Sondo Pty Ltd and Avel Pty Ltd and Deputy Commissioner of Taxation
[2003] AATA 168
•20 February 2003
Administrative
Appeals
Tribunal
DECISION AND REASONS FOR DECISION [2003] AATA 168
ADMINISTRATIVE APPEALS TRIBUNAL )
) No WT1999/124, 125
TAXATION APPEALS DIVISION ) Re SONDO PTY LTD and AVEL PTY LTD Applicant
And
DEPUTY COMMISSIONER OF TAXATION
Respondent
DECISION
Tribunal Associate Professor SD Hotop, Deputy President Date20 February 2003
PlacePerth
Decision The reviewable objection decisions, dated 30 September 1999, are affirmed.
….........(sgd S D Hotop)......................
Deputy President
CATCHWORDS
TAXATION – sales tax – claim of credit for overpaid sales tax – sales of coin-operated video game machines and printed circuit boards (“PCB”) – whether sale price for each video game machine or PCB included consideration for grant of licence publicly to exhibit cinematograph film – whether apportionment of global amount of sale price appropriate
Sales Tax Assessment Act 1992 ss16, 34, 36, 43, 51, 95, Sched 1, Table 1, Table 3
Taxation Administration Act 1952 s14ZZK
Acohs Pty Ltd v R A Bashford Consulting Pty Ltd (1997) 144 ALR 528
Galaxy Electronics Pty Ltd v Sega Enterprises Ltd (1997) 75 FCR 8
REASONS FOR DECISION
20 February 2003 Associate Professor SD Hotop, Deputy President INTRODUCTION
1. Sondo Pty Ltd (“Sondo”) and Avel Pty Ltd (“Avel”) have applied to the Tribunal for review of two decisions, dated 30 September 1999, made on behalf of the Deputy Commissioner of Taxation (‘the respondent”). Each of the two decisions under review was a decision to disallow an objection by Sondo or Avel (as the case may be), dated 8 January 1999, against a decision, dated 10 November 1998, made on behalf of the respondent disallowing its claim for a credit of a specified amount of sales tax paid by it 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”).
2. At the hearing the applicants, Sondo and Avel, were represented by Mr S Gageler of Senior Counsel, and the respondent was represented by Mr R Le Miere of Queen’s Counsel and Mr M Corboy of Counsel. The Tribunal had before it the statement and documents (“T documents”) lodged by the respondent pursuant to s37 of the Administrative Appeals Tribunal Act 1975, as modified by s14ZZF of the Taxation Administration Act 1952 (“the TA Act”), and 12 documentary exhibits (marked A1-A12) tendered by the applicants. Oral evidence was given by Malcolm Steinberg, Kevin Mennell, David Salt, Neil O’Sullivan and Douglas Thorp, who were called as witnesses by the applicants. No evidence was presented by the respondent.
The Factual Background
3. The relevant factual background, about which there is no dispute between the parties, is as follows.
4. Sondo is, and was at all material times, a wholly-owned subsidiary of Avel.
5. At all material times Avel carried on business as an operator and retailer of coin-operated video game machines (“video game machines”).
6. At all material times Sondo carried on business as a manufacturer of video game machines, and as a supplier of video game machines and component parts thereof - in particular, “printed circuit boards (“PCBs”) – to Avel exclusively.
7. Each video game machine included a PCB which contained within it the computer program which created the unique visual images, sound effects and movements of the relevant video game.
8. During the claim period Avel imported under quote from various suppliers video game machines which it then either:
(a) sold by retail; or
(b) applied to its own use in video game arcades which it operated.
9. During the claim period Sondo imported under quote from various suppliers component parts – in particular PCBs – of video game machines and either:
(a)manufactured or assembled the video game machines, including the abovementioned component parts, and sold them to Avel; or
(b) sold the abovementioned PCBs only to Avel.
10. It is common ground that:
(a)the sale of each video game machine by Sondo to Avel (referred to in subparagraph 9(a) above) was an “assessable dealing” and a “taxable dealing” under s16 of the Sales Tax Assessment Act 1992 (“the Assessment Act”): see s16 of that Act and item AD1a or AD2a in Table 1 in Schedule 1 to that Act;
(b)the sale of each PCB by Sondo to Avel (referred to in subparagraph 9(b) above) was an “assessable dealing” and a “taxable dealing” under s16 of the Assessment Act: see s16 of that Act and item AD11b or AD12b in Table 1 in Schedule 1 to that Act;
(c)the retail sale of each video game machine by Avel (referred to in subparagraph 8(a) above) was an “assessable dealing” and a “taxable dealing” under s16 of the Assessment Act: see s16 of that Act and item AD12b in Table 1 in Schedule 1 to that Act; and
(d)the application to its own use (“AOU”) of each video game machine by Avel (referred to in subparagraph 8(b) above) was an “assessable dealing” and a “taxable dealing” under s16 of the Assessment Act: see s16 of that Act and item AD13c in Table 1 in Schedule 1 to that Act.
11. In accordance with an agreement made under s43(1) of the Assessment Act between the respondent and Sondo, it was agreed that:
· the “taxable value” of each “taxable dealing”, referred to in subparagraph 10(a) above, comprising the sale of a video game machine by Sondo to Avel was Sondo’s cost of manufacture of the machine + 5%;
· the “taxable value” of each “taxable dealing”, referred to in subparagraph 10(b) above, comprising the sale of a PCB by Sondo to Avel was Sondo’s landed cost of the PCB + 5%.
12. In accordance with an agreement made under s43(1) of the Assessment Act between the respondent and Avel, it was agreed that:
· the “taxable value” of each “taxable dealing”, referred to in subparagraph 10(c) above, comprising the retail sale of a video game machine by Avel was Avel’s landed cost of the machine + 5%;
· the “taxable value” of each “taxable dealing”, referred to in subparagraph 10(d) above, comprising the AOU of a video game machine by Avel was Avel’s “into-store” cost of the machine + 5%.
13. It is also common ground, on the basis of the decision of the Full Federal Court in Galaxy Electronics Pty Ltd v Sega Enterprises Ltd (1997) 75 FCR 8, that the combination of visual images, sound effects and movements created by the relevant computer program embodied in each of the abovementioned video game machines and PCBs constituted a “cinematograph film” within the meaning, and for the purposes, of the Copyright Act 1968 and the Assessment Act, and that the owner of the copyright in each such “cinematograph film” was the relevant overseas supplier.
14. The amount of sales tax paid by Sondo in respect of its “taxable dealings”, referred to in subparagraphs 10(a) and 10(b) above, in the claim period was calculated on the basis that the “taxable value” of each of those “taxable dealings” was the total amount paid by Sondo to the relevant overseas supplier in respect of each PCB supplied (including freight and handling costs and customs duties), plus 5% of that amount.
15. The amount of sales tax paid by Avel in respect of its “taxable dealings”, referred to in subparagraphs 10(c) and 10(d) above, in the claim period was calculated on the basis that the “taxable value” of each of those “taxable dealings” was the total amount paid by Avel to the relevant overseas supplier in respect of each video game machine supplied (including freight and handling costs and customs duties), plus 5% of that amount.
16. On 13 February 1998 a claim was made, on behalf of the applicants, to the respondent for a refund of part of the amount of sales tax paid by each of the applicants in respect of the abovementioned “taxable dealings” which occurred in the claim period. Each such claim was made pursuant to s51 of the Assessment Act and relied on credit ground CR1 in Table 3 in Schedule 1 to that Act, namely, “Claimant has paid an amount as tax that was not legally payable”.
17. On 10 November 1998 the respondent disallowed the applicants’ abovementioned claim for a refund of sales tax.
18. On 11 January 1999 a “Notice of Objection to Refund Decision Dated 10 November 1998” was lodged, on behalf of the applicants, with the respondent.
19. On 30 September 1999 the respondent made an “objection decision” under s14ZY of the TA Act disallowing the applicants’ “taxation objection”.
20. On 20 November 1999 an application was lodged, on behalf of each of the applicants, with the Tribunal for a review of the respondent’s objection decision regarding each applicant.
The Relevant Legislation
21. Section 16 of the Assessment Act sets out the general rules for taxing “assessable dealings”. The expression “assessable dealing” is defined in s5 of the Assessment Act to mean “any dealing covered by Table 1” – that is, Table 1 in Schedule 1 to that Act. Section 16(1) provides:
“Table 1 sets out all the assessable dealings that can be subject to sales tax”.
Pursuant to s16(2) of the Assessment Act, an “assessable dealing”, for which no exemption is available under Div 2 of Pt 3 of that Act, is a “taxable dealing” (see also the definition of “taxable dealing” in s5 of that Act). Section 34 of the Assessment Act, which refers to the method of calculating the “taxable value” of a “taxable dealing”, relevantly provides:
“(1) The general rules for calculating the taxable value are set out in Table 1.
(2)In some cases, amounts must be added to the amount set out in Table 1. These additions are set out in Subdivision B of this Division.
…”.
Subdivision B of the relevant Division (Div 3) of the Assessment Act, which is headed “Additions to taxable value”, contains inter alia, section 36 which provides:
“(1) If a royalty is paid or payable, or likely to be paid or payable, in connection with any of the following events in respect of particular goods:
(a) …
(b) …
(c) a sale of the goods;
(d) …
(e) …
then the taxable value of any taxable dealing with those goods that happens at or after that event includes the amount or value of the royalty.
(2) In this section:
“royalty” means any amount to the extent to which it is paid or payable (whether or not periodically) as consideration for any of the following things (or for the right to do them):
(a)doing anything that would be an infringement of copyright if it were done without the licence of the copyright owner, but not including any of the following:
(i)…
(ii)…
(iii)…
(iv)…
(v)causing a cinematograph film to be seen in public;
(vi)…
…
Terms used in paragraph (a) of this definition have the same meaning as in the Copyright Act 1968”.
Section 43 of the Assessment Act provides:
“(1) The Commissioner may enter into an agreement with a taxpayer about calculating the taxable values of particular taxable dealings.
(2)So far as the agreement is inconsistent with this Act, the agreement prevails”.
Section 51 of the Assessment Act relevantly provides:
“(1) Tables 3 and 3A set out the situations in which a claimant is entitled to a credit.
….
(3)A claimant is not entitled to a credit unless the claim for the credit is lodged within 3 years after the time when the credit arises.
(4)A claim for a credit must be made in the form and manner approved by the Commissioner, and must be accompanied by such supporting evidence as the Commissioner requires”.
Division 3 of Pt 8 of the Assessment Act contains s95 which provides for the “apportionment of global amounts” 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.”
Table 1 in Schedule 1 to the Assessment Act contains the following relevant items:
“Table 1: Assessable dealings
Part A : Australian goods [1] No. [2] Assessable dealing [3] Person liable [4] Time of dealing [5] Normal taxable value AD1a wholesale sale by a person who manufactured the goods in the course of any business seller time of sale the price (excluding sales tax) for which the goods were sold … … … … … AD2a retail sale by a person who manufactured the goods in the course of any business seller time of sale the notional wholesale selling price … … … … …
Part B : Imported goods [1] No. [2] Assessable dealing [3] Person liable [4] Time of dealing [5] Normal taxable value … … … … … AD11b wholesale sale by any person seller time of sale the price (excluding sales tax) for which the goods were sold AD12b retail sale by a person who obtained the goods under quote; excludes case covered by AD12d seller time of sale the notional wholesale selling price … … … … … AD13c AOU by a person who obtained the goods under quote applier time of AOU (a) if the goods were purchased under quote: the purchase price;
(b) if the goods were locally entered under quote by the applier: 120% of (customs value + customs duty)… … … … … Notes:
1. …
2. In Table 1:
….
“notional wholesale selling price” means the price (excluding sales tax) for which the taxpayer could reasonably have been expected to sell the goods by wholesale under an arm’s length transaction.
3. …”.
In s5 of the Assessment Act “AOU” is defined to mean “application to own use”. Section 5 also contains a definition of the phrase “obtain goods under quote” but it is not necessary to set out that definition here. Table 3 in Schedule 1 to the Assessment Act contains the following relevant item:
“Table 3: Credit grounds
[1] No. [2] Summary of ground [3] Details of ground [4] Amount of credit [5] Time credit arises CR1 Tax overpaid Claimant has paid an amount as tax that was not legally payable. the amount overpaid, to the extent that the claimant has not passed it on when the amount became overpaid …”.
22. Division 4 of Pt IVC of the TA Act contains various provisions relating to review by the Tribunal of objection decisions. Most notably, for present purposes, s14ZZK provides:
“On an application for review of a reviewable objection decision:
(a)the applicant is, unless the Tribunal orders otherwise, limited to the grounds stated in the taxation objection to which the decision relates; and
(b)the applicant has the burden of proving that:
(i)if the taxation decision concerned is an assessment (other than a franking assessment) – the assessment is excessive; or
(ii)if the taxation decision concerned is a franking assessment – the assessment is incorrect; or
(iii)in any other case – the taxation decision concerned should not have been made or should have been made differently.”
The Applicants’ Case
23. The applicants’ case comprised the oral evidence and witness statements of Malcolm Steinberg, Kevin Mennell, David Salt, Neil O’Sullivan and Douglas Thorp, together with 6 additional documentary exhibits.
The evidence of Malcolm Steinberg
24. Mr Steinberg confirmed that he had prepared and signed a witness statement dated 16 August 2001 and a supplementary witness statement dated 23 April 2002 and that the factual contents of those statements are, to the best of his knowledge, true and correct and that the opinions expressed in those statements are held by him.
25. The contents of Mr Steinberg’s witness statement of 16 August 2001 (Exhibit A3), not including the annexures thereto, are as follows:
“1.I set up the business trading as Leisure & Allied Industries (‘LAI’) in 1958 and I have been a director and chief executive officer of the company carrying on the business since then. As chief executive officer I have had overall responsibility for all of the company’s operations.
2.LAI’s operations have for many years been separated into two divisions. The manufacturing division has been run by the subsidiary company Sondo Pty Ltd. The operation of the Timezone outlets and the retail sales of amusement machines, has been done through Sondo’s parent company, Avel Pty Ltd. I am a director of Sondo Pty Ltd and Avel Pty Ltd.
3.Amusement machines which are designed for commercial use in an arcade are called coin operated machines, because they come with a coin operated mechanism to take payment from the arcade patron.. Coin operated game machines are much more expensive to buy than the same game packaged and sold to a home consumer.
4.Generally speaking a coin operated machine has slightly more software compared to a consumer product. This is because the coin operated machine has to allow for the coin operated mechanism and also because the coin operated machines only run for a few minutes so the software is different to limit the duration of the game. However from the consumer’s point of view it is the same game.
5.An example is import file 174 which relates to the import of Judge Dredd kits from Acclaim in the UK. Annexed hereto and marked ‘MS1’ is a bundle of correspondence from import file 174. Acclaim’s fax dated 8 September 1997 sets out the contents of the kit, being the PCB plus various accessories such as guns and holsters and decals. We agreed to pay 995 GBP for this kit (see the invoice from Acclaim dated 23 December 1997). My memorandum of 19 December 1997 shows that this game was released at the same time into the consumer market at a price of around $150 AUD, whereas we were paying around $2500 AUD for what is the same product. Our facsimile of 22 December 1997 and Acclaim’s reply facsimile of 22 December 1997 set out our concern at the effect of the consumer game on our market, and Acclaim’s response to that concern.
6.As appears from my memorandum of 19 December 1997, Sondo could have gone out and purchased the Judge Dredd home consumer product, installed it in a hard drive, manufactured a cabinet around it, sold it to Avel and put it in an arcade. This would have been considerably cheaper than paying Acclaim for the manufacturing kit, but it would also have been a breach of copyright and Avel would have been sued for it.
7.Another example which is around at the moment is a Sega game called Virtua Tennis. The same game is sold to home consumers in Australia under the name Dreamcast System for around $99 AUD, which is the software cost, plus around $199 - $299 for the software player. Sondo could purchase the home consumer product and a unique inter face PCB off a manufacturer in Taiwan which would convert the home consumer product into a coin operated game and this costs only a few hundred dollars. If Sondo did this it would have the Virtua Tennis game and Avel could put it in an arcade and the arcade patrons would not know the difference. The Virtua Tennis manufacturing kit sells to us for about US$2200 so Avel would save several thousands of dollars by doing it this way. However it would be a breach of copyright and Avel can not do it. Attached hereto and marked ‘MS2’ is a copy of an invoice from Village to LAI for $5,850 for a Virtua Tennis PCB Kit. This cost includes some element of retail profit for Village, which had imported the kit into Australia, and I would expect they paid around US$2200 for the kit themselves.
8.Another example is the game Killer Instinct. This game was actually purchased by us from Midway Pty Ltd which had obtained the licence to manufacture and sell the game for coin operated use. The home consumer game was licensed to Nintendo. Williams and Midway are the same entity. Killer Instinct is still available both as a consumer product and a coin operated machine (though not in new condition). The cost of manufacture of the home consumer version is considerably higher because it needs twenty or thirty hours of game play whereas in a coin operated machine the arcade patron only gets about two or three minutes of game time. So it doesn’t need as much of the software programme in the coin operated machine as for the home consumer version. The home consumer version is actually more expensive to manufacture but it is the same game. The coin operated machine sells for around $2,700. Attached hereto and marked ‘MS3’ are invoices dated 21/2/96 (taken from import file no 324), 27/3/96 (taken from import file no 55) and 28/10/94 (taken from import file no 318, which is for a complete game) showing the average cost to LAI of purchasing these games is around $2,700 for the kit or $5,200 for a complete game. The home consumer version of Killer Instinct sells for around $45.00. Attached hereto and marked ‘MS4’ is a letter from Nintendo to LAI dated 14 September 1999.
9.The invoice from import file no 318 is particularly interesting because the purchase order and invoice both show a breakdown of the software component of this price. This software cost was probably determined for the purposes of the TACP [Tax Advantage Computer Program] exemption which then existed, but it shows that we were separately identifying the software component cost even back in 1994.
10.I have examined the particulars of paragraphs 6 and 17, and the particulars of paragraphs 28 and 29 of the Sondo Statement of Facts, and the particulars of paragraphs 4 and 15 of the Avel Statement of Facts. Of the games listed in those particulars, the following specific games have both a consumer version and a coin operated version:
(a)Tekken;
(b)Dayton USA;
(c)Killer Instinct;
(d)Time Crisis;
(e)Golden Tee Golf;
(f)Die Hard;
(g)Mortal Kombat;
(h)NBA Hang Time;
(i)Rampage World Tour;
(j)Virtua Fighter.
11.New games or games which have just come onto the market are promoted to arcade operators and other interested buyers at trade sales which are held in Japan and the USA twice each year. I would go to these trade sales and look at the various new games that were available and pick out the ones that were of interest to me. I would then negotiate with the game supplier’s representative at the trade sale for the terms of our supply. Because the negotiations were almost always verbal, I kept no notes and there is not always correspondence which sets out the negotiations. If there were any notes, these would have been thrown out once the Exclusive Distribution Agreement (‘EDA’) was signed.
12.I always attempted to negotiate with a supplier on the basis that we would only take a new game from them if they granted an EDA for Australia and New Zealand to Avel Pty Ltd. The importance of the EDA to LAI was that it provided exclusivity and the ability to enforce copyright in the particular territory, ie to prevent competitors using or selling the particular game. As an example, I refer to correspondence which appears in the ‘Documents upon which the Applicant intends to rely’ (‘Bundle’) [Exhibit A5] as follows:
(1)extracts from file 33/34, facsimile from LAI dated 5 April 1995;
(2)extracts from file 47/48, facsimiles from LAI dated 4 and 5 December 1995; and
(3)extracts from file 199, particularly facsimile from LAI dated 8 June 1996.
13.In my negotiations with the game supplier’s representative I would negotiate over any premium to be paid for an EDA and the unit cost of the games. Negotiations for the EDA and the unit cost per game were carried on at the same time even though the EDA did not ever mention the price for each game. I would attempt to reach agreement with the game supplier’s representative at the trade sale and it would all be documented later when the EDA was drafted and signed by all the parties.
14.I would always attempt to use the premium payable for an EDA to reduce the unit cost for each game. For instance, the game supplier might want to supply us with one hundred units at $1,000 per unit. I would attempt to negotiate an EDA and haggle over a premium. Let’s say we agreed on a premium of $25,000 for the EDA. I would then bargain on the basis that we would pay only $750 per unit on the basis that we would take one hundred units then the game supplier would receive in total the same amount, that is $100,000. Sometimes the EDA would be drafted on the basis that we would have to take these minimum quantities. The advantage to us of doing it like this was if we took more than one hundred units then we would be paying significantly less per unit than the game supplier’s original asking price. So in the example given above, if we ended up taking two hundred units at $750 per unit then we would pay a total of $150,000 for the units, $25,000 premium for the EDA, giving a total of $175,000. This is a saving of $25,000 overall compared to the game supplier’s original price of $1,000 per unit.
15.So I would attempt to use the premium paid on an EDA to reduce our cost per unit. Also I would attempt to structure the EDA so that there was no maximum number of games so if the game was popular and Avel ended up taking more than the number which formed the basis of the negotiation then it was in front.
16.In effect, this negotiation was an allocation of risk based on my judgment as to how many games the market could bear. In the long run, my judgment was more often right than wrong and I believe Avel saved considerably by structuring its EDA’s in this way.
17.Generally speaking, the game supplier would only give Avel exclusivity if it took a fixed quantity or paid a fee upfront.
18.For many EDA’s there is no premium or even a minimum quantity. This would reflect the bargaining position Avel had relative to the game supplier. Some of the lesser known game suppliers needed Avel to get their game out into the market because Avel had an extensive network of Timezone outlets. I knew this and I would have the upper hand in the negotiations and would rarely if ever agree to pay a premium to the lesser known suppliers for these games. The major suppliers, like Sega, knew that they could get their product into the market through any number of arcade operators and therefore knew that they could charge a premium. So the terms of the EDA’s just reflect this difference in bargaining power between me and the game supplier.
19.Once the basis of the agreement had been concluded at the trade sale then the EDA was signed up later. After the EDA was signed up then Avel or Sondo would issue a purchase order and import the goods. The game suppliers always knew that Sondo was a manufacturing subsidiary of LAI, and regarded the terms of the agreements made with Avel as applying to purchase orders issued by Sondo. Sondo always regarded itself as bound by the terms of any EDA concluded with Avel. This understanding is set out in the extracts from the following files in the Bundle:
(1)File 363, particularly LAI’s facsimile of 16 June 1995;
(2)File 134, the minutes of meeting on 24 March 1997;
(3)File 79, LAI’s facsimile of 3 October 1996; and
(4)File 38, LAI’s facsimile of 18 October 1995.
20.Generally speaking LAI would get a test machine to assess, usually before the trade show. The performance of the test machine was used to assess how many machines to take and what price to pay for them. Annexure MS1 includes the Daily Test Game Tracking sheets for the Judge Dredd game.
21.The other thing done before entering an EDA was an assessment whether to buy complete machines or to simply buy the manufacturing kit and manufacture the remainder of the machine through Sondo. The game suppliers would usually offer a new game either as a complete machine which was ready to be put into the arcade, or as a kit containing the essential components of the game from which Sondo would then manufacture the cabinet for installation in the arcade. Sondo’s engineers would always assess the cost of manufacture of the cabinet and add to that the cost of the kit. If this was less than the landed costs of the complete machine then Sondo would manufacture the machine itself by buying the kit from the game supplier. I would make this assessment on every occasion I considered a new game, provided that the quantity of games to be manufactured would justify it. An example of this is in the Bundle being extracts from file 58, particularly LAI’s facsimile of 2 January 1996. Generally speaking, I would not bother attempting to manufacture three or four machines of a particular game because it was just not worth it, but if Sondo could manufacture thirty or forty then it was probably worth it.
22.From the game supplier’s point of view, they would have a price for the complete machine and another price for the manufacturing kit. The difference between these two was usually roughly the cost of manufacture of the machine.
23.A manufacturing kit consisted mainly of the PCB which contained the software that made the game unique. For instance, the manufacturing kit for a game from Sega would probably cost about $10,000. But the cost of producing a PCB was only a few hundred dollars. I know this because Sondo has often made PCBs itself, not in-house, but through manufacturers either in Perth or overseas in Taiwan.
24.The manufacturing kit supplied by the game supplier would also often include unique things like plastic mouldings for placing on the cabinet (see for example annexure MS1, facsimile from Acclaim dated 8 September 1997). Sondo’s engineers would assess whether it was cheaper to buy these plastic mouldings from the game supplier, or to manufacture them itself. This in turn would depend on how many Sondo was making. Things such as plastic mouldings, or steering mechanisms, were pretty easy to make but it was a question of how many Sondo wanted to make and at what cost, compared to the cost that the game supplier would charge.. The game supplier could generally do it cheaply because they were doing a large run and could take advantage of economies of scale.
25.Within a manufacturing kit, the only truly unique thing was the PCB. This contained the software which made the game unique. I estimate that the actual cost of manufacture of a completed game including manufacturer’s profit was about 50% of what Avel agreed to pay, and the actual cost of manufacture of a PCB was less than 20% of what Sondo agreed to pay. With manufacturer’s profit the PCB cost would still be less than 20% of what Sondo agreed to pay for a PCB. Over and above the actual cost of manufacture of the goods, the remaining portion of the payment was for the right to show or exhibit the game in the arcade. These figures are based on a comparison of what the home consumer version of the game costs, what we know to be the approximate cost to manufacture the PCB or the Complete Game, and from that fact that the game suppliers have accepted a component of software/intellectual property cost in this range from around 1994 (when the issue was TACP) and since 1997 (when the issue has been the exhibition rights, examples of which are attached and marked ‘MS5’). Although this was never discussed in detail between me and the game suppliers, because they would never disclose the breakdown of their costs this was always understood between ourselves and the game supplier.
26.I have recently negotiated a contract with a US manufacturer called Benchmark. They were proposing to sell us a complete machine to be used for exhibition purposes at a price of around $3,000. I negotiated with Benchmark to manufacture the whole machine and pay Benchmark a licensing fee of around about $1,000 per completed machine. That is, Benchmark would be paid a fee per game manufactured and in return they would supply us with a bill of materials and all of the software that was needed to make the game.
27.The negotiation ultimately fell through, though for other reasons. However it illustrates that within each manufacturing kit or completed game, there is in effect a fee being paid to the game supplier for the commercial showing of the game. Attached and marked ‘MS6’ are copies of my emails to and from Benchmark in relation to this negotiation. These are all of the documents I have in relation to this negotiation.
28.Another example of this is in the Bundle, File 21 which shows that Kyle Hodgetts (the owner of this game) was prepared to allow us to build the games in Australia and simply pay him a lump sum royalty for each game.
29.I have always understood that the rights to show the game are actually in the price for the PCB supplied by the game supplier in the manufacturing kit or the completed machine. The PCB is what contains the unique software that makes the game different. I have always understood from my negotiations with the game suppliers that by buying the machine, LAI would get the right to show the game to the public and to earn revenue from it. This was taken for granted so it was not expressly discussed and spelt out with the game supplier. But it was obvious and understood from the facts that I was interested in acquiring the machine with a coin operated mechanism, that I was in the business of operating arcades and from the quantities of machines that I would take and what the suppliers knew about my business.
30.As a result of my various negotiations with the game suppliers I believe I have an understanding of what motivates them in the negotiation process. Although they would never disclose their profit margins to me, my understanding is that the game suppliers have a hardware cost, which is the cost of making the cabinet or the PCB. They also have a software development cost which is generally amortised over the number of units that they expect to sell. They have a profit margin in addition. Generally speaking, the big game suppliers like Sega had fixed margins and they were very hard to negotiate with over price. From their perspective, the coin operated version of the game was a much smaller part of the overall market than the consumer game. For instance, as at 1997, Sega might sell three million games for consumer use and if they are charging $20 or $30 mark up or profit on each game then that is $60 million or $90 million. The market as at 1997 for coin operated versions of the same game was smaller and Sega might only sell ten thousand versions of the coin operated game. So if their mark up or profit for each coin operated game is $2,000 or $3,000 then their total profit from the coin operated game is $20 million or $30 million. This is how they see the market. They build the consideration for the right to commercial exploitation of the game into the unit purchase price because that is the simplest and easiest way to collect it.
31.Of the game suppliers that we dealt with during the period of this claim, the only ones who we are still dealing with are Namco (on a small basis only, we don’t buy much) and Konami (rarely use these people and now deal with their UK office and not the Japan office). The game suppliers will not cooperate with us and provide details of the cost of manufacture of their PCBs or manufacturing kits. Some years ago, Avel had a copyright case run in conjunction with Sega to establish copyright to one of the games. Sega were extremely unhelpful even though we were on the same side and would not make witnesses available or send them to Australia to give evidence. The game suppliers are not interested in helping when they have absolutely nothing in it for themselves.
32.I have attempted to contact a former employee of Sega to assist in providing evidence to support this case. Although this lady was initially co-operative, once I explained that I would like a statement from her to be used in Court she stopped returning my calls and emails.
33.As far as I am aware, none of the game suppliers have offices in Australia. Sega had a joint venture known as Sega Ozi Soft which had some representation in Australia in relation to consumer products. But it is not the same entity as the game supplier that we dealt with.
34.I recall that several years ago Village Roadshow had a joint venture with Sega to distribute Sega’s products in Australia. I recall seeing a breakdown of their costs of importing a game which showed the sales tax as being much lower than what we paid. This made us look at our sales tax which led to the realisation that we were paying sales tax on the value of the cinematographic rights.
35.The payment for the cinematograph right as part of the price of each PCB or machine is necessary because it is nearly impossible for the game developer to know how often the game is played, so the game developer cannot charge a royalty per game. This means that the only way the game developer can extract payment for the cinematographic exhibition right is in the form of an amount on sale of the PCB or complete machine. However, there is a business in the USA which is allowing people to play various games on its website and charging a small royalty per game, approximately 10¢. The name of this business is PrizeGames.com. Attached and marked ‘MS8’ is a printout of its performance figures since June 2000, showing the increase in revenues. The significance of this is that it shows that the game developer is aiming to recover a royalty in relation to each game and would do so on a ‘per play’ basis if it could, but with the technology that existed between 1994 and 1997 this was not possible so a lump sum payment was necessary. This lump sum payment was included in the price of the game.
36.Recently LAI in Indonesia developed a game suitable for playing on its website (called mataharigames.com). The name of the game is Police Trainer and it has been very successful. LAI is now developing this game as a coin operated version for arcade use and expects to sell this game for around $3000 USD. We expect to be able to sell 3000 – 5000 games throughout the world and generate gross income of USD $900,000 - $1,500,000. The cost to develop this game was only $10,000 USD, which is insignificant compared to the gross revenue. This illustrates that the software development cost is and has been a very small or insignificant part of the cost of each new game. This is the reason that I now think that the 20% estimate referred to in paragraph 25 above is conservative.”
26. The contents of Mr Steinberg’s supplementary witness statement of 23 April 2002 (Exhibit A4), not including the annexures thereto, are as follows:
“1.This statement is supplementary to my witness statement dated 16 August 2001.
EDA Negotiations
2.In general, I would attempt to negotiate an Exclusive Distribution Agreement (‘EDA’) with a supplier where I thought that the game was going to be a good game and profitable. The primary thing that I was interested in is exclusivity, or exclusive distribution rights to the product, and to be in a position to prevent parallel importation (by other distributors of the same game). The practical way to prevent parallel importation was by being given the ability to enforce various intellectual property rights in the game, such as trademarks and copyright.
3.Whether or not I obtained an EDA in relation to a particular game depended on a few things. If I only wanted to put the game into our own arcades (the Timezone arcades) and was not particularly interested in selling it to other arcade operators in Australia, then I may not bother with an EDA. However if I thought that it was a good game and I wanted to market it and distribute it through my distribution channels and sell it to rival arcade game operators, then I would try and get exclusivity in relation to that game.
4.The EDAs are specific to each game and if the game is not specified in an EDA then that game is not covered by the EDA. For instance, if a game was successful then the supplier would usually attempt to produce a subsequent game which was a derivative of the original and this might be called a ‘Twin’ (which would mean that two players could play the game at once) or it might be given initials like ‘DX’ or something similar. The ‘Twin’ and ‘DX’ games were different to the original and were created after the original. Just because Avel may have had an EDA for the original game would not necessarily mean Avel has an EDA for the ‘Twin’ or the ‘DX’ version.
Namco
5.I refer to the Namco EDA dated 1 November 1992 (Avel T docs page 40).
6.This EDA relates to the Final Lap III game, which I remember. I signed this agreement and it was signed by Namco’s sales manager but I cannot remember who this was. I cannot now remember any of the negotiations for this agreement but I note the following things.
7.Namco had their own agreements. Most suppliers would accept the agreement that Avel put forward, but Namco was one of those which would not.
8.The key purpose of this agreement was to create exclusivity for Avel. The key clause was Clause 1(g) and that was the main issue for Avel.
9.Clause 1(a) gave Avel the right to first publish the game which gave it exclusivity. If someone else had first published the game then Avel would not be able to be the exclusive distributor of it.
10.Clause 1(b) is simply there to cover the situation where Namco is not also the registered copyright owner. This clause assures Avel that Namco owned the copyright and were able to give Avel the exclusivity that I wanted.
11.I note that there is a breakdown for the payments made under this EDA and some of that breakdown is attributable to the exclusivity clause and the trademark. The payment made in respect of copyright was really to enforce the copyright which Avel needed in conjunction with exclusivity.
12.I refer to the Namco EDA dated 20 February 1995 (Avel T docs page 57).
13.I note that this EDA is for the Point Blank game. This EDA was signed by Eddie Cochrane but I do not recognise who signed on behalf of Namco. Although the EDA was signed by Cochrane, I negotiated all of the EDAs and Cochrane only signed for me if I was unavailable.
14.I note that the payments for the specific rights under this EDA total $12,000. The rights are broken down to round percentages, for instance the right for clause 2 is 10% of the total; the right for clause 5.1 is 40% of the total, etc. I cannot now recall the negotiations or the reasoning behind this apportionment. I know that the amounts specified in this EDA are lower, for instance, than for the Cybercycles EDA dated 25 March 1995. From this I infer that this game must have had a lower potential then Cybercycles. I note that there was an addendum to this game, and it was common to extend the term of an EDA if the game was popular. The extension fee of $25,000 is not broken up amongst the different rights.
15.The total payment made by Avel to Namco under this EDA is $12,000. The sole purpose of this payment (and all payments specified in any EDA) is to obtain exclusivity for that game and to be given the power to prevent parallel imports.
16.I refer to the Namco EDA dated 25 March 1995 (Avel T docs page 66).
17.This EDA relates to the game Cybercyles. I cannot now remember any negotiations for this agreement. I note that there is a breakdown of what each payment was for under the EDA and that an amount of $15,000 was attributable to the copyright.
18.I refer to the Namco EDA dated 2 January 1996 (Avel T docs page 106).
19.I note that this EDA is with Namco America which is a different corporation to Namco Japan. I signed this EDA and I recognise the name of the person who signed on behalf of Namco although I don’t now recall why that person was involved in signing the agreement on behalf of Namco. I don’t remember negotiating this agreement or any of the background to this negotiation. I recall that the game Time Crisis, which is the subject of this EDA, was a pretty hot game and I note that Avel paid $150,000 for these exclusive rights.
20.I refer to the Namco EDA dated 1 November 1996 (Avel T docs page 178).
21.I note that this is an EDA with Namco America, that it is in a different format and that it covers the games Tokyo Wars, Aqua Jet and Alpine Racer II. I signed this agreement.
22.I note that this game provides Avel with the right to enforce copyright but specifies that Namco America is the owner of all copyright. This was consistent throughout the agreements where the supplier always retained the copyright but gave Avel the right to enforce the copyright so as to protect its exclusivity.
23.I refer the Namco EDA dated 14 March 1997 (Avel T docs page 216).
24.This EDA is with Namco Japan and it is signed by Eddie Cochrane. The game was for Tekken III PCB kits. Tekken III was a good popular game. I note that Avel did not pay a significant amount of money for this distributorship.
25.I note the agreement covers both new and used games. I recall that the reason for this was that there was a court decision in Japan which said that copyright applied to products sold both new or used and this clause was inserted to clarify that position. I note that the term of the agreement was 1 year but it was liable to be extended. I cannot recall now any other details of this negotiation or this agreement.
26.I refer to the copy of transaction files 33 and 34, which are annexed hereto and marked ‘MS9’.
27.These files relate to the importation of ‘Cybercyles’ production kits. These parts were for components to put into games to be built in Australia by Sondo and sold to Avel as complete machines.
28.I was not directly involved in the importation of these units. I did not get involved in this level of detail and I left the importation arrangements for Eddie Cochrane who was in charge of that aspect of the business. However on reviewing the file, I note the imports were from Namco USA company. I cannot recall any other details relating to this transaction but it appears to be a typical transaction.
29.I refer to the copy of transaction file 81, which is annexed hereto and marked ‘MS10’.
30.This file relates to the importation of ‘Time Crisis’ PCBs which were sold by Sondo to Avel. I cannot recall any details regarding this transaction but it appears to be a typical transaction.
31.I refer to the copy of transaction file 82, which is annexed hereto and marked ‘MS11’.
32.This file relates to the importation by Avel to ‘Tokyo Wars DX’ complete machines. There are a relatively small number of games the subject of this transaction and I would assume that these were samples. It was common for Avel to bring in samples of the games to try out in the market before deciding whether or not to manufacture them and for technical reasons to assist in the ultimate manufacture of the games. I note that Avel paid US$50,000 for the supply of one machine. I cannot recall any details regarding this transaction but it appears to be a typical transaction
33.I refer to the copy of transaction file 200, which is annexed hereto and marked ‘MS12’.
34.This file relates to the importation by Avel of ‘Prop Cycle’ complete machines. I note that these were complete machines. Avel appears to have paid a relatively good price for the supply of these machines which indicates that there may have been a close-out – Namco would have had some inventory that Avel bought at a good price to help them clear stock. I cannot recall any details regarding this transaction but it appears to be a typical transaction.
35.I recall now that when ‘Prop Cycle’ was released, Namco was under pressure from our competitors in Australia not to grant exclusivity to any one distributor. When this game was released, Namco succumbed to that pressure and decided that it would not grant exclusivity to Avel or to anyone else in relation to this game. I recall that I was very annoyed with this at the time and told Namco that their plan would not work. I was right. Our competitors in Australia did not take as many games from Namco as they promised they would and Namco ended up not selling as many games as they would have sold if they had granted exclusivity to Avel. Namco got stuck with games they could not sell and it looks like Avel bought them at a cheap price and cleaned them out.
36.I refer to Annexure MS5 at page 34 of my previous statement, being an invoice dated 23 March 1998 from Namco.
37.This invoice related to the Final Furlong game and I note that the price of the exhibition rights is approximately 63% of the price of the kit. I recall that the kit for this game was a lot more involved than most kits because it included plastic horses and stands for those horses. These items of hardware would have decreased the proportion of the price for the exhibition rights relative to the price of the kit.
38.I do not now recall negotiating with Namco the price of the exhibition rights for this game. The way I negotiated the amount for these exhibition rights was as follows. I went to one supplier, the name of which I cannot now remember, and I explained to them that Avel wanted to separately specify the price of the exhibition rights in the invoice because this amount was tax-free. I negotiated with that supplier the breakdown of 50% and 80% which they agreed to. I then went to later suppliers and used that as a starting point. Most of the subsequent suppliers agreed to a similar breakdown though some of them thought that the amount wasn’t right so we changed it. Subsequently I did this negotiation game-by-game with each supplier but generally once the suppliers had accepted the principle then they tended to adopt similar prices to whatever they had agreed previously.
39.I refer the Annexure MS5 at page 37, being an invoice dated 10 March 1999 from Namco.
40.I note that the complete machine purchase shows the price for the exhibition right at 60% of the total. This is a bit higher than normal but it was obviously agreed by the supplier. I note that this invoice includes Final Furlong kits and the Final Furlong kit price shows 80% for the price of the exhibition right. This is higher than the other Final Furlong invoice (at page 34 of MS5), which I cannot now explain. Perhaps it was because it was a one-off or perhaps it was because it just slipped through without being picked-up.
Sega
41.I refer to the Sega EDA dated 25 August 1994 (Avel T docs page 44).
42.This EDA relates to the Daytona Twin game which was a very big game. There should be addendums to this game because it was extended a couple to times. I remember negotiating parts of this agreement. The agreement was signed by Eddie Cochrane on my behalf. I remember dealing with a different Sega representative than the one who signed this agreement. I think the name of the person I dealt with was Yamaguchi. The negotiations were done in Japan though the agreement was probably signed some time later by me and by Cochrane in Australia. I note that there were minimum quantities specified. I recall Sega wanted to control any copyright enforcement but enabled Avel to bring its own enforcement actions with their consent. I suspect Avel did not pay a fee for this agreement because it committed to a significant quantity of games.
43.I refer to the Sega EDA dated 19 December 1994 (Avel T docs page 51).
44.I note that this is for the game Rally Champ and is a very similar agreement to the previous one. Daytona had been a very successful game so Avel was very anxious to do a deal with the Rally Champ game. This deal was probably done in September at the Jamma Fair though it would have been signed up a bit later on in December. I not that there were minimum quantities. I recall that this game was nowhere near as popular as Daytona.
45.However I recall that in 1996, LAI lost the Sega agency for Australia to Village in Melbourne. At this time Village did a joint venture with Sega to import and distribute all Sega products into Australia. Although Sega offered Avel the same deal if it could match Village’s price, Avel couldn’t do so. So from 1996 onwards, Avel was not the agent for Sega in Australia and generally if Avel purchased any Sega products it purchased them through Village in Melbourne.
46.I refer to the copy of transaction file 64, which is annexed hereto and marked ‘MS13’.
47.This file relates to the importation of six Daytona DX cabinets with 50 inch screens and PCBs by Sondo, which were then manufactured into complete games and sold to Avel. The Daytona DX is a different product to the Daytona Twin and would not have been covered by the EDA. This is a relatively cheap price for these games which is because they were used cabinets, not new cabinets. I cannot recall any details regarding this transaction but it appears to be a typical transaction.
48.I refer to the copy of transaction file 253, which is annexed hereto and marked ‘MS14’.
49.This file relates to the importation of ‘Fighting Vipers’ kits, some of which were manufactured into complete games and sold to Avel, others of which were simply sold to Avel as PCBs. I cannot recall any details regarding this transaction but it appears to be a typical transaction.
50.I refer to the copy of transaction file 361, which is annexed hereto and marked ‘MS15’.
51.This transaction relates to the importation by Avel of Rally Champ complete games. All of the details of this would have been handled by Eddie Cochrane. I cannot recall any details regarding this transaction but it appears to be a typical transaction.
52.There are unlikely to be any post-1997 invoices with Sega showing separate itemisation for the exhibition rights, because from 1996 onwards Avel did not have the Sega agency for Australia and purchased any Sega products from Village in Melbourne.
Williams
53.I refer to the Williams EDA dated 12 March 1997 (Avel T docs page 192).
54.I negotiated this EDA and I signed for it. Negotiations were with Jo Dillon but the EDA was signed by Fedesna who was the general manager.
55.This is Williams standard form distributor agreement. I recall that Australia was the only country that required specific powers to enforce copyright and this was always a hassle to Williams. They didn’t need agreements like this in any of the other countries they operated in. The game covers pinball games as well as the arcade games and specified minimum quantities.
56.As for the other EDAs, the main purpose of Avel was to get exclusive distribution rights in the territory and although no money was paid in dollars, Avel took minimum quantities. The minimum number of 33 per year was the number that would easily fit into a regular sea container. I note that there is no specific term to this agreement.
57.I refer to the Williams EDA dated 23 May 1991, a copy of which is annexed hereto and marked ‘MS16’.
58.I do not recall any negotiations relating to this EDA. I note that the EDA was only for 1 year and the quantities were slightly higher than the 1997 agreement. Otherwise it is similar in structure to the 1997 agreement. I note that Avel paid $100,000 for products in all territories, which is a reasonably high price. I can recall that around this time Williams were very reluctant to enter into exclusive agreements in any of their territories. I seem to recall that this agreement was a concession to us and so Williams limited it to 1 year though it was structured so that if Avel, for instance, purchased some games on the last day of that year then Avel would continue to have exclusivity for up to 10 months afterwards.
59.The term of this agreement was for 1 year which means that it ran out in 1992. This means that from 1992 until the other agreement was entered into in 1997 Avel did not have exclusivity with Williams, although as a matter of fact the agreement between Williams and Avel was that Avel was treated as the exclusive distributor. That is, Williams did not supply any of Avel’s other competitors in Australia. However if Avel had attempted to enforce copyright in Australia by trying to rely on the EDA then it would have encountered serious difficulties and it would have been up to Williams to enforce that copyright.
60.I refer to the copy of transaction file 217, which is annexed hereto and marked ‘MS17’.
61.This file relates to the importation of ‘Cruisin USA’ kits which were made into complete games by Sondo and sold to Avel. I note that these were component kits.
62.This is a significant number of kits which indicates to me that Avel must have believed that it had exclusivity otherwise it would not have ordered this quantity of kits. I cannot recall any details regarding this transaction but it appears to be a typical transaction.
63.I refer to the copy of transaction file 138, which is annexed hereto and marked ‘MS18’.
64.This file relates to the importation of Rampage World Tour kits which were on-sold by Sondo to Avel. I cannot recall any details regarding this transaction but it appears to be a typical transaction.
65.I refer to the copy of transaction file 409, which is annexed hereto and marked ‘MS19’.
66.This file relates to the importation of the ‘Touch Master’ complete games by Avel. This is a counter-top unit which explains why the price is relatively low. I cannot recall any details regarding this transaction but it appears to be a typical transaction.
67.I refer to the copy of transaction file 140, which is annexed hereto and marked ‘MS20’.
68.This file relates to the importation of the ‘Real Monsters’ complete machines by Avel. I cannot recall any details regarding this transaction but it appears to be a typical transaction.
69.I refer to Annexure MS5 of my previous statement at page 31, being an invoice dated 4 November 1997 from Williams.
70.I note the price for the exhibition rights on this invoice is 70% of the total price. These are complete machines and there are only 8 of them. I don’t recall any of the negotiations regarding the exhibition rights in this invoice. I note that there was a relatively small quantity and perhaps this was handled by Eddie Cochrane.
Bulldog
71.There was no EDA with Bulldog. I refer to the copy of transaction file 345, which is annexed hereto and marked ‘MS21’. This file relates to the importation by Sondo of PCBs for ‘Golden Tee Golf’.
72.It appears from Annexure ‘MS21’ that Bulldog were agents for Incredible Technologies. Bulldog weren’t the copyright owner and they simply appeared to be the ones making the sale and collecting the order, then Incredible Technologies would manufacture and deliver the product. This was a non-exclusive transaction because Bulldog would not have been in a position to grant any exclusivity and Avel would have simply bought a sample of this game to see how it stood up in the market. This was a pretty good game but not good enough to take it much further. If it had been very successful, then Avel would have tried to negotiate an exclusivity arrangement for the future. The only written agreement with Bulldog would have been the purchase order and the invoice.
General
73.Annexed hereto and marked ‘MS22’ is a summary of information relating to the suppliers referred to in this Supplementary Statement, namely Bulldog, Namco, Sega and Williams. This summary shows, in relation to these suppliers, the games for which there existed an EDA. This summary also shows, in relation to each game, the amount of refund being claimed by Sondo or Avel in respect of that game, broken down into the type of transaction categories which have been used throughout the claim. I am informed by my solicitors and verily believe that the information contained in these columns was obtained by them from an examination of the Particulars of the claim, which have been admitted, and is correct though I have not checked it for myself.
74.On my instructions, an employee of Leisure and Allied Industries Group has examined the records of Avel and Sondo for copies of all invoices issued by any game supplier to either Avel or Sondo after December 1997. Annexed hereto and marked ‘MS23’ are a bundle of such invoices which relate solely to Sondo Pty Ltd.
75.Annexed hereto and marked ‘MS24’ are a bundle of such invoices which relate solely to Avel Pty Ltd.
76.In addition to Annexures MS23 and MS24, I am informed and verily believe that there were approximately 16 other invoices for the period after December 1997 which are located in the Melbourne office of Leisure and Allied Industries, and there are approximately 19 other transactions after December 1997 for which the transaction file cannot now be located.
77.Annexed hereto and marked ‘MS25’ is a summary of the information contained in Annexures MS23 and MS24 which, I am informed and verily believe, is accurate.
78.Annexed hereto and marked ‘MS26’ is a letter from the ATO to Avel Pty Ltd dated 22 August 1985. I was not involved in the negotiations which gave rise to this letter, although I recall that there was an issue between Avel Pty Ltd and the ATO regarding the wholesale price for which Avel sold its products. These negotiations were handled by Ken Fehily of Fehily Loaring, who at the time were assisting me with sales tax matters.
79.Annexed hereto and marked ‘MS27’ is a letter from the Australian Tax Office to Sondo dated 26 September 1990. Again I was not involved in the negotiations leading up to this letter and I expect that these matters were handled by Ken Fehily.
80.Annexed hereto and marked ‘MS28’ is a Credit Note issued by Sondo to Avel dated 22 April 2002. Sondo has also issued Avel a Credit Note dated 30 November 1997 which appears in the Applicant’s Bundle at page 195.
81.Avel (through an associated company ‘Matahari Studios Pty Ltd’) is presently involved in the supply side of the market in that it develops and supplies products for the consumer market. One of the products that Avel has developed is called GameBoy Advance and Avel’s associated company gets $4 or $5 per unit royalty for each game. However if that game was sold as a coin operated unit then Avel’s associated company would want a royalty of at least $1,000. At present there is no coin operated market for this game. However Matahari Studios Pty Ltd is presently developing a game for the Play Station II operating system which does have a coin operated market. I anticipate that the consumer version of this product will generate a royalty of $8 or $10 but if the game is sold as a coin operated version then the royalty will be in the thousands of dollars.”
27. In cross-examination Mr Steinberg acknowledged that when Avel purchased a video game machine from an overseas supplier during the claim period it was understood by the parties that Avel would either use the machine in one of its arcades or on-sell it to a third party, and, for the purposes of each such purchase transaction, no discussion ever took place between Avel and the relevant supplier regarding the acquisition by Avel of the right publicly to exhibit the “cinematograph film” constituted by the video feature of the relevant machine.
28. Mr Steinberg acknowledged that the video game “Virtua Tennis”, referred to in para 7 of his witness statement of 16 August 2001, is a relatively recent game and was not available during the claim period. He also acknowledged that he was unaware of the actual details of the transaction involving the importation by “Village” of that game, as referred to in para 7.
29. Mr Steinberg was referred to para 12ff of his witness statement in which reference was made to “Exclusive Distribution Agreements” (“EDAs”) entered into between Avel and various suppliers. He confirmed that the 26 EDAs contained in the Avel T documents – that is, the T documents relating to the Avel application for review (WT 1999/125, T3-T28) – were the only ones that could be found in Avel’s records and that it was possible, though unlikely, that other relevant EDAs had been made. He added, however, that in respect of the “vast majority of the games” purchased by Avel an EDA had not been made.
30. Mr Steinberg said that the intention of each EDA was to make Avel the “exclusive distributor” of the relevant coin-operated video game machine, that is, to confer on Avel “exclusive distribution rights” in respect of the relevant machine. He acknowledged that, contrary to what was stated in para 13 of his witness statement, the purchase price of the relevant video game machine was stated in some of the EDAs.
31. Mr Steinberg was referred to paras 23 and 25 of his witness statement regarding his estimates of the costs of manufacturing PCBs and video game machines. He said that he was referring only to the cost of materials (“hardware”) and labour and his estimates did not include the costs of research and development, and software.
32. Mr Steinberg said that since December 1997 (that is, since the expiration of the claim period) suppliers have been specifying on their invoices regarding the sales of video game machines the cost of the “exhibition right” associated with the relevant machine, and that this cost is generally equivalent to 50% of the total sale price of the machine. He acknowledged, however, that the suppliers had commenced to specify the “exhibition right” cost only after he had requested them to do so “for tax reasons”. He also acknowledged that the relevant cost specifications appeared in Avel’s purchase orders (which preceded the suppliers’ invoices) but explained that the cost figures specified in Avel’s purchase orders, and subsequently specified in the corresponding suppliers’ invoices, had previously been agreed between Avel and the relevant suppliers.
33. Mr Steinberg agreed that whenever Avel or Sondo purchased a video game machine or a PCB, the purchase included the relevant software and the exhibition right. He also agreed that the purchase price of a game or a PCB reflected the degree of popularity of the relevant game and that the retail price of a more popular game might be 20%-30% higher than that of a less popular game even though the hardware and software costs of both games were approximately equal.
34. Mr Steinberg was referred to the EDAs contained in the Avel T documents – in particular, EDAs made between Namco America Inc (“Namco”) and Avel. He acknowledged that, contrary to what was stated in para 7 of his supplementary witness statement of 23 April 2002, it appeared that the EDAs between Namco and Avel set out in T7, T8 and T15 of the Avel T documents had been prepared by, or on behalf of, Avel rather than by, or on behalf of, Namco. He confirmed that Avel wished to ensure that those EDAs conferred on it an exclusive copyright licence such that it would be able to institute legal proceedings against any person who infringed that copyright. According to the terms of each of those EDAs, Namco granted to Avel “exclusive licences” in relation to, inter alia, trade marks, software and copyright regarding the relevant video game and Avel agreed to pay to Namco a specified monetary consideration for each of those exclusive licences, and that consideration did not form any part of the purchase price paid by Avel for the relevant video game. Mr Steinberg agreed that Avel would, pursuant to the EDA, pay the supplier the amounts specified in that EDA for the various rights conferred upon it thereby and then, when it purchased the relevant video game, it would pay to the supplier a separate purchase price for the game over and above the amounts paid pursuant to the EDA.
35. Finally, Mr Steinberg was referred to a “Record of Conversation” (Avel T documents – T41) prepared by Mr A Lambe of the Australian Taxation Office, comprising a record of a meeting between himself, Mr J Loaring and Mr Lambe held on 23 June 1999 in relation to the claim by Sondo and Avel for a refund of sales tax (the subject of the present applications for review). According to that record Mr Lambe inquired of Mr Steinberg whether, in the event that a video game machine purchased from a supplier was destroyed, the purchaser would be required to pay to the supplier, for an identical replacement machine, the same amount that had been paid for the purchase of the original machine, or a lesser amount. Mr Steinberg’s recorded response was:
“Mr Steinburg (sic) advised that a replacement game would cost the same as the original. He advised that this is based on the method of costing undertaken by the overseas suppliers. They are not concerned with what rights are attached to the goods according to Australian law, they want a fair market price for goods that are going to make money for the operator. He advised that the overseas suppliers are engaged in selling a product”.
Mr Steinberg accepted that that was an accurate record of what he said at that meeting. He confirmed that the purchaser of a replacement video game machine would not receive a discount on the basis that it had already purchased the “exhibition right” in relation to that video game.
The evidence of Kevin Mennell
36. Mr Mennell confirmed that he had prepared and signed a witness statement dated 29 November 2000 and that its contents are, to the best of his knowledge and belief, true and correct. He also confirmed that he had prepared a document entitled “Estimated Production Cost of PCB for Video/Redemption – Ripper Ribbitt Style Game” dated 16 May 2001 and that the contents of that document are, to the best of his knowledge and belief, true and correct.
37. The contents of Mr Mennell’s witness statement (Exhibit A6) are as follows:
“1.I started with LAI in September of 1982 and I finished on 30 June 1998 to take on the General Manager position in Jakarta, Indonesia for Matahari Leisure, a joint venture company between LAI and Matahari of Indonesia.
2.When I started I was the assistant production engineer then I was promoted to production engineer. Then I became the research and development manager then I became the assistant manufacturing manager and I have been the manufacturing manager for four years. On 1 July 1998 I went to Indonesia and I set up LAI’s manufacturing plant in Jakarta in the position of General Manager/Director.
3.I was the manufacturing manager during the period of October 1994 to 30 June 1998. I was totally responsible for manufacturing at LAI. During this period we employed between forty five and one hundred people.
4.Prior to my promotion to manufacturing manager I was an employee of Sondo Pty Ltd. Once I became manufacturing manager I was employed by Kelquist Pty Ltd.
5.LAI manufactures electronic interactive entertainment games or machines. Back in the late 60s the company also made pinball machines and pool tables. But once the video game craze started, with the games Pong and Space Invaders, the company went entirely into video games. During the period I have been with the company it hasn’t made pin ball machines or pool tables.
6.One of the important things that goes into a video game is a printed circuit board (‘PCB’). A PCB consists of a resin base then a layer of copper which is the track of the PCB, then another layer of resin. It is a bit like a biscuit. The copper track in the middle being the path of the circuit. On one side of the PCB will be the solder tracks for the various parts and on the other side of the PCB will be the parts, such as resistors, capacitators, integrated circuits diodes etc. A PCB has holes in it for these parts to fit through and they are then soldered on the bottom side, though some components can be surface mounted.
7.LAI used to manufacture PCBs. We would get the simple board made externally and we would populate it in house with the various parts. That is we would have an outside manufacturer construct the copper layer and the two layers of resin and we would then bring the boards in and populate them with the various parts and then solder them into place.
8.LAI would also design the track for the PCB. So our engineers would set out a design for a PCB, send the track design out to the manufacturer, get a one off working model, test it and then if it worked put out an order for a hundred or a thousand or however many we needed.
9.Occasionally we would get external manufacturers to both make the PCB and populate it with the parts. This all depended on cost, whether we could populate it cheaper ourselves or not. Sometimes depending on the quantities involved, it was cheaper for the external manufacturer to populate the board rather than us.
10.I can’t remember all the names of our external manufacturers. One of the local manufacturers in Perth was Jemal. I can’t remember the other ones.
11.The PCBs we manufactured were not the video PCBs but the PCBs relating to systems control. Things like the coin mechanism controls, sound and amplifiers scoring and other control systems were PCBs that we could make. The video PCBs are far more complex and technically advanced than the PCBs we used to make. Video PCBs are capable of producing 2D and 3D images, and their processing speed is superior, due to the amount of information that is required to be processed for game play and graphic generation.
12.Recently, when I was in Indonesia, we organised the production and development of our first video PCB at LAI. There was quite a background to this PCB. The game was called Ripper Ribbit. We purchased a PCB for this game and produced it in 1998. But we wanted to be able to make a game machine that involved the redemption of a ticket. We realised the market had changed and we had to offer something that people couldn’t get in their own lounge rooms. So we wanted to design a video game that produced a ticket which could be redeemed for a prize. So we had to develop a game that did this. We worked with a person who had developed a PCB that was capable of this. We purchased the PCBs and downloaded our game. But there were limitations on this and so we had to change the PCB and then we got a Taiwanese manufacturer to make it. We took delivery of it in Indonesia just before I finished working there. This was the first video PCB that LAI had produced.
13.The kinds of PCB that we used to make at LAI, the mechanical electrical ones for control, sound, amplifier, are relatively cheap to manufacture. They cost between US $2-US $100 to make, which gives you the PCB with parts, and if you add in the CPU (central processing unit) then there is an additional cost of $2-$5 US. That is just the cost to manufacture and does not include research and development. This price is what we used to pay some of the Taiwanese manufacturers for the simple PCBs and would also include their profit margin of 5% to 8%.
14.I know the profit margin for the contract manufacturers as a result of my dealings with them. I have been dealing with contract manufacturers for many many years and I often go to Taiwan and get to know these people. Their margins are relatively low, 5% to 8%, but they make a profit because they can do such high volumes and because there is such a small labour content due to the automated processes used.
15.Because I have never been involved until recently in the manufacture of a video PCB it is difficult for me to estimate the actual cost of manufacture of a high end multi-layered PCB required for the more advanced games. But based on my dealings with the Taiwanese contract manufacturers and my experience in the industry I can make a rough guess. For instance the Daytona PCB which we used to buy for $3,000 - $4,000 I estimate would actually cost to produce around US$1,200 to US$1,500, at the most.
16.I have looked through the job costing sheets and job cost variance analysis. It is difficult to estimate the cost of manufacture of the video PCBs from this information. When I was at LAI I had a file for each job which showed a cost split up, variances and an explanation for all the variances. This file would include a breakdown of the kit cost because a manufacturing kit from the video supplier would include many things other than the PCB. There would be things like steering wheels, foot pedals, coin mechanisms and other peripheral components.
17.If I was able to look at these files, I would be able to provide a reasonable estimate of the cost of manufacture of the PCB for that game. I would also be able to tell roughly what price we were being charged for the PCB when it was included in a kit with other things like steering wheels, foot controls and coin mechanisms.
18.Nowadays you can get the software for a game on a computer disk rather than a PCB. It is now possible for a disk to contain all of the information that a PCB used to contain, and process it in the same time. In Indonesia, you can buy a Sony Playstation game on disk for between US$0.80 and US$1.50. In Australia the same disk costs $85 but included with it is a big manual and fancy box and a nice plastic cover. The additional difference in cost would reflect the copyright or creative component cost of the game. Video PCBs definitely cost more than compact disks because they also include R&D cost, custom component costs and are much more time consuming to produce.
19.There is a game called Point Blank which we used to put into our cabinets. The PCB for this game is very simple, a 2D graphic. Looking at File No.181 it appears we used to pay about AUS$2,044 for the PCB for that game. It is a very simple game and I think that the actual cost of manufacture for that PCB would be about US$500 to US$700. It is a very simple game with no 3D graphics.”
38. The document dated 16 May 2001 (Exhibit A7) prepared by Mr Mennell comprises:
·his calculation of the cost of hardware alone for a PCB for a “Ripper Ribbit Style Game”, based on figures given to him by 2 suppliers in Taiwan;
·his estimates of the costs of hardware and software, and of hardware alone, for a PCB for 4 video games comparable to the “Ripper Ribbit Style Game”, namely, “Point Blank”, “Egg Venture”, “Tickee Tickats”, and “Frantic Fred”.
Mr Mennell’s cost estimates (in US dollars, unless stated otherwise), as stated in the abovementioned document, are as follows:
·cost of hardware alone for PCB for “Ripper Ribbit Style Game”: $264 or $183 (depending on the supplier);
·costs of PCBs for comparable games:
–“Point Blank”: hardware and software - $1916; hardware alone - $575;
–“Egg Venture”: hardware and software - $1295; hardware alone - $183;
–“Tickee Tickats”: hardware and software - $A920; hardware alone - $183;
–“Frantic Fred”: hardware and software - $1697; hardware alone - $183.
The evidence of David Salt
39. Mr Salt confirmed that he had prepared and signed a witness statement dated 16 February 2001 (Exhibit A2) and he verified the contents of that statement. Those contents are as follows:
“1.Up until 30 June 2000, I was the finance manager of a company called Village Entertainment Equipment Sales & Service Pty Ltd (‘the company’). The company was the vehicle for a joint venture between Village Entertainment and Sega of Japan. The purpose of the joint venture was to import coin operated video arcade games manufactured by Sega in Japan into Australia. These games were then either installed in video arcades operated by Village or sold directly to other video arcade game operators.
2.The joint venture operated for three years and stopped trading on 30 June 2000.
3.I was not personally involved in the negotiations for the purchase of the coin operated video arcade games from Sega in Japan. However I was intimately involved in the financial management of the company. I signed off on the purchase orders that were issued by the company to Sega and the letters of credit that were issued by the company as payment for the arcade games. I knew what the prices were for the games that the company purchased, what the landed costs were, what the company had to sell the games for in order to make a profit and what the company was paying for when it purchased a game off Sega.
4.The purchase price that the company paid Sega for each video arcade game included in it the physical cost of the hardware, some recovery of the development cost and payment for the intellectual property rights associated with the games. The company was never charged separately for the right to show the video games in public nor did it pay separately for that right. The price for that right was built into the purchase price for the video arcade game that was paid to Sega.
5.On those occasions when the company on-sold a video arcade game to another video arcade operator, then it the company (sic) also on-sold the right to show the video arcade game in public but it did not separately specify the price for that right nor was it paid separately for that right. Once again payment for the right to show the video arcade game publicly was included in the entire purchase price.
6.The company was a competitor of Leisure & Allied Industries, as well as being a supplier to Leisure & Allied Industries of certain Sega video arcade games. Whenever the company sold a video arcade game to Leisure & Allied Industries, it did not separately charge for the right to show publicly the video game, nor was the company paid separately for that right.. Payment for the right to show publicly was included in the purchase price of the video arcade game”.
40. In cross-examination Mr Salt confirmed that his former responsibilities as Finance Manager of Village Entertainment (“the company”) included preparation of the company’s accounts, management of its cash flow, and associated financial duties. He said that his role in relation to the purchase of video arcade games by the company was to arrange payment of the relevant invoices received from the suppliers, and that he was not involved at any stage in negotiating the purchase price of such games or determining the components of that price. As regards the on-sellling of video arcade games by the company, Mr Salt said that the price negotiations were conducted, and the invoices were prepared, by the company’s “sales people” and his role was merely to ensure that payments in accordance with the invoices were received by the company and to record those receipts in the company’s accounts.
41. In relation to paras 5 and 6 of his witness statement Mr Salt confirmed that:
·invoices issued by the company for the sale of video arcade games merely stated the sale price of the relevant game and contained no reference to a right to exhibit the video game in public;
·there was no written contract between the company and the purchaser of the video arcade game other than the relevant purchase order and invoice.
Mr Salt acknowledged that he had no particular knowledge about any right to exhibit a video game in public, and that his understanding was simply that if such a right existed then it was “part of the deal” and payment for it must have been included in the overall sale/purchase price of the video game.
42. In re-examination Mr Salt said that, in his present capacity as General Manager of Village Roadshow Leisure, he has responsibility for authorising payment for video arcade games purchased by that company. He confirmed that he would not be prepared to authorise payment for a video arcade game if he were informed that “the right to show the video arcade game in public was not to be attached to it”.
The evidence of Neil O’Sullivan
43. Mr O’Sullivan confirmed that he had prepared and signed a witness statement dated 20 February 2001 (Exhibit A1) and he verified the contents of that statement. Those contents are as follows:
“1.I am the Director of Finance of Nintendo Australia Pty Ltd.
2.Nintendo used to sell by wholesale a video game called Killer Instinct. This game is sold to Coles Myer who then sell the game to home users in a form that enables the home user to play the game on their Super Nintendo system at home. The recommended retail selling price of Killer Instinct was $99.
3.Nintendo also used to sell by wholesale a game called Cruisin USA. This game is sold directly to Coles Myer who then sell the game to home users in a form that enables the home user to play the game on their Nintendo 64 system at home. The recommended retail selling price of Cruisin USA was $79.
4.Both Killer Instinct and Cruisin USA had an equivalent arcade game that was almost identical to the Nintendo or Super Nintendo system sold to home users”.
The evidence of Douglas Thorp
44. Mr Thorp confirmed that he had prepared and signed a witness statement dated 16 February 2001 (Exhibit A8) and that the contents of that statement are, to the best of his knowledge and belief, true and correct. The contents of that statement (as amended) are as follows:
“1.I own the business known as Valhalla Games which operates from premises at 493 Wellington Street, Perth. I have owned the business for 10 years and I work in the business daily.
2.The business buys and sells all sorts of games, such as models and model kits of cars, ships and aircraft, and a very large range of computer games and accessories. We sell new versions of computer games and we also buy and sell second hand versions of those computer games. We often sell a new version of a game to one of our regular customers, then buy it back from them some time later and sell it second hand from the shop.
3. The business keeps records of all the games which it has or has had available for sale and the prices for those games new. These computer records also contain notes of the prices at which other retailers sell new versions of the computer games. We collect this information in order to keep an eye on the market and to enable us to fix prices for the second hand versions of those computer games. The information contained in these computer records is entered either by me, or by a member of staff under my supervision.
4.I have examined the records of the business to determine the prices for which the business would be prepared to sell various games. Often there is a range of prices, for several reasons. One reason is that there are often several versions of a game, put onto the market over a period of time. The computer records do not show the dates that the different versions come onto the market. However, it is common for a popular game to have up to 3 versions. Sometimes the manufacturer will also prepare a compilation, such as a trilogy containing a mix of three individual games. Generally speaking, later versions are more expensive than earlier versions, and [compilations] are more expensive still.
5.Another reason is that there may be more than one new selling price for a game. This happens when the manufacturer attempts to remove a small amount of remaining stock by lowering the price, either slightly, or significantly. For example, if, after some time, a manufacturer is holding some stock that it wants to get rid of, it may attempt to get rid of that stock through a particular retailer for a reduced price. If the manufacturer still does not get rid of its stock, then it may dump the stock through a large chain like Woolworths or Target by offering it for sale for, say, $5 or $10. Obviously, these actions by the manufacturers bring the market down and affect the price at which we can sell new and second hand versions of the same game.
6.In assessing the second hand value of a game, we have regard to the new price of the game, and the quality or condition of the second hand game. We discount the new price according to whether the second hand game is in good or poor condition. Sometimes we factor in some of the intrinsic value of some of the goods, or the prevailing market. For instance, there are now several websites based in the USA which auction versions of certain computer games. These websites appear to obtain prices of several hundred dollars for some of the games, which appears to me to be because these games have become collectors items and there is a market in the USA sufficient to bear these prices. If we had regard to these markets, the price of some of our second hand games would be significantly higher.
7.Based on the computer records referred to above, the new prices for the following games are as follows:
(i)Tekken. Version 1 retailed for $79.95 but the notes show that other retailers were selling it for $100 and $59. Version 2 retailed for $32.00 but also sold through other retailers for $39.95 and $100.
(ii)Daytona USA. This retailed for $100 originally, but has most recently retailed for $69.95. There was also a budget price of $30 and a version by Sega for $49.95;
(iii)Killer Instinct. Our most recent price for the Gold version on Nintendo 64 is $80, but it has also retailed new at $40 and $100. We currently have a version in stock second hand for $44 (on a Nintendo 64 System);
(iv)Time Crisis. The platinum version retails new for $45, or $99.95 with a gun. It has also retailed for $60.
(v)Golden T Golf. The most recent retail price is $29.95.
(vi)Die Hard. There are several versions of this game. Version 1 is no longer available. Version 2 sold second hand for between $27 and $40. The Trilogy sells for $40 but this price has ranged between $40 and $100. The Playstation version has sold for $50 and $80.
(vii)Mortal Kombat. This game has versions 1, 2 and 3 and a Trilogy. Versions 1, 2 and 3 sold in the range from $15 (second hand) and $40 to $100 (for new). The latest price for the Trilogy is $40 but it has sold for up to $130.
(viii)NBA Hang Time. This originally sold new for $80 and went up to $90, but is now $50.
(ix)Rampage World Tour. This sold for $100 new on a Nintendo 64 System. Version II on a Play Station or Nintendo System sold for $80, and $60 on Game Boy.
(x)Virtua Fighter. Version 1 sold for between $30 (budget price) to $70. Version 2 sold new for $70 or $59 second hand.
8.The computer records do not show these various prices were being asked or when the different versions of the game came onto the market. However, from my memory, the range of prices for these different games has not changed significantly over the period that I have been operating this business. Although I cannot say for certain the prices for these games between 1994 and 1997, from memory the range of prices would be from around $30 up to around $80 or $90 for a new game. It was only rarely that prices for computer games went out of this range, such as when a manufacturer dumped the stock, or a game was particularly popular and retailers took advantage of that popularity to charge a higher price”.
45. In examination-in-chief Mr Gageler (for the applicants) tendered photocopies of the packaging of 3 of the games listed in para 7 of Mr Thorp’s witness statement, namely, “Time Crisis”, “Die Hard”, and “Mortal Kombat” (Exhibit A9). Mr Thorp confirmed that he presently had those games in stock and that the abovementioned photocopies were copies of the front and back of the boxes in which those games were packaged. The photocopy of the back of each game package contains a reference to the owner of the copyright in the game and the following statement:
“For home use only. Unauthorised copying, adaptation, rental, lending, re-sale, arcade use, charging for use, broadcast, cable transmission, public performance, distribution or extraction of this product or any trademark or copyright work that forms part of this product are prohibited”.
Additional documentary exhibits
46. Mr Gageler also tendered the following exhibits:
·bundle of documents comprising Sondo’s purchase orders, and the suppliers’ invoices, regarding PCBs for the following video games: “Egg Venture”, “Ghost Hunters”, and “Rampage World Tour” (A10);
·letter dated 13 June 2001 from Norton & Smailes (the applicants’ solicitors) to the Australian Government Solicitor setting out the methodology used in calculating the applicants’ claims for refund of sales tax (the subject of the present applications for review) (A11);
·invoice dated 9 October 1996 issued by Village Nine Leisure to Leisure & Allied Industries Pty Ltd for the sale of 5 “Virtua Fighter 3 DX Units” (A12).
The Questions for the Tribunal’s Determination
47. The fundamental question for the Tribunal’s determination is whether the price for which each relevant complete video game machine was sold, or for which each relevant PCB was sold, in the claim period included an amount by way of consideration for the grant of the right to exhibit in public the “cinematograph film” constituted by the combination of visual images, sound effects and movements created by the relevant computer program embodied in each such video game machine or PCB. If that question is answered in the affirmative, the following additional question or questions will then arise for determination:
·whether s95(2) of the Assessment Act is applicable so as to allow, for the purposes of assessment of sales tax, an apportionment of the total selling price of each video game machine or PCB between an amount allocated to the sale of the goods themselves alone and an amount allocated to the grant of the abovementioned public exhibition right; and, if so:
·what is the amount that, in terms of s95(2) of the Assessment Act, “could reasonably be expected to have been allocated” to the grant of that public exhibition right if that grant had been the only subject matter of the transaction?
It is appropriate, for the purpose of addressing the above questions, for the Tribunal to focus (as did the parties in presenting their respective cases) on the transactions whereby Avel and Sondo purchased video game machines and/or PCBs from overseas suppliers during the claim period because, by reason of the relevant s43 Agreements made between the respondent and each of Sondo and Avel (referred to in paragraphs 11 and 12 above), the “taxable values” of the relevant “taxable dealings” were calculated on the basis of the amounts paid by Avel and Sondo to those overseas suppliers for the purchase of those video game machines and PCBs.
The Submissions
48. Mr Gageler (for the applicants) made detailed written and oral submissions, the essence of which is as follows:
·in each transaction wherein Avel or Sondo purchased a video game machine or a PCB from an overseas supplier, Avel or Sondo paid a global amount to the supplier for which it received both property in the machine or PCB, and a licence of the copyright in the cinematograph film embodied in the machine or PCB;
·the grant of a copyright licence was inherent in the nature of each such transaction and must be implied either as a matter of law or as a matter of business efficacy because:
–each machine or PCB sold to Avel or to Sondo was for use in a video arcade;
–that use necessarily involved causing the embodied cinematograph film to be seen and heard in public; and
–that use would constitute an infringement of the copyright of the overseas supplier unless a copyright licence were granted by the supplier to Avel or to Sondo;
·the fact that EDAs were made between Avel and some of its suppliers does not detract from the validity of the above propositions because:
–the crucial feature of each EDA was the grant to Avel of the exclusive right to distribute the relevant video game machine or PCB;
–the additional grant to Avel of an exclusive copyright licence by each EDA was for the purpose of effectuating the grant of the exclusive distribution right;
–in those EDAs which expressly provided for the payment of monetary consideration by Avel to the supplier for the grant of, inter alia, a copyright licence, that consideration was payable, as a matter of substance and commercial reality, for the exclusivity of the copyright licence rather than for the copyright licence itself (the grant of which was inherent in the relevant abovementioned sale/purchase transaction);
·because in each sale/purchase transaction a global amount was paid by Avel or Sondo to an overseas supplier for which it received both property in the video game machine or PCB and a copyright licence, s95(2) of the Assessment Act is applicable and requires the making of a judgment regarding “the amount that could reasonably be expected to have been allocated to” that element of each transaction comprising the grant of the copyright licence alone;
·the evidence and material before the Tribunal establish that the appropriate amounts to be allocated to the grants of the relevant copyright licences are:
–in the case of the sale/purchase of a video game machine – 50% of the global amount paid by Avel for that machine;
–in the case of the sale/purchase of a PCB – 80% of the global amount paid by Sondo for that PCB.
Submissions were also made in relation to the quantum of the sales tax refunds to which, it was claimed, Avel and Sondo were entitled pursuant to s51 of the Assessment Act but it is not necessary to set out those submissions here.
49. Mr Le Miere (for the respondent) made written and oral submissions, the essence of which is as follows:
·the EDAs made between Avel and certain suppliers of video game machines or PCBs conferred on Avel a licence to exhibit in public the cinematograph film embodied in the relevant machine or PCB;
·those EDAs furthermore:
–always conferred on Avel the right exclusively to distribute the relevant video game machine within a specified territory;
–generally conferred on Avel the right to use any trade marks associated with that video game;
–sometimes conferred on Avel other rights, including the right to use the software forming part of that game;
–often expressly stipulated the consideration to be provided by Avel for the various rights conferred on Avel thereby;
·it is not necessary to imply into those agreements whereby Avel purchased video game machines from certain overseas suppliers the right for Avel publicly to exhibit the cinematograph films embodied in those machines because such a right had already been conferred on Avel by the EDAs made between it and those suppliers;
·although, as regards the transactions wherein Avel purchased video game machines from suppliers with which it had not made an EDA, the grant to Avel of a licence publicly to exhibit the cinematograph films embodied in those machines was implied therein, there is no evidence that consideration was required by any of the suppliers, or was paid by Avel, for such a licence;
·nor should it inferred from the circumstances that consideration was required by each supplier, and was paid by Avel, for such an implied licence having regard to the following established facts or circumstances:
–the suppliers and Avel never discussed or referred to any consideration required by the suppliers to be paid by Avel for such a licence;
–the suppliers and Avel never identified the grant of such a licence as an element of the sale/purchase transaction or referred to the grant of such a licence to Avel as part of that transaction;
–Avel’s purchase orders and the suppliers’ invoices in respect of the purchase/sale of the relevant video game machines referred only to the machines and the prices to be paid therefor and made no reference to a copyright licence or a public exhibition right or licence in relation to those machines;
–In the event that a video game machine purchased by Avel was destroyed and Avel wished to purchase from the supplier an identical replacement machine, the same purchase price as had been paid for the original machine would be payable for the replacement machine;
·the correct inferences to be drawn from the circumstances are that:
–each agreement whereby Avel purchased a video game machine from an overseas supplier was simply an agreement for the sale of goods – that is, an agreement whereby title to the machine (the goods) was transferred to Avel;
–the price paid by Avel to the supplier in accordance with such an agreement was the price paid by Avel solely for title to the machine;
·because the only element of the relevant transactions between Avel and its suppliers was the sale of the video game machines themselves, and the transfer of title to those machines, to Avel, and the amounts paid by Avel to the suppliers related to that element alone, s95(2) of the Assessment Act is not applicable;
·alternatively, if those transactions did involve another element, namely, the implied grant of a copyright licence or public exhibition right in relation to the cinematograph films embodied in the video game machines, Avel has not discharged its onus of establishing how much (whether 50% as contended by Avel, or any other proportion) of the “global amount” paid by Avel for each machine “could reasonably be expected to have been allocated to that [other] element” – namely, the copyright licence or public exhibition right – “if that element had been the only subject matter of the transaction”, as required for the application of s95(2) of the Assessment Act.
Submissions were also made in relation to the transactions between Sondo and its suppliers in relation to the sale/purchase of PCBs. Those submissions were, mutatis mutandis, in substance similar to those set out above except that it was submitted that, notwithstanding that Sondo did not enter into any EDAs with its suppliers of PCBs and therefore did not thereby acquire a licence publicly to exhibit the cinematograph film embodied in each PCB, it was nevertheless not necessary to imply into the agreements whereby Sondo purchased the PCBs from it suppliers a licence publicly to exhibit the cinematograph film embodied therein because its sole intention was to sell the PCBs to Avel and it never intended to, and never did, exhibit such film publicly.
Consideration and Findings
59. In Galaxy Electronics Pty Ltd v Sega Enterprises Ltd (1997) 75 FCR 8 the Full Federal Court of Australia held that the aggregate of visual images embodied in a computer program contained within, and generated by the playing of, a video game machine constituted a “cinematograph film”, as defined in s10 (read with s24) of the Copyright Act 1968, and accordingly those visual images were subject to copyright protection under Pt IV of that Act. It is common ground that that proposition applies to the video game machines and PCBs that are the subject of the present applications for review.
51. The Tribunal accepts the applicants’ submission that it was an implied term of each transaction whereby a video game machine or a PCB was sold by an overseas supplier to Avel or to Sondo that a copyright licence or licence publicly to exhibit the cinematograph film embodied in the machine or PCB was thereby granted by the supplier (the owner of the relevant copyright) to Avel or to Sondo, as the case may be, at least on the basis that such an implication was necessary to give business efficacy to that transaction: see Acohs Pty Ltd v RA Bashford Consulting Pty Ltd (1997) 144 ALR 528 at 543-547.
52. The fundamental question for the Tribunal’s determination in this matter is, as mentioned in paragraph 47 above, whether the price paid by Avel or Sondo for each video game machine or PCB included an amount by way of consideration for the grant of the abovementioned copyright licence or public exhibition licence itself.
53. The fact that Avel had entered into EDAs with some of its suppliers of video game machines is, in the Tribunal’s opinion, of no particular significance as regards the proper determination of the abovementioned question. The Tribunal accepts the applicants’ submission that the essential feature of each of those EDAs was not the grant of a copyright licence and other rights per se to Avel, but rather the grant to Avel of exclusiveness in respect of that copyright licence and those other rights, and that the consideration that was paid by Avel in accordance with each EDA was paid for that exclusiveness.
54. As regards the transactions whereby Avel and Sondo purchased video game machines and PCBs from overseas suppliers during the claim period, the documentary material before the Tribunal, in the form of Avel’s and Sondo’s purchase orders and the suppliers’ invoices, indicates merely that Avel or Sondo purchased a specified number of units of the relevant video game machine or PCB at a specified price per unit. The unit price specified is generally a single figure, although in some cases the prices of component parts of the unit “hardware” are individually specified and in a few cases the value of the unit “software” is specified. In none of the relevant purchase orders or invoices, however, is any reference made to a copyright licence or a public exhibition right in respect of the relevant video game machine or PCB, let alone a price specified for the grant of such a licence or right. On its face each purchase order and invoice purports to relate merely to the purchase/sale of a specified number of units of a particular video game machine or PCB for a specified price per unit.
55. The Tribunal heard evidence from Mr Steinberg regarding his estimates of the costs of manufacturing the relevant video game machines and PCBs together with the amount of a “reasonable profit mark-up” for the manufacturer, as compared with the (much greater) prices actually paid by Avel and Sondo for those machines and PCBs, and his suggested explanation of the substantial difference between those two amounts, namely, that the prices actually paid by Avel and Sondo included payments for the rights to exhibit the video game in public. Mr Steinberg acknowledged, however, that his cost estimates did not include research and development costs and software costs. Mr Steinberg also acknowledged that another important factor in determining the sale/purchase price of a video game machine or PCB was the expected popularity of the relevant video game. He further acknowledged that in none of the negotiations for the sale/purchase of the relevant video machines and PCBs in the claim period was there any discussion between the parties regarding the grant of the right publicly to exhibit the video game, and that no reference was made to such a right, let alone consideration for the grant thereof, in the relevant purchase orders and invoices created for the purpose of those sale/purchase transactions.
56. The Tribunal also heard evidence regarding the very substantial difference between the unit cost of a coin-operated video game machine and the unit cost of the “home consumer version” of the same video game, the suggested explanation of that cost difference being the fact that the former unit cost includes an amount paid for the right publicly to exhibit the game, whereas the latter unit cost does not.
57. Having regard to all the evidence and material before it, the Tribunal is not satisfied that, in respect of any of the sale/purchase transactions between Avel or Sondo and the overseas suppliers regarding the relevant video game machines and PCBs during the claim period, Avel or Sondo was required to pay, and did pay, a specific consideration for a licence publicly to exhibit the cinematograph film embodied in each of the relevant machines or PCBs. In the Tribunal’s opinion the proper inference to be drawn from the whole of the evidence before it is that the grant of such a licence – indeed, the very existence of such a licence – was not within the contemplation of the parties involved in each such transaction. In the Tribunal’s opinion, the sale/purchase price for each video game machine and PCB which was negotiated between the supplier and Avel or Sondo, as the case might be, was simply what each party to the transaction regarded as a fair market price for the sale/purchase of the property in those goods – in other words, the price that the supplier required to be paid for the transfer of title, and the price that Avel or Sondo was prepared to pay for the acquisition of title, to those goods.
58. 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, 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 (according to para 25 of his witness statement of 16 August 2001 (Exhibit A3)), 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 – see para 30 of Mr Steinberg’s witness statement of 16 August 2001 (Exhibit A3)). 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 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 (see para 38 of Mr Steinberg’s supplementary witness statement of 23 April 2002, and paragraph 32 above), 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 (which expired on 31 December 1997) and which are the subject of the present applications for review.
59. Accordingly, the Tribunal finds that, in each relevant transaction in the claim period whereby Avel or Sondo purchased video game machines or PCBs from an overseas supplier, Avel or Sondo was not required by the supplier to pay, and did not pay to the supplier, a specific consideration for a licence publicly to exhibit the cinematograph film embodied in each of those machines or PCBs. The Tribunal finds instead that, in each such transaction, the amount paid by Avel or Sondo to the relevant supplier represented the price paid by Avel or Sondo solely for the acquisition of property in, or title to, the goods the subject of that transaction, namely, the relevant video game machine(s) or PCB(s).
60. It necessarily follows from the above finding, namely, that in each transaction the whole of the amount paid by Avel or Sondo to the relevant overseas supplier related solely to the sale/purchase of the relevant goods, namely, the video game machine(s) or PCB(s), that no question of apportionment of that “global amount” arises and s95(2) of the Assessment Act is therefore inapplicable in this case. Likewise, none of the other matters, including the quantum of refund of sales tax to which the applicants might be entitled, that were agitated by the applicants now arises.
Conclusion
61. The conclusion of the Tribunal, having regard to the whole of the evidence and material before it, is, therefore, that each of the applicants has not discharged the burden, imposed upon it by s14ZZK(b)(iii) of the TA Act, of proving that the relevant “taxation decision … should not have been made or should have been made differently”. More specifically, Avel and Sondo have not established to the Tribunal’s reasonable satisfaction that, in respect of the relevant “assessable dealings” in the claim period, they have each paid an amount of sales tax that was not legally payable and are accordingly each entitled to a credit pursuant to s51 of the Assessment Act, and that the reviewable objection decisions, dated 30 September 1999, are wrong.
Decision
62. For the above reasons the reviewable objection decisions, dated 30 September 1999, are affirmed.
I certify that the 62 preceding paragraphs are a true copy of the reasons for the decision herein of Associate Professor SD Hotop, Deputy President
Signed: ............(sgd V Wong).........................................
AssociateDate/s of Hearing 1-3 May 2002
Date of Decision 20 February 2003
Counsel for the Applicant Mr S Gageler SC
Solicitor for the Applicant Norton & Smailes
Counsel for the Respondent Mr R Le Miere QC and Mr M Corboy
Solicitor for the Respondent Australian Government Solicitor
Key Legal Topics
Areas of Law
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Taxation Law
Legal Concepts
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Sales Tax Assessment Act 1992
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Taxation Administration Act 1952
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Claim of Credit for Overpaid Sales Tax
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