mr Pech understood to mean that he could continue to use the word "nockAbout" on the trailers manufactured by him.
Relationships between Mr Pech and Machon broke down in or about April 1996, however, the partnership between Mr Pech and Mrs Glenda Pech, his mother, continued to manufacture trailers bearing the word "nockAbout".
The claim by Machon against the present Applicants was filed in the Federal Court at Sydney on 16 December 1997. The partnership discontinued using the word "nockAbout" in February 1998 in order to mitigate damages.
I accept the male Applicant as a truthful witness. He is a man unskilled in business and no doubt that is why his erstwhile partner Machon was able, by means of sharp practice, to register the trademark thought up by the Applicant and his wife and used the Applicant as a brand name on the trailers manufactured by him.
I also find, having regard to Mr Pech's evidence before me, that he and his mother were partners and had an honest belief that they had been granted verbally by Machon a permission or licence to continue to use the trademark "nockAbout" or a variation thereof.
Further, it seems clear that once the Applicants and Machon fell out, Machon used his ownership of the trademark to extort money from the Applicants. Not only did Machon take action to stop the Applicants using the name "nockAbout", contrary to the verbal permission granted, but he also took other steps to harm the Applicants' business interests, for example by complaining to the local Council that the Applicants were carrying on an unlawful use under a Town Planning Scheme. As Mr Pech put it in evidence: "He would not be happy until he wrecked our business".
Given the evidence of Mr Pech, I am satisfied the original intention of the Applicants in defending the case brought by Machon was that they regarded themselves as having a licence from Machon to use the trademark.
An amended defence to the action (see Document T15) also initiated a counter-claim against Machon. That counter-claim is not drafted in accordance with the evidence given to me by Mr Pech but I accept his evidence that he was advised by counsel that, as attack was the best means of defence, a claim was made that the trademark had been fraudulently registered by Machon. As stated, the pleadings do not accurately reflect this basic claim but I understood from Mr Pech's evidence that this was indeed the gravamen of his complaint.
Document T5 contains notes of a conversation between an officer of the Respondent's Office and the Applicants' Tax Agent. Where the history of the matters, as given by the Tax Agent, differs from the evidence of Mr Pech, I accept the evidence of Mr Pech. I find that the Tax Agent did not have a detailed knowledge of the events that led to the Applicants' defence and counter-claim in the action.
Having regard to the evidence before me and the pleadings in the case brought by Machon against the partnership of Mr and Mrs Pech senior, I find that the intention of the Applicants in defending the matter was to maintain their "right" to continue to use the word "nockAbout" as a name or brand on the trailers manufactured by them.
The Applicants claimed that the legal costs incurred by them were not to defend an asset but to defend the way in which they conducted their business and hence those expenses were a deductible expense.
Although numerous cases were referred to by the parties, I consider I do no disrespect to their submissions by referring directly to the distillation of the authorities by Hill J in Smithkline Beecham Laboratories (Australia) Ltd v Federal Commissioner of Taxation 93 ATC 4629. At p4633 his Honour said:
"The parties are in agreement that in determining the deductibility of legal expenses, regard must be had to the purpose for which those expenses were incurred. Where the expenditure sought to be deducted is expenditure incurred in the course of litigation, that requires consideration to be given of the purpose of the taxpayer in undertaking that litigation. ...
…
But whatever the correctness on its facts of Hallstroms Pty Ltd v FC of T (1946) 8 ATD 190 at 195; (1946) 72 CLR 634 at 647, there can be little doubt that expenditure incurred to preserve or to protect a business as such will ordinarily be expenditure of capital: cf FC of T v Consolidated Fertilizers Limited 91 ATC 4677 at 4687-4688; (1991) 101 ALR 385 at 339-400 per Spender and Lee JJ. On the other hand, where legal costs are incurred in defending the taxpayer and its officers from criticism of its methods of trading, the outgoings will clearly be on revenue account; FC of T v Snowden & Willson Pty Limited (1958) 11 ATD 463 at 465; (1958) 99 CLR 431 at 437 per Dixon CJ."

And his Honour continued at p4634 to state:

"The resolution of the question whether an outgoing is of capital or revenue is often greatly assisted by reference to the judgment of Dixon J in Sun Newspapers Limited & Associated Newspapers Limited v FC of T (1938) 5 ATD 87; (1938) 61 CLR 337. In that case his Honour referred (at ATD 94; CLR 360) to the distinction between income and capital as dependent upon the distinction between the profit yielding subject on the one hand and the process of operating it on the other. Relevant to the distinction, as his Honour points out, is a difference between an outlay which is recurrent, repeated or continual on the one hand, and an outlay which is final or made 'once and for all' on the other. Expenditure made to bring into existence or procure an asset or advantage of a lasting nature to enure for the benefit of the profit-earning subject would ordinarily be on capital account as distinct from expenditure which falls:
'within the very wide class of things which in the aggregate form the constant demand which must be answered out of the returns of a trade or its circulating capital …' …"

In Case 21 11 C.T.B.R. (N.S.) 96 the Taxation Board of Review said at p98 para 12, after referring to the dissenting judgment of Dixon J in Hallstroms supra:
"But, even if the whole scheme of the litigation is regarded as an attempt to establish a freedom to manufacture the articles to the patented design, we do not think that in the circumstances the out-going would have been one of capital. A similar argument was rejected by the court in Federal Commissioner of Taxation v Snowden & Willson, supra, and it is to be remembered that this aspect of the company's business was small and financially rather unimportant. If the freedom sought had been established no new product would have been produced nor even, on the evidence, a more efficient one. A conclusion that increased sales may have been expected would not be justified. It seems that all that would have been involved was increased efficiency of the profit-yielding subject resulting from the course of operations of the business. Thus the costs involved appear to refer more to the operation of the business than to the profit-making structure itself and thus to represent a revenue expense and not a capital outlay."

At p4634 of Smithkline Beecham Laboratories supra Hill J referred to expenditure to bring into existence or procure as asset as being an outgoing of capital. In this matter the expenditure could not procure a future permission to use the trademark. The legal proceedings were to defend a right to use the trademark in the past. That right being a mere licence, given it would seem without consideration, could have been revoked at any time and at will by Machon. The Applicants' defence to Machon's action was in reality a defence that claimed that a licence had been granted. That is to say the Applicants' expenditure on legal costs was to defend the way in which they had conducted their business, that is to say by using part of the trademark "nockAbout Campers" and to avoid incurring a penalty (damages) for the alleged unauthorised use of the trademark or for passing off.
These factors are therefore sufficient to satisfy me that the expenditure incurred by the Applicants was of a revenue nature and hence deductible.
The decisions under review will therefore be set aside and the matters remitted to the Respondent with the direction that the legal expenses incurred by the Applicants are allowable deductions.
I certify that the 26 preceding paragraphs are a true copy of the reasons for the decision herein of:
Senior Member M D Allen
Signed:         Kwai-Ling Wong           .....................................................................................
  Associate
Date of Hearing  16 May 2001
Date of Decision  22 June 2001
Solicitor for the Applicant         Mr K Munro, Kevin Munro & Associates
Solicitor for the Respondent    Mr G Last, Australian Taxation Office