Estee Lauder Pty. Limited v. F.C. of T.
Judges:Burchett J
Court:
Federal Court
Burchett J.
In this case, on 26 May 1988 I delivered reasons for judgment (now reported as
Estee Lauder Pty. Ltd. v. F.C. of T. 88 ATC 4412; (1988) 80 A.L.R. 314) in respect of certain questions directed to be decided separately before the trial of the proceedings. The bringing in of short minutes of orders was thereafter delayed by protracted negotiations which took place between the parties in an endeavour to settle the whole matter. Those
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negotiations having ultimately failed, Estee Lauder Pty. Limited (``Estee Lauder'') has brought in short minutes expressing the orders it claims to be appropriate by virtue of my earlier reasons. Certain issues, on which the parties were at odds, emerged from these short minutes, and I have heard further argument and permitted some further evidence to be adduced.One of the issues dealt with in my earlier reasons was whether, for the purposes of sec. 18(2)(b) of the Sales Tax Assessment Act (No. 1) 1930 (the Act), royalties and technical service fees paid by Estee Lauder to certain of its international affiliates should be taken into account as costs of manufacture requiring reflection in the notional wholesale purchase price to be calculated in respect of the goods. I discussed this question at some length at ATC pp. 4419-4422; 80 A.L.R. pp. 322-326 of the report of the case. I shall not repeat that discussion, as these reasons should be read with what I then said. It is sufficient, for present purposes, to set out a brief extract:
``In my opinion, sec. 18(2)(b) should be construed as looking, at least in a case where there is no wholesaler of identical goods as defined, to a hypothetical manufacturer and wholesaler manufacturing the goods under conditions similar to those which apply to the taxpayer.... [T]he necessary hypothetical purchase can be envisaged, and its price can be estimated by reference to the manufacturing costs involved, of most of which Mr Burger's calculations provide evidence. However, if Mr Burger's calculations are used, it will be necessary to add the cost of availability to the notional manufacturer of the industrial property in respect of which Estee Lauder pays royalties and technical service fees. That cost can be measured by reference to those royalties and technical service fees.''
The dispute in connection with the short minutes has centred upon the royalties and technical service fees. Estee Lauder, in the relevant period, paid royalties calculated at three per cent of certain sales figures, together with technical service fees calculated at a further three per cent of the same figures. For the Commissioner, it is argued that I should not apportion to the goods in question appropriate fractions of the royalties and fees actually paid, but should look at the agreements under which they were owed in order to derive the conclusion, as he contends, that higher amounts should have been paid, of which appropriate fractions should now be attributed to the particular items in dispute. For Estee Lauder, this is denied; but it is also urged that no part of the royalties, and only 26.5 per cent of the technical service fees, should properly be taken into account as part of the costs of manufacture of the goods. The whole of the royalties, and the balance of the technical service fees, are claimed to relate to selling, and not manufacture. Towards the end of the argument, an alternative proposition was advanced that the royalties, as well as the technical service fees, should be regarded as attributable only in part to manufacture. A further alternative contention was that no part of the technical service fees should be taken into account.
The royalties are paid under three licence agreements, two of which are expressed to be governed by New South Wales law, and one by Australian law. The first is an agreement made 1 February 1969 between Estee Lauder Cosmetics Ltd., a Canadian corporation, and Estee Lauder, by which there was granted to Estee Lauder ``the exclusive right and license to manufacture, use and sell [certain cosmetics] in Australia under the Australian trademark `Estee Lauder'... together with the right to sublicense others thereunder''. The agreement provided that Estee Lauder ``shall and agrees to pay'' to the Canadian company ``a royalty equal to three percent (3%) of NET SALES (as hereinafter defined) of the [cosmetics] in Australia...''. There is a definition by which ``NET SALES shall mean the gross volume of sales of [cosmetics to which the agreement applies] by [Estee Lauder] or its sublicensees under the TRADEMARK [and certain other trademarks] less commissions, returns and allowances...''. Certain exclusions were provided for. There was also an express term providing for the Canadian company's co-operation ``in all advertising, promotion and publicity in Australia...''. The term included the following:
``All advertising and promotion materials which may be used by [Estee Lauder] and its sublicensees in a mass-consumer advertising medium or in a mass-consumer promotion campaign, including, but not by way of limitation, all product `tie-in' advertising and promotion campaigns, shall be submitted by [Estee Lauