Sondo Pty Ltd and Anor and Commissioner of Taxation
[2006] AATA 276
•24 March 2006
Administrative
Appeals
Tribunal
DECISION AND REASONS FOR DECISION [2006] AATA 276
ADMINISTRATIVE APPEALS TRIBUNAL )
) No WT2004/109-110
TAXATION APPEALS DIVISION ) Re SONDO PTY LTD and AVEL PTY LTD Applicants
And
COMMISSIONER OF TAXATION
Respondent
DECISION
Tribunal Deputy President S D Hotop
Senior Member S PenglisDate24 March 2006
PlacePerth
Decision
The Tribunal sets aside the objection decisions dated 30 September 1999 and remits the matter to the respondent for reconsideration in accordance with the direction that each of the applicants is entitled to a credit under s 51(1) of the Sales Tax Assessment Act 1992 (Cth), the amount of which is to be determined on the basis that, pursuant to s 95(2) of that Act, the amount that is to be allocated to the public exhibition right in the relevant transactions is 50% of the value of the public exhibition right determined by Mr Carter as specified in his report dated 21 September 2004.
..............................................
Deputy President
ADMINISTRATIVE APPEALS TRIBUNALü
ý No WT2004/109-110
TAXATION APPEALS DIVISION þRe:SONDO PTY LTD and
AVEL PTY LTD
Applicants
And:COMMISSIONER OF
TAXATION
Respondent
DIRECTION [2006] AATA 276
Tribunal : Deputy President S D Hotop
Senior Member S PenglisDate: 27 March 2006
Place: Perth
The Tribunal made a decision in these applications on 24 March 2006: [2006] AATA 276.
It has come to the Tribunal’s attention that there are obvious errors in paragraphs 16 and 24 of the Tribunal’s Reasons for Decision.
Accordingly, the Tribunal directs the Registrar, pursuant to subsection 43AA(1) of the Administrative Appeals Tribunal Act 1975 (Cth), to alter paragraphs 16 and 24 of the Tribunal’s Reasons for Decision as follows:
·in paragraph 16, the number “49” in line 2 is to be deleted and the number “50” is to be substituted therefor;
·in paragraph 24, the numbers “68” and “74” in line 3 are to be deleted and the numbers “74” and “80” are to be substituted therefor.
..............................................
Deputy President
CATCHWORDS
TAXATION - sales tax – claim of credit for overpaid sales tax - video games for use in amusement arcades - no reference in sales contracts to public exhibition right and (hence) no amount specified as payable for such right – implied term in contracts that such right granted to purchaser - calculation of amount to be allocated to such right for purposes of sales tax law – objection decisions set aside
Sales Tax Assessment Act 1992 (Cth) s 51 and s 95(2)
Taxation Administration Act 1953 (Cth) s 14ZY and s 14ZZ
Avel Pty Ltd v Federal Commissioner of Taxation (2004) 55 ATR 173; 2004 ATC 4260
Galaxy Electronics Pty Ltd v Sega Enterprises Ltd (1997) 75 FCR 8
Sega Enterprises Ltd v Galaxy Electronics Pty Ltd (1996) 69 FCR 268
Re Sondo Pty Ltd and Avel Pty Ltd and Deputy Commissioner of Taxation (2003) 52 ATR 1025; 2003 ATC 2047
REASONS FOR DECISION
24 March 2006 Deputy President S D Hotop
Senior Member S Penglis
Introduction
1. These applications for review are again before the Tribunal following the decision of the Full Court of the Federal Court of Australia in Avel Pty Ltd v Federal Commissioner of Taxation (2004) 55 ATR 173; 2004 ATC 4260 that those applications “be remitted to the Tribunal for assessment of the credits payable under the Sales Tax Assessment Act 1992 (Cth)”.
2. Sondo Pty Ltd (“Sondo”) and Avel Pty Ltd (“Avel”) had applied to the Tribunal for review of two objection decisions, dated 30 September 1999, of the respondent. Each of those decisions was a decision to disallow an objection by Sondo or Avel (as the case may be) against a decision of the respondent disallowing a claim for a credit of a specified amount of sales tax paid in relation to certain “assessable dealings” regarding coin-operated video game machines, or component parts thereof, during the period from 1 October 1994 to 31 December 1997 (“the claim period”).
3. On 20 February 2003 the Tribunal affirmed the objection decisions: see Re Sondo Pty Ltd and Avel Pty Ltd and Deputy Commissioner of Taxation (2003) 52 ATR 1025; 2003 ATC 2047.
The Factual Background
4. In Avel the Full Federal Court summarised the relevant factual background as follows:
“1.The applicants are related corporations which carry on business in the entertainment industry. Avel Pty Ltd (‘Avel’), the parent of Sondo Pty Ltd (‘Sondo’), runs ‘Time Zone’ amusement arcades where patrons may play coin-operated video amusement games.
2.A most important component of a video game is the printed circuit board (PCB) which controls its functions.
3.During the relevant period, 10 October 1994 to 31 December 1997 (referred to as ‘the claim period’), Sondo imported component parts for video game machines, in particular PCBs, and either manufactured or assembled the video game machines and sold them to Avel or else sold PCBs (ie on their own) to Avel. Avel also imported video game machines which it either sold by retail or applied to its own use in its video game arcades.
4.It is common ground that the combination of visual images, sound effects and movements created by the relevant computer programme embodied in each of the video game machines and PCBs constitutes a ‘cinematograph film’ within the meaning of the Copyright Act 1968 (Cth) and the Sales Tax Assessment Act 1992 (Cth)(‘the Act’) and that the owner of the copyright in each of these cinematograph films was the relevant overseas supplier.
5.Under agreements made pursuant to s43(1) of the Act between the respective applicants and the respondent in respect of these goods, the ‘taxable value’ of each ‘taxable dealing’ between Sondo and Avel was Sondo’s cost of manufacture of the machine plus 5% or, in the case of the sale of a PCB, Sondo’s landed cost of the PCB plus 5%. In relation to Avel, the relevant cost upon retail sale of a video game machine was its landed cost of the machine plus 5%, and in respect of video game machines applied by Avel to its own use the relevant cost was its ‘into-store’ cost of the machine plus 5%.
6.During the claim period Avel and Sondo purchased the video game machines or PCBs from overseas suppliers at a specified price per unit. The unit specified price was generally a single figure, although in some cases the prices of component parts of the unit ‘hardware’ were individually specified and, in a few cases, the values of the unit ‘software’ were specified. In none of the relevant purchase orders or invoices was any reference made to a copyright licence or a public exhibition right in respect of the relevant video game machine or PCB.
7.The evidence indicated that the same video games (but with a longer running time and without the coin operating facility) were sold to consumers far more cheaply than the prices charged to Avel or Sondo.”
The Statutory Framework
5. In Avel the Full Federal Court referred to the relevant statutory provisions as follows:
“9.It is not necessary for the purposes of this appeal to set out the various provisions of the Act, other than s 95, which lead to the question whether that section applies. But we identify the statutory trail as follows:
Section 16 – Incorporation and application of the general rules in Table 1
Section 5 – Definitions of ‘assessable dealing’, ‘application to own use’, ‘taxable dealing’ and ‘taxable value’
Section 34 – Incorporation and application of the general rules for calculating the taxable value in Table 1
Section 36 – Assessable dealing with goods that involve the payment of an associated royalty
[In general terms s36(1) provides that if a royalty is paid in connection with a sale of goods, the taxable value of any taxable dealing with those goods includes the amount or value of the royalty. Section 36(2) has the effect of excluding from the meaning of ‘royalty’ for the purposes of that section a royalty in relation to the public exhibition of a cinematograph film.]
Section 43 – Agreements with the Commissioner about calculating taxable values of particular taxable dealings
Section 51 – Credit entitlements (incorporating Table 3)
Table 1 – Assessable dealings
Table 3 – Credit grounds
[Item CR1 in Table 3 summarises that ground as ‘tax overpaid’ and states, by way of details of the ground, ‘Claimant has paid an amount as tax that was not legally payable.]
10.Each of the agreements made under s43(1) between the applicants and the respondent (referred to at paragraph 5 above) was evidenced by a short letter from the respondent to the respective applicant. It was common ground that each of the respective costs referred to in those agreements was to be assessed consistently with s36(1). That is, if s95 applied, the cost assessment would exclude any amount to be allocated to a royalty.
11.Section 95 of the Act provides as follows:
‘(1)If there is a need to know the price for which particular goods were sold, but the parties have not allocated a particular amount to those goods, the price for which those goods were sold is (for the purposes of the sales tax law) the price for which the goods could reasonably be expected to have been sold if they had been sold separately.
(2)Similarly, if there is a need to know how much of a global amount relates to some other element of a transaction, but the parties have not allocated a particular amount to that element, the amount to be allocated to that element (for the purposes of the sales tax law) is the amount that could reasonably be expected to have been allocated to that element if that element had been the only subject matter of the transaction.’”
The Decision of the Full Federal Court in Avel
6. In Avel the Full Federal Court held that:
·there was an implied term of each transaction (that is, contract of sale) that Avel or Sondo (as the case may be) acquired, together with property in the relevant goods (namely video game machines and PCBs), a right publicly to exhibit the cinematograph film embodied in the goods;
·because each relevant transaction included such an implied term, each transaction involved both a sale of goods and “some other element” (within the meaning of s 95(2) of the Sales Tax Assessment Act 1992 (Cth) (“the Act”), namely, the right publicly to exhibit the cinematograph film embodied in the goods (“the public exhibition right”);
·a “global amount” was payable under each transaction, the parties “not [having] allocated a particular amount to that [other] element”;
·there was a “need to know how much of [the] global amount” payable under each transaction related to the public exhibition right because the assessment of the taxable value of the relevant goods would, in accordance with s 36(2) of the Act, not include that particular amount;
·accordingly, s 95(2) of the Act was applicable and required the respondent Commissioner – and the Tribunal, on review – to calculate an amount to be allocated to the public exhibition right “as best [they] could on the evidence available”.
The Matter to be Determined by the Tribunal
7. The matter now to be determined by the Tribunal, pursuant to s 95(2) of the Act, is the particular amount (being part of the global amount actually paid by Sondo and Avel to suppliers for the goods in the relevant transactions in the claim period) which is to be allocated to the public exhibition right which comprised an element of each of those transactions. The Tribunal is required to determine that amount in order that the amount of the credits, to which Sondo and Avel are entitled under s 51(1) of the Act, may also be determined.
8. In accordance with s 95(2) of the Act, the amount that is to be allocated to the public exhibition right for the purposes of the Act is “the amount that could reasonably be expected to have been allocated to” that element of the relevant transactions “if that element had been the only subject matter of the transaction[s]”. That amount is to be determined by the Tribunal “as best [it can] on the evidence available”: Avel at (ATR) 182; (ATC) 4268.
The Applicants’ Case
9. The evidence presented by Sondo and Avel (“the applicants”) comprised the witness statements of Malcolm Steinberg, Kevin Mennell, David Salt, Neil O’Sullivan, Douglas Thorp, Jenny Wilks, and Luke McKimmie, and 3 expert reports of Paul Carter, together with the oral evidence of certain of those persons. Various other documentary exhibits were also tendered and received into evidence.
10. The evidence of Malcolm Steinberg, Kevin Mennell, David Salt, Neil O’Sullivan and Douglas Thorp, which was given at the previous hearing before the Tribunal, is set out in paragraphs 24 to 45 (inclusive) of the Tribunal’s Reasons for Decision in Re Sondo Pty Ltd and Avel Pty Ltd, and will not be repeated here. The Tribunal will now summarise the evidence of those witnesses who appeared on behalf of the applicants at the second hearing.
Jenny Wilks
11. Ms Wilks gave evidence that she has worked for Leisure and Allied Industries (the trading arm of Avel) for 28 years during which time she has performed mostly clerical and administrative roles. The effect of Ms Wilks’ evidence was to detail the information provided to PricewaterhouseCoopers (for the purpose of these proceedings) concerning the annual takings per arcade game earned during the claim period, and to explain how she went about obtaining and providing that information. The primary documentation upon which Ms Wilks relied to provide the requested information to PricewaterhouseCoopers was tendered and received into evidence.
Luke McKimmie
12. Mr McKimmie commenced work with Leisure and Allied Industries in 1996 as a technician. In 1999 he became a State Service Manager, which position he occupied until December 2003. Mr McKimmie gave evidence to the effect that he was asked by the applicants’ solicitors to perform an exercise for PricewaterhouseCoopers. He was given a paper copy of a spreadsheet which listed a large number of arcade games and was asked to categorise the games according to the following codes, namely:
·complex board, complex cabinet
·complex board, simple cabinet
·simple board, complex cabinet
·simple board, simple cabinet.
Mr McKimmie identified the document that he prepared for PricewaterhouseCoopers as being Appendix J to Mr Carter’s report dated 21 September 2004 (see below).
Paul Carter
13. Mr Carter is a chartered accountant and partner of PricewaterhouseCoopers’ corporate finance and recovery practice. Mr Carter has extensive experience in business and share valuation, including numerous matters in which he has provided expert evidence to courts on intellectual property and other valuation issues in revenue disputes, including providing evidence on numerous occasions on behalf of the Australian Taxation Office.
14. Mr Carter’s evidence-in-chief included 3 reports, dated 21 September 2004, 1 August 2005 and 8 August 2005, respectively, which he had prepared at the request of the applicants’ (then) solicitors.
15. Mr Carter’s brief was “to consider the value of the public exhibition right paid by Avel and Sondo as part of the purchase of video arcade games or parts thereof”. Two letters of instruction to Mr Carter from the applicants’ (then) solicitors, dated 25 May 2004 and 8 July 2004, respectively, were tendered by the respondent.
16. The Tribunal notes at this point that the respondent’s submissions (see paragraph 49 below) placed considerable weight on the following paragraphs in the letter of 8 July 2004 from the applicants’ (then) solicitors to Mr Carter:
“We confirm the views that we expressed previously to the effect that you may accept, for the purposes of your report, that all of the computer programme contained within a PCB generates or contributes to the generation of the cinematograph film which appears on the screen in front of the player. We have reviewed the decisions of the Federal Court in Sega Enterprises Limited v Galaxy Electronics Pty Ltd & Anor (1998) 40 FCA (Justice Burchett at first instance) and Galaxy Electronics & Anor v Sega Enterprises Limited & Anor (1997) 403 FCA (on appeal Justices Lockhart, Wilcox and Lindgren). In our view those decisions support the view that it is the entirety of the computer programmes on the PCB which generate or contribute to the generation of the cinematograph film which is protected by copyright.
…Since it is the entirety of the computer programmes on the PCB (the image, sound, scoring and other programmes) which contribute to the moving images and sounds experienced by each player, then clearly all of those programmes contribute to the cinematograph film. It follows therefore that when, in our case, Avel or Sondo is purchasing the printed circuit board it is paying for an exhibition right in respect of a cinematograph film generated by all of the programmes that may be on that PCB”.
17. Mr Carter’s approach was that the “value of the public exhibition rights can be determined as the difference between the overall cost of the complete video game or PCB, and the underlying cost of the constituent parts, including a reasonable profit margin on those parts”. On that basis, based on calculations set out in his report, Mr Carter concluded that “the total refund of Sales Tax is $4,767,512”.
18. In his report dated 21 September 2004 (Exhibit A5), Mr Carter stated (at para 18):
“As a cross-check I have considered the value of the public exhibition rights in the cinema industry where a proportion of box office takings are paid as a royalty. The royalty payment to the copyright owner by the distributor amounts to about 12.5% of box office takings. Using this royalty rate, and on the basis that an average game lasts between five and ten years and has takings of about $10,000 per year, the value of the public exhibition rights would be between $3,600 and $6,300. In my opinion, these results calculated by comparison with the cinema industry support the calculated values set out above, of between $3,100 and $6,400, calculated on the basis of the component costs of the video games and the consequent tax refund”.
19. Mr Carter also provided an “alternative calculation” as follows (at paras 19-20):
“The calculation set out above allocates value to the public exhibition rights on a pro-rata basis where the video games have been sold to Avel or Sondo at a price that appears to be below total cost, inclusive of a reasonable profit margin and allowance for recovery of software costs. I have prepared an alternative calculation where no such allocations have been made and which therefore assumes that, where the overall cost of the video game is lower than the cost of the components, plus a reasonable profit margin and allowance for recovery of software costs, there is no value attributable to the public exhibition rights …
In my opinion such an approach is likely to understate the value of the public exhibition rights, but such a calculation may be considered to be an indication of the minimum value of the public exhibition rights”.
20. On the “alternative calculation”, based on calculations set out in his report, Mr Carter calculated the refund of sales tax to be $4,383,464.
21. Mr Carter’s report, dated 1 August 2005, contains his comments on the report of the respondent’s expert, Wayne Lonergan, dated 15 December 2005. Mr Carter’s report of 1 August 2005 is considered below (see paragraph 42).
22. In his report, dated 8 August 2005, to the applicants’ solicitors, Mr Carter stated:
“You have subsequently provided me with a number of additional transactions which I am instructed to assume were omitted from the transactions which were the subject of my report of 21 September 2004. You have asked that I calculate the value of the public exhibition rights, and the associated sales tax refund for these transactions. In doing so, I have adopted the same basis and employed the same methodology, as set out in my report of 21 September 2004…”
23. As a result of calculations set out in that report, Mr Carter concluded that the “sales tax refund arising from these additional transactions therefore amounts to $412,103”.
24. The Tribunal’s understanding is that these transactions are those which were the subject of an application by the applicants to the Tribunal for leave to amend their particulars. This matter is considered below (see paragraphs 68-74).
The Respondent’s Case
25. The evidence presented by the respondent comprised 3 expert reports and the oral evidence of Wayne Lonergan, together with additional documentary exhibits comprising documents referred to in Mr Lonergan’s reports, correspondence passing from the applicants’ solicitors to Paul Carter, a volume of documents entitled “Asset Register, June 2005”, and an addendum to the Curriculum Vitae of Mr Lonergan.
Wayne Lonergan
26. Mr Lonergan was a Corporate Finance Partner at Coopers & Lybrand (now PricewaterhouseCoopers) for 23 years before commencing an independent valuation practice in January 2001. He has had over 35 years’ experience in corporate finance and valuations, including valuations of intellectual property and royalties, and valuations in the film and media industries. He is the author of several books in the area of valuation of property, including The Valuation of Businesses, Shares and Other Equity (4th ed, Allen & Unwin, 2003), and of over 80 published technical papers on valuations and related accounting matters. He is also an Adjunct Professor in the Faculty of Economics and Business, School of Business, The University of Sydney.
27. Mr Lonergan’s brief was set out in para 4 of his report, dated 15 April 2005 (Exhibit R3), as follows:
“The Australian Government Solicitor has instructed me to firstly review the valuation report prepared by Mr Carter and the documents made available to him for the purposes of preparing the ‘valuations’, and secondly provide a report setting out my opinion on:
(a)whether Mr Carter was provided with sufficient information/documents to enable him to provide the requested valuations
(b) whether the methodology used by Mr Carter in arriving at his valuation is correct
(c) assuming the answers to (a) and (b) are yes, whether the valuations provided by Mr Carter are correct
(d) any other issues which are relevant to an assessment of the accuracy of Mr Carter’s valuations or the methodology he employed, and
(e) to set out my opinion as to the value (amount) which is, in my view, attributable to the grant or acquisition of the public exhibition rights embodied in video game machines and printed circuit boards (PCBs) in respect of the amounts paid by the applicants to their supplier for the purchase of these machines and PCBs during the period 10 October 1994 to 31 December 1997”.
28. Mr Lonergan summarised his conclusions in his report, dated 15 April 2005 (paras 19-32), as follows:
·“Mr Carter’s ‘top-down’ methodology is inherently unreliable unless every deductible item is identified and its value is correctly calculated.”
·“Mr Carter’s whole analysis of the purported cost structure of purchased PCBs and games is based upon his estimates of what comprises the components, his estimate of their cost prices, and his estimated profit margin. His analysis is not based on the factual cost structure or profitability of the manufacturers involved. In essence, Mr Carter’s report appears to be little more than conjecture.”
·“Mr Carter has not made any allowance for numerous key cost elements that he should have allowed for”.
·“Mr Carter’s assumed profit margins are far too low”.
·“[Mr Carter] has massively overstated the value of the residual, that is the total identifiable intangible asset value.”
·“Mr Carter has also omitted to deduct the value of other identifiable intangible assets from his residual and has wrongly included the value of those assets in his assessed value of the public exhibition rights.”
·“The technically preferred methodology for calculating the value of a royalty is the ‘relief from royalty’ method. Mr Carter’s assumed royalty rate used in his cross-check of 12.5% is far too high. Mr Carter’s reference to cinema royalty rates as a reference point is inappropriate and misleading. Mr Carter has not obtained sufficient information to properly form the conclusion he has drawn. Mr Carter has failed to consider numerous issues. If he had done so his conclusion would have been significantly different. Mr Carter’s cross-checks for reasonableness are flawed.”
·“…the maximum amount attributable to the value of public exhibition rights would, after having made (for the purposes of this report) a number of assumptions in favour of the taxpayer, not exceed $289,657.”
29. In his report, Mr Lonergan explains the methodology by which he calculated the abovementioned amount of $289,657. As stated, he applied the “relief from royalty” method. That method, according to the report (at para 157), “involves quantifying the maximum royalty payment a licensee would be willing to pay for the use of all required identifiable intangible assets”. The report adds that, in determining the level of royalty payment a licensee would be willing to pay, the royalty:
“(a)must be sustainable over its economic life as factors such as obsolescence, future competition, etc may erode margins and therefore restrict the ability of the licensee to continue paying the level of royalty assumed
(b)should be set at a sufficiently low level to encourage the licensee to invest and grow the market and provide the licensee with an adequate return on capital
(c)must take into account the nature of the industry and factors such as the life cycle of the asset, cyclicality etc.”
30. Mr Lonergan then expressed his opinion (at para 158) as follows:
“…a minimum royalty cover of three to four times (and often substantially more) would be needed to allow for the above factors. In other words, a licensee would not be prepared to pay a royalty unless profits before royalties were a multiple of three to four times the amount of royalty paid for the use of the underlying licensed intellectual property, right of public exhibition etc. This is because the licensee needs to earn an adequate return on capital (for the risks they have borne) and labour whilst maintaining the capacity to pay a royalty, during times of both economic prosperity and hardship.”
31. Mr Lonergan further opined (at paras 159-160) as follows:
“The relief from royalty methodology is generally the preferred approach because it considers the economic benefits accruing to a licensee from all the intellectual property and rights that the licensee exploits for commercial gain. Ultimately, a user of a commercial right (in this instance being the public exhibition right) is only prepared to pay for the use of that right to the extent that they are able to achieve adequate economic returns after paying for the use of such a right.
It follows therefore that it is appropriate to have regard to the financial performance of Avel (during the claim period), as opposed to that of Sondo. This is because Avel, being an end user, exploits the public exhibition rights (whereas Sondo as an on-seller does not) and it is therefore Avel’s capacity to pay which provides the relevant guide to the quantum of the royalties that may have been paid by Avel and Sondo.”
32. An aspect of Mr Lonergan’s methodology which attracted considerable criticism on behalf of the applicants was expressed in his report (at para 165) as follows:
“It is reasonable to assume that the value (if any) attributable to public exhibition rights was only a small percentage of the total residual value of the identifiable intangible assets associated with the PCBs. This is because (inter alia):
(a) the rights to use software are generally very valuable
(b)the right to use the software was fundamental to the interactive games playing experience
(c) exclusive distribution rights are also valuable
(d)if the public exhibition rights were of material value it is likely that they would have been the subject of specific contractual terms and the payment for those rights would have been separately specified
(e)from the manufacturers’ perspective they would be unlikely to charge any material amount for public exhibition rights, as part of their marketing strategy is normally to create brand awareness to facilitate the sale of other games, eg sale of games to domestic consumers
(f)non-commercial purchasers could reasonably have been expected to object to paying any material amount for public exhibition rights if they were not going to use them
(g) it is reasonable to expect that Sondo would have objected from a working capital perspective to having to pay any material amounts for public exhibition rights for PCBs in stock, in work in progress, in transit etc, and
(h)at a more fundamental level, people who use game machines in arcades are primarily paying to play the machine and paying for an interactive experience. This is in contrast to (say) movies or juke boxes where the essence of the experience is passive watching/ listening on a shared basis.” (footnotes omitted)
33. Mr Lonergan then (at para 166) made reference to the “accounting standard on materiality” which, in summary, defines “materiality” as:
·0%-5% of value – probably not material (depending on its nature)
·5%-10% of value – probably material
·10%+ of value – definitely material.
34. On that basis, Mr Lonergan concluded (at para 167) that “the value of the public exhibition rights is an immaterial part of the total value of intangible assets”. He added:
“Accordingly, I have attributed a maximum of 10% of the residual intangible value to the value of public exhibition rights and 90% to software and other rights, including the exclusive distribution rights.”
35. Mr Lonergan stated (at para 186) that in performing his calculations he had:
·aggregated Avel’s profit and loss reports for the states of Victoria, New South Wales, Western Australia and Queensland on a financial year basis;
·adjusted Avel’s aggregated results to eliminate the elements of Avel’s business which are unrelated to the use of public exhibition rights;
·adjusted Avel’s aggregated results to eliminate any royalty amortisation already reflected in the accounts;
·applied the relief from royalty method (using royalty coverage of both 3 and 4 times) to ascertain a per annum royalty that Avel had the capacity to pay for the use of the public exhibition rights in 1995, 1996, 1997 and the first half of 1998;
·ascertained a per annum royalty that Avel had the capacity to pay per average machine operation during 1995 and 1996;
·derived an up-front royalty figure by discounting the annual royalties Avel had the capacity to pay over the economic life of an average machine purchased during 1995 and 1996; and
·multiplied the up-front royalty that Avel may have had the capacity to pay per machine during the claim period by the number of machines and PCBs purchased by Avel and Sondo throughout the claim period.
36. After performing detailed calculations, Mr Lonergan concluded (at para 234):
“On the basis that Avel and Sondo purchased 4,429 PCBs, including those in complete machines throughout the claim period, in my opinion, Avel and Sondo paid an amount of $2,896,566 in upfront royalties 10% of which I have attributed to the value of exhibition rights, $289,657. This number assumes in favour of the taxpayer that:
(a) there was no reduction in the royalty in loss years; and
(b) all PCBs purchased were used by Avel.” (footnotes omitted)
Mr Lonergan calculated the amount of the applicable sales tax refund to be $97,325.
37. By way of a cross-check, Mr Lonergan referred to published industry royalty rates. He noted that research conducted by Intellectual Property Research Associates indicated that the royalty rates for the technology industry were typically low, lying within the following bands:
· 33% of royalty rates are 3% or less;
· 36% of royalty rates are 4% or less;
· 56% of royalty rates are 5% or less;
· 61% of royalty rates are 6% or less;
· 66% of royalty rates are 7% or less;
· 72% of royalty rates are 8% or less;
· 74% of royalty rates are 9% or less;
· 90% of royalty rates are 10% or less.
Mr Lonergan added (at para 238):
“It should be noted that these are annual royalty payments, not ‘upfront’ payments (which would be significantly lower). It should also be noted that these royalty rates are a mixture of wholesale rates and retail rates. The average retail royalty rate would be significantly lower.”
38. Mr Lonergan then performed various calculations and concluded his report (at para 240) as follows:
“I note that the royalty rates that Avel had the capacity to pay in the financial years ended 30 June 1995 and 1996 were 2.80% and 2.17% respectively. These fall within the first of the bands as outlined by Intellectual Property Research Associates, and in my opinion are reasonable given the low profitability of Avel”.
39. In a further report, dated 25 July 2005, Mr Lonergan made additional comments regarding the appropriateness of the “relief from royalty” method of intangible asset valuation, and concluded (at para 32):
“I state in my First Report … that a licensor would not be prepared to pay a royalty of more than 25% to 33⅓% of the (after interest but before tax) earnings generated from the use of the underlying licensed intellectual property or right. My opinion is supported by a commonly referred to intellectual property valuation rule of thumb known as the Rule of 25. The theory underlying this rule of thumb is that the licensee should retain a majority of the profits (ie 75%) generated by the intellectual property because it has undertaken operational and commercial risks...”
Mr Lonergan went on to note that the “Rule of 25” is discussed more extensively in a paper written in 2002 by Robert Goldscheider, John Jarosz and Carla Mulhern entitled “Use of the 25 per cent Rule in Valuing IP”, a copy of which was received into evidence by the Tribunal.
40. In a report dated 9 August 2005, Mr Lonergan set out his calculations of the value of the public exhibition rights and the amount of the applicable sales tax refund with respect to the applicants’ additional files located in July 2001 which were the subject of Mr Carter’s report of 8 August 2005 and the applicants’ application for leave to amend their particulars (see paragraphs 22-24 above). He calculated the value of the public exhibition rights to be $33,323 and the amount of the applicable sales tax refund to be $11,163.
The Expert Witnesses’ Critiques of Each Other’s Evidence
41. Pursuant to a direction of the Tribunal, Mr Carter and Mr Lonergan gave their evidence at the hearing in accordance with the “concurrent evidence” procedure set out in O 34A r 3 of the Federal Court Rules. That procedure required each of them to, inter alia, express his opinions about the opinions expressed by the other.
Mr Carter’s Opinions about the Opinions of Mr Lonergan
42. Mr Carter’s opinions about the opinions expressed by Mr Lonergan were articulated in his report of 1 August 2005 (Exhibit A6) and in his oral evidence, and may be summarised as follows:
·Mr Lonergan considers the relevant payments to be royalties similar to those that are routinely paid by manufacturers for the use of intellectual property. Mr Lonergan does not view a payment for “public exhibition rights” as anything different to those usual royalties. Further, Mr Lonergan does not consider that comparison of the present circumstances with the amounts that are paid by cinemas or television companies is relevant. In Mr Carter’s opinion, royalties on the one hand, and payments for public exhibition rights on the other hand, are two different things. In Mr Carter’s opinion, the royalties that are said by Mr Lonergan to be comparable are not comparable and do not relate in any way to public exhibition rights.
·Mr Lonergan bases his calculation of the royalty rate upon the capacity of the licensee to pay, according to certain parameters. Mr Carter contends that the payment for public exhibition rights has already been made by the purchaser within the total cost of the game. This means that the purchaser has already determined that the combined cost of the hardware and the software (including the payment for the public exhibition right) is affordable (otherwise the purchaser would not have purchased the game). Further, because sales tax has been paid on the whole amount of the game cost, apparently the applicants could afford even more than would have been paid if part of the payment had been characterised as a public exhibition right (because the amount paid for sales tax would have reduced and the purchaser could have paid this amount to the copyright holder instead). Mr Carter opines that, conceptually, Mr Lonergan is attempting to value the public exhibition right in isolation, rather than apportioning the actual total price paid between two fundamental components. The former approach, which is capable of deriving the same answer as the latter approach, fundamentally addresses the wrong issue and thereby ignores the critical information of what has actually been paid for the total item. Mr Lonergan asserts that the question is one of “capacity to pay”, rather than what has actually been paid.
·Mr Lonergan’s “rule of thumb” (that profits should be 3 to 4 times the royalty) ignores the reality that in the television and cinema businesses the cost of the public exhibition rights is much more than a third or a quarter of profits.
·Mr Lonergan ignores the way public exhibition rights are commonly dealt with. For example, in the television industry it is clear that television stations must commit to, and pay, lump sums for program rights on the basis of perceived attractiveness, regardless of how the program subsequently is received by the viewers.
·With respect to Mr Lonergan’s apportionment of 10% of the possible maximum royalty payment to the public exhibition rights, Mr Carter responded (at para 15):
”Mr Lonergan has a different view (or different instructions) to me as to what is actually comprised within the public exhibition rights. Mr Lonergan lists various intangible assets that he asserts were acquired with the purchase of the games, and concludes that the public exhibition rights were only an immaterial part of the total value of the intangible assets acquired. I have been asked to assume that the software is indistinguishable from the public exhibition rights.
Having concluded that the public exhibition rights are only ‘an immaterial part of the total value of intangible assets’ Mr Lonergan uses the Australian accounting standard on materiality to assert that ‘immaterial’ must translate to a maximum of 10% of the total intangibles’ value. While appearing ‘scientific’, this is in fact entirely arbitrary, as the accounting standard has absolutely no relevance to quantification of the royalty. It is, in my opinion, inappropriate and misleading to determine that an amount is immaterial by totally subjective means, and then to use the accounting standard to apply a quantitative measure and derive a specific numerical amount”.
43. During the course of the hearing before the Tribunal, Mr Carter expressed various other opinions about Mr Lonergan’s reports and evidence, but it is unnecessary to set them out here.
Mr Lonergan’s Opinions about the Opinions of Mr Carter
44. In addition to the opinions summarised in paragraph 28 above, Mr Lonergan, in his report of 25 July 2005 (Exhibit R4), expressed the following opinions about Mr Carter’s report of 21 September 2004:
· The report contains “numerous inconsistencies in reasoning” (examples of which Mr Lonergan identified in detail).
· In specifying the price ranges for “simple” and “complex” PCB designs, Mr Carter adopts a “simple average of the ranges” so as to produce a single cost figure for simple and complex PCBs, without taking into account “weighted averages”.
· Mr Carter estimates profit margins (such as the profit margin on the cost of assembly, 10%) but does not disclose or refer to the actual gross profit margins generated by the applicants.
· Mr Carter in his determination of assembly costs has regard to the direct assembly costs of Sondo. In doing so, Mr Carter implicitly assumes that foreign based arcade game manufacturers share and abide by the same labour laws and rates of pay as Australian manufacturers. This is not so.
· Mr Carter adopts “current day prices for the cost of the peripheral components rather than those prices that were current during the relevant period”. Although Mr Carter acknowledges this point, he also states that it is “reasonable to assume that inflationary effects are likely to have been generally offset since the cost of technical or computer components have tended to decrease over the period”, but he provides no evidence to support this assertion.
· Mr Carter fails to take account of foreign exchange rate differentials, and this is a particular problem when applying his “top down” methodology.
45. During the course of the hearing before the Tribunal, Mr Lonergan expressed various other opinions about Mr Carter’s reports and evidence, but it is unnecessary to set them out here.
The Applicants’ Submissions
46. The applicants’ submissions were, in essence, as follows:
· Like s 95(1) of the Act, s 95(2) is concerned with the apportionment of global amounts actually paid in real transactions where there is some “need” to do so for the purpose of applying the Act. The operation of the section is therefore inherently purposive and inherently practical.
· Section 95 as a whole is concerned with allocation, not valuation.
· Section 95(2) applies, by definition, where the parties, who have in fact entered into a real transaction which in fact has a non-sale element (that is, a conferral of a contractual right or the undertaking of a contractual obligation involving something other than the passing of property in goods), have agreed on a global amount for that transaction but have not in fact allocated a particular amount to the non-sale element of the transaction. What it requires is the making of a judgment as to “the amount that could reasonably be expected to have been allocated to that element if that element had been the only subject matter of the transaction”.
· The making of such a judgment defies scientific precision. It is ultimately to be approached as a matter of practical common sense. The guiding principle is what the parties to the transaction could reasonably be expected to have done on the hypothesis that they were dealing only with the non-sale element of the transaction.
· The public exhibition right in this case is the right publicly to display the cinematograph film constituted by the “combination of visual images, sound effects and movements created by the relevant computer programme embodied in each of the video game machines and PCBs”. Those visual images, sound effects and movements are created in the process, and for the purpose, of the player playing the game. To attempt to distinguish between the cinematograph film and the player’s overall experience of the game is therefore to misunderstand what makes up the cinematograph film.
· It is the right publicly to display the cinematograph film (that is, the game) that is embodied within the video game machine which allows a video game machine to be used for the purpose of an arcade game. To use an arcade game by making it available to customers is to publicly display the cinematograph film. Video game machines and PCBs are obviously sold as fit to be used for that purpose. Without a public exhibition right, use for that purpose would be in breach of the Copyright Act 1986 (Cth) – hence the need to imply a term in the relevant transactions regarding the grant of a public exhibition right, as a matter of business efficacy.
· The applicants accept, as a matter of law, that there is copyright in the set of instructions which constitute the computer programme distinct from the copyright in the cinematograph film, and that there must be implied into each contract of sale (as a matter of business efficacy) a licence to use the computer programme. The applicants do not accept, however, that any significant part of the global amount paid should be allocated to the grant of the licence to use the computer programme.
· The assertion of Mr Lonergan, that the applicants acquired in each transaction for the purchase of a video game machine or PCB some further parcel of “identifiable intangible assets” (including exclusive distribution rights) which account for a significant part of the price that was paid, should be rejected. Apart from exclusive distribution rights, Mr Lonergan has failed even to identify those other “identifiable intangible assets” let alone to attribute value to them. Their existence as significant elements (express or implied terms) of the real transactions in question is not established on the primary evidence and is no more than a matter of theoretical speculation on his part.
· As to exclusive distribution rights, there is nothing in the evidence to suggest that those rights were acquired other than pursuant to an exclusive distribution agreement. Furthermore, as regards the vast majority of the relevant transactions, there was no associated exclusive distribution agreement.
· Mr Carter’s methodology is to be preferred to that of Mr Lonergan as it is anchored in the real transactions upon which s 95(2) operates. It proceeds primarily on the basis that the amount the parties could reasonably be expected to have allocated to the separate grant of the public exhibition right is the difference between:
- a reasonable valuation of the goods that were sold, and
- the global amount the applicants in fact paid for those goods and the public exhibition right.
·Whether or not that approach accords with standard approaches to the “valuation” of intangible property, as an approach to the “allocation” required by s 95(2) it is entirely reasonable and intuitively appealing.
· The application of the approach adopted by Mr Carter obviously calls for judgments to be made in the valuation of the various components of the goods that were sold. The judgments made by Mr Carter as to those cost components are reasonable. The criticisms made by Mr Lonergan in this respect go to matters of detail and are all adequately answered by Mr Carter in his evidence.
47. As regards Mr Lonergan’s “relief from royalty” methodology, the applicants submitted that there are “numerous problems with the application of this methodology for the purpose of s 95(2) of the Act”, including:
·Whatever its merits as a valuation method, the “relief from royalty” method is inherently not apposite to the task required by s 95(2). It is not concerned with the apportionment of a global amount. It is not anchored in any real transactions. It looks only to the applicants’ capacity to pay. That capacity to pay is treated solely as a function of total profit.
·Even as a valuation method, the “relief from royalty” method suffers from the limitation that it is “highly subjective”, particularly in relation to the choice of “royalty cover”.
· The application of the “Rule of 25” to apportion profit to royalty is inappropriate where the intellectual property right to which the royalty relates is integral to the product sold – that is, where the essence of the thing sold and used to generate profit is not the goods (branded or generic) but the intellectual property embodied in the goods and where the goods are simply the means of delivering that intellectual property. The rule simply does not hold in the media and entertainment industry.
· The attribution of only 10% of royalty to the public exhibition rights is merely arbitrary.
48. Finally, the applicants noted (if only as a further cross-check of the results arrived at independently by Mr Carter) that the amount actually attributed to the public exhibition right by the overseas suppliers, when they were asked to break down the global amount in their invoices for transactions occurring immediately after the claim period, was 70% – a figure which, they submitted, “compares reasonably well with Mr Carter’s figure of 66%”.
The Respondent’s Submissions
49. The respondent’s submissions regarding the proper construction and application of s 95(2) were, in essence, as follows:
·Section 95(2) of the Act requires the objective touchstone of reasonableness to be applied to the parties in question as regards what those parties (acting reasonably) would have allocated (out of what is a global amount) to that element. This artificial exercise first requires that the “element” in question be isolated and identified. The following enquiry is then as to the amount (out of the global amount) that the very parties (acting reasonably) would themselves, ie consensually, have allocated to the “element” applying a certain hypothesis. The hypothesis is “if that element had been the only subject matter of the transaction”. There is no case law of any applicable guidance in relation to the implementation in practice of s 95(2) particularly as regards its concluding hypothesis of isolation (ie “only subject matter”) regarding the identified element in the transaction.
·The “relief from royalty” method more faithfully implements the dictates of s 95(2) by going about directly seeking to identify the public exhibition right (the relevant “element” for the purposes of s 95(2)) as regards the cinematograph film embodied within the PCB as part of its computer program. On the other hand, Mr Carter’s “top down” methodology comes at that same “element” by first seeking to identify and attribute a cost to all the other elements and so, by process of elimination, derive as a residual an amount, being what is left, as necessarily attributable to the public exhibition right component of the “global amount”.
·A commencement point for a s 95(2) analysis must be the “global amount”, and the lesser “amount” to be attributed to the relevant “element” will be a subset of the “global amount”. But the objective allocation process as required by s 95(2) also requires that a legal assumption be made, ie that the relevant “element” is to be approached on the basis that it is the only subject matter of a transaction. “Relief from royalty” as a method satisfies this test better because it focuses attention immediately and directly on the relevant “element”, ie the public exhibition right, rather than working backwards from the estimated costs of the surrounding components. Mr Carter’s criticism of Mr Lonergan for “attempting to value the public exhibition right in isolation” is, therefore, itself inconsistent with the requirements of s 95(2).
50. The respondent’s submissions also referred to the instructions given by the applicants’ (then) solicitors to Mr Carter for the purpose of preparing his first report (see paragraph 16 above). It was submitted that the effect of those instructions was to require Mr Carter “to necessarily attribute the entirety of the price levied for all the intangible rights granted by the vendor of the PCB, wholly to the public performance (sic) right”. The respondent submitted that those instructions were not entirely in accord with the judgments in Sega Enterprises Ltd v Galaxy Electronics Pty Ltd (1996) 69 FCR 268 and Galaxy Electronics Pty Ltd v Sega Enterprises Ltd (1997) 75 FCR 8 on which they were purportedly based and were flawed in that the purchase of a PCB includes intangible assets in addition to the public exhibition right (eg the copyright in the set of instructions which constitute the relevant computer programme).
51. The respondent also referred to the evidence of Ms Wilks and noted that the accounting materials and information accessed and provided by her to PricewaterhouseCoopers, which were used and relied on by Mr Carter in making the calculations which were included in his reports, comprised management accounts (rather than audited accounts). The respondent submitted that those accounting materials and information were selective and unreliable and, furthermore, invited the Tribunal to draw an adverse inference from the applicants’ failure to produce the relevant audited accounts.
52. The respondent presented in tabular form a summary of submissions regarding:
·the “pros” and “cons” of each of the methodologies adopted by the expert witnesses, namely, the “relief from royalty” methodology adopted by Mr Lonergan, and the “top-down” methodology adopted by Mr Carter, and
·issues regarding difficulties and advantages involved in the implementation of each of those methodologies,
in the present case.
53. Finally, the respondent referred to paragraph 58 of the Tribunal’s Reasons for Decision in Re Sondo (above) at (ATR) 1056; (ATC) 2075-2076. Paragraph 58 states:
“Mr Steinberg’s assertion, that the difference between the cost of manufacture (including a ‘reasonable profit mark-up’) of a complete video game machine and of a PCB, on the one hand, and the purchase price paid by Avel or Sondo therefor on the other – namely, approximately 50% of the purchase price in the case of a complete machine, and 80% of the purchase price in the case of a PCB – represents the amount paid by Avel or Sondo for the public exhibition right in respect of the relevant video game, is, in the Tribunal’s opinion, a somewhat crude one, being based... solely on:
·a comparison with the cost of the ‘home consumer version’ of the relevant video game;
·his estimate of the approximate manufacturing cost of a complete machine and of a PCB;
·the fact that since 1997 suppliers of complete machines and PCBs to Avel and Sondo have specified in their invoices a separate amount to be paid for the public exhibition right in respect of the relevant video game.
In the Tribunal’s opinion those bases do not establish that Mr Steinberg’s abovementioned assertion is valid. As regards the first basis, the comparison between the unit cost of a complete coin-operated video game machine and the unit cost of the ‘home consumer version’ of the same video game is, in the Tribunal’s opinion, not a valid one for present purposes because a coin-operated machine intended for video arcade use and a ‘home consumer’ game intended for private use are, notwithstanding that they involve the same video game, substantially different products and the market for each is substantially different (the market for the former being very much smaller than the market for the latter...). The second abovementioned basis is, in the Tribunal’s opinion, flawed in that it focuses only on the ‘hardware’ manufacturing costs of complete machines and PCBs and does not take account of the associated research and development costs and ‘software’ costs or the relative popularity of the video game. Finally, the fact that suppliers have, since 1997, been specifying in their invoices a separate amount to be paid for the public exhibition right in respect of the relevant video game is, quite apart from the credibility of such specification and the circumstances which led to the commencement of that particular practice…, simply not to the point as regards the relevant sale/purchase transactions between overseas suppliers and Avel or Sondo which took place in the claim period …”
The respondent submitted that the opinion of the Tribunal and its reasons therefor, as expressed in that paragraph, have not been disturbed by the decision of the Full Federal Court in Avel and remain “entirely appropriate”.
Analysis and Findings
54. As stated by the Full Federal Court in Avel, the Tribunal’s present task is to calculate the amount to be allocated to the public exhibition right in respect of each relevant transaction “as best as [it can] on the evidence available”.
55. Section 95(2) of the Act mandates that the amount to be allocated to the public exhibition right, relevantly, is “the amount that could reasonably be expected to have been allocated to [it] if [it] had been the only subject matter of the transaction”. The expert evidence adduced before the Tribunal approached the calculation of that amount from entirely different angles: the “top-down” method (Mr Carter) versus the “relief from royalty” method (Mr Lonergan).
56. The Tribunal accepts, as submitted by the applicants, that s 95 of the Act is concerned with allocation, not valuation. Nevertheless, in the Tribunal’s opinion valuation evidence may clearly be relevant to a determination of “the amount that could reasonably be expected to have been allocated to [the relevant element] if that element had been the only subject matter of the transaction”. Indeed, the Tribunal notes that, to test the reasonableness of the conclusion determined by the application of his “top-down” methodology, Mr Carter himself undertook a “valuation” of the relevant element in accordance with what he considered to be prudent valuation principles.
57. The Tribunal does not accept the respondent’s submission that Mr Carter’s “top-down” approach in estimating the amount to be allocated to the public exhibition right is inappropriate. In this regard the Tribunal accepts the submissions made on behalf of the applicants that the operation of s 95(2) of the Act is “inherently purposive and inherently practical”, that the making of a judgment as to the amount to be allocated in accordance with s 95(2) “defies scientific precision” and is “ultimately to be approached as a matter of practical common sense”, and that Mr Carter’s “top-down” methodology “is anchored in the real transactions upon which s 95 (2) operates”.
58. In closing submissions, senior counsel for each party highlighted what he submitted to be flaws in the approach and analysis of the expert witness for the other party. Having carefully considered the evidence and submissions advanced on behalf of the parties, the Tribunal is of the opinion that the implementation of each of the 2 different methodologies adopted by the expert witnesses arguably contains flaws.
59. As regards the implementation of Mr Carter’s “top-down” methodology, the Tribunal notes, for example, the following arguable deficiencies:
·no direct information relating to the manufacturer’s actual costs was used by Mr Carter;
·Mr Carter adopted profit margins that were only estimates;
·no allowance was made by Mr Carter for the return to the manufacturer of research and development costs.
60. The Tribunal notes that one of the bases of the respondent’s criticism of the expert evidence of Mr Carter is that much of the accounting material provided to him by the applicants was based on internal management accounts, rather than audited accounts. The Tribunal, however, has reservations as to how useful audited accounts would have been having regard to the fact that such accounts are unlikely to have contained the detailed information found in the management accounts. In any event, the fact that audited accounts were not produced does not of itself provide a reason why the Tribunal should discount the weight to be given to Mr Carter’s evidence, particularly as there was nothing before the Tribunal to suggest that the management accounts upon which Mr Carter’s evidence was founded were unreliable.
61. As regards the implementation of Mr Lonergan’s “relief from royalty” methodology, the Tribunal observes, for example, that:
·Mr Lonergan’s proposition that if the public exhibition right was of material value it is likely that it would have been the subject of specific contractual terms and the payment for that right would have been separately specified, is mere conjecture and without evidential foundation;
·similarly, Mr Lonergan’s proposition that, from the manufacturers’ perspective, they would be unlikely to charge any material amount for public exhibition rights because part of their marketing strategy is normally to create brand awareness to facilitate the sale of other games (such as games for domestic consumers), appears to be speculation and lacking any evidential basis;
·likewise, Mr Lonergan’s statements that “non-commercial purchasers could reasonably have been expected to object to paying any material amount for public exhibition rights if they were not going to use them”, and “it is reasonable to expect that Sondo would have objected from a working capital perspective to having to pay any material amounts for public exhibition rights for PCBs in stock, in work in progress, in transit etc”, are merely conjectural.
62. Accordingly, although the Tribunal regards the expert evidence before it as instructive, in its opinion it is by no means determinative. In the Tribunal’s opinion, the appropriate amount to be allocated to the public exhibition right falls somewhere between the amount determined by Mr Lonergan and the amount determined by Mr Carter.
63. The Tribunal notes that the sole purpose of the goods the subject of the relevant transactions was for use in an arcade open to the public at which place members of the public, for a fee, play the video games. Put simply, the right publicly to display the cinematograph film embodied in the video game machines is an essential component of the relevant transactions. Indeed, given the purpose for which those goods were acquired, but for that right it is unlikely that the transactions would have been consummated at all. Accordingly, the Tribunal is of the opinion, having regard to the purpose for which the video game machines and PCBs were built, sold and acquired, that the right to display the cinematograph film in public was a very significant part of the relevant transactions.
64. The Tribunal concludes, therefore, that Mr Lonergan’s allocation of only 10% of the overall value of the intangible assets to the public exhibition right is substantially less than “the amount that could reasonably be expected to have been allocated to that element if that element had been the only subject matter of the transaction”, within the meaning of s 95(2) of the Act.
65. As has been noted, the applicants conceded that there is copyright in the set of instructions which constitute the computer programme, distinct from the copyright in the cinematograph film, and that a licence to use the computer programme must, as a matter of business efficacy, be implied into each contract of sale. The Tribunal considers that concession to have been rightly made. In making that concession, however, the applicants did not accept that any significant part of the global amount paid should be allocated to the grant of the licence to use the computer programme. The Tribunal disagrees. The goods acquired comprised both “hardware” and “software”. Mr Carter deducted from the total price various components referable to the “hardware”, but made no deduction for a return on the cost of developing the “software”, being the research and development costs previously referred to (no doubt as a result of the instructions he was given by the applicants’ (then) solicitors). In a way, it is the “software” that is the essential component of the game, with the “hardware” housing the software and facilitating the player’s access to the software. Accordingly, there is much to be said for the proposition that, in breaking down costs, a return on the “software” would be a significant item for the vendor. The Tribunal concludes, therefore, that the licence to use the computer programme is, like the public exhibition right, an essential ingredient of the overall transaction.
66. For the sake of completeness, the Tribunal notes that, in support of their submission that “[no] significant part of the global amount paid ought be allocated to the grant of the licence to use the computer program”, the applicants relied on two grounds. First, they submitted that the evidence established that the computer programme for use in a video game machine is only slightly different from the programme for use in what is commercially the same game sold to consumers for home use, yet there is a “huge difference” between the global prices paid for PCBs for the arcade versions of games and the retail prices paid for the equivalent home consumer version. Whereas the home consumer version allows the cinematograph film to be viewed (played) in private, the arcade version allows essentially the same game to be viewed (played) in public. It was said that it “accords with common sense to see that difference as attributable to the public exhibition right”.
67. The Tribunal does not accept this submission for the reasons set out in paragraph 58 of the Tribunal’s Reasons for Decision in Re Sondo (reproduced in paragraph 53 above). As submitted by the respondent, the opinion of the Tribunal and its reasons therefor, as expressed in that paragraph, have not been disturbed by the decision of the Full Federal Court in Avel and remain “entirely appropriate”.
68. The other ground relied on by the applicants was that, “for the reasons given orally by Mr Carter [TS 73], even though it may be theoretically possible to do so, it is inappropriate to separate out for valuation purposes the right to use the computer program from the right to benefit from the effect of the use of the program in public”. It was submitted that the “only relevant use of the computer program is to generate the cinematograph film that is the game and it is obviously the public exhibition of the game that is of significant value”.
69. Mr Carter’s oral evidence on this point was as follows (Transcript, p 73):
“Firstly, it was essential that I understand what it is that is being valued. I was instructed that the public exhibition rights were effectively indistinguishable from the software that drives the interactive experience. The changing image on the screen and the software that allows the player to change that image are indivisible, in other words. I would add that even if I had not been so instructed, I believe I would have come to the conclusion that the interactive software and the public exhibition right are indivisible in valuation terms because, as I understand it, the image on the screen is generated by the software. That it is impossible to have the image without the software driving that image.
It is a digital fact, if you like, that the image is generated by that software. So that without the software there is no image and without the image there is no way of playing the game. Ultimately, that leads to the conclusion that in my view they would be indivisible for the purposes of what I am trying to do in providing a valuation for the purpose of allocating a cost...”
It can thus be seen that Mr Carter does not say that it is “inappropriate” to separate out the two rights for valuation purposes. Rather, what he says supports the proposition that the two rights are indivisible in the sense that one cannot exist without the other, and is consistent with the view of the Tribunal that it is not appropriate to value one right more highly than the other.
70. It follows, in the Tribunal’s opinion, that the amount allocated by Mr Carter to the public exhibition right alone should be substantially reduced, and that, correspondingly, the amount so allocated by Mr Lonergan should be substantially increased.
71. As regards the competing approaches of the 2 expert witnesses, the Tribunal generally prefers Mr Carter’s practical approach to the allocation issue to the more academic and theoretical approach adopted by Mr Lonergan. Although neither is flawless, the Tribunal believes that the implementation of Mr Carter’s analysis, adjusted in accordance with these reasons, is more likely to result in a more reasonable “allocation” of an amount for the public exhibition right, for the purposes of s 95(2) of the Act, than the implementation of Mr Lonergan’s methodology.
72. Because of the nature of the matter to be determined, and the expert evidence adduced before the Tribunal, the precise extent of the reduction which should be made to Mr Carter’s allocation (or, for that matter, had it been considered to be the preferable approach, the precise extent of the increase to Mr Lonergan’s allocation) is problematic. The Tribunal, doing the best it can on the evidence available, is of the opinion that it is not appropriate to ascribe to the public exhibition right a quantifiable proportion of the global amount payable under the relevant transactions greater than that ascribed to the licence to use the computer programme. To do so would simply be speculative and arbitrary.
73. The Tribunal concludes, therefore, that the amount to be allocated to the public exhibition right is 50% of the amount determined by Mr Carter as specified in his report dated 21 September 2004 (Exhibit A5).
Application for Leave to Amend Particulars – Additional Transactions
74. In addition to the transactions the subject of the present applications for review, there are, so the Tribunal was informed by the applicants, other transactions the records of which were kept in files overlooked by the applicants at the time of their application to the respondent for a refund of sales tax. The applicants sought to include those transactions in their applications before the Tribunal. This took the form of an application to the Tribunal for leave to amend the particulars of the transactions before the Tribunal.
75. The respondent opposed the applicants’ application for leave, primarily on the basis of s 51(3) of the Act which provides:
“A claimant is not entitled to a credit unless the claim for the credit is lodged within three years after the time when the credit arises”.
According to the respondent’s submissions, ss 61 and 63 of the Act provide for monthly or quarterly returns to be lodged and payments to be made to the respondent within 21 days of the end of the period. Table 3 in Schedule 1 to the Act sets out the grounds for claiming a credit. It was common ground before the Tribunal that item CR1 in Table 3 is applicable, namely, “Claimant has paid an amount as tax that was not legally payable”. Table 3 provides that the time when the credit arises in respect of item CR1 is “when the amount became overpaid”, which, given the construction and operation of ss 61 and 63, must be at the latest on the 21st day after the end of the relevant period, or any earlier date on which payment was in fact made. The respondent submitted, therefore, that time commenced to run, at the latest, on the 21st day after the end of the quarter or month (depending on whether the taxpayer was a quarterly or monthly remitter) in which the taxable dealing took place. The respondent submitted that the last relevant quarter, the subject of the additional claims, was that ending 31 December 1997. Accordingly, the time for a claim in respect of that period expired in January 2001. As the first of the additional claims for credit was not raised until mid-2001, it, and those which followed, were lodged outside the 3-year limitation period referred to s 51(3) of the Act.
76. The applicants’ submission in reply was simply as follows:
“The answer is that the original claim in each case did not in form or in substance identify particular transactions. The claim identified a class of transactions by reference to:
· period;
· subject-matter; and
· basis of refund claim.
The additional transactions fall squarely within that class. Their consideration raises no new issues.”
77. The applicants’ applications for refunds were made to the respondent by letter dated 13 February 1998. Specific amounts were claimed by reference to specific transactions. Whilst the transactions were not particularised in the correspondence, the breakdown of the refund claims was so particularised, and the letter stated:
“The full details of the calculation of the amounts overpaid are available for your inspection, but essentially they have been calculated by applying a standard percentage to the taxable value returned.”
The letter went on to state:
“The total amount of the refund being claimed is based on an analysis conducted of the complete transactions for the period 1 June 1995 to 20 November 1997 (ie 30 months). The refund amounts determined from that period were then extrapolated for the entire period of the refund claim for the period 1 October 1994 to 30 November 1997 (ie 38 months)”.
Whilst it is therefore true that the original claim in each case did not identify particular transactions and merely identified a class of transactions by reference to the period, the subject-matter, and the basis of the refund claim, the truth is that the additional transactions now sought to be included were not in fact included in the “complete transactions” referred to in the letter dated 13 February 1998. Those transactions were not, in fact, the subject of the applicants’ original claim as, at the date of that claim, they were unknown to the applicants (the records of the same having been kept in files which were overlooked at the time of the refund application).
78. The Tribunal therefore concludes that, as a matter of fact, no claim for credit was lodged by the applicants with the respondent with respect to the additional transactions which the applicant now seeks to include, within 3 years after the time when the credit arose. As a consequence, s 51(3) of the Act operates to deny an entitlement on the part of the applicants to a credit for those transactions. For that reason, the applicants’ application for leave to include those additional transactions in the transactions that are before the Tribunal is refused.
79. Whilst that is sufficient to dispose of this aspect of the matter, the Tribunal notes that there is a further reason why the applicants’ application for leave should be refused, namely, that the additional transactions have not been the subject of any decision by the respondent. Accordingly, no reviewable objection decision in respect of the additional transactions has been made by the respondent within the meaning of s 14ZY of the Taxation Administration Act 1953 (Cth) and, accordingly, no right of review by the Tribunal exists pursuant to s 14ZZ of that Act.
80. Accordingly, the applicants’ application for leave to amend their particulars to include the abovementioned additional transactions in the transactions presently before the Tribunal is refused.
Decision
81. For the foregoing reasons the Tribunal sets aside the objection decisions dated 30 September 1999 and remits the matter to the respondent for reconsideration in accordance with the direction that each of the applicants is entitled to a credit under s 51(1) of the Act, the amount of which is to be determined on the basis that, pursuant to s 95(2) of the Act, the amount that is to be allocated to the public exhibition right in the relevant transactions is 50% of the value of the public exhibition right determined by Mr Carter as specified in his report dated 21 September 2004 (Exhibit A5).
I certify that the 81 preceding paragraphs are a true copy of the reasons for the decision herein of Deputy President S D Hotop and Senior Member S Penglis
Signed: .....................................................................................
AssociateDates of Hearing 10 and 11 August 2005
Date of Last Written Submissions 29 August 2005
Date of Decision 24 March 2006
Counsel for the Applicant Mr S Gageler SC
Solicitor for the Applicant Hicks Retallack
Counsel for the Respondent Mr K Martin QC and Ms C Thompson
Solicitor for the Respondent Australian Government Solicitor
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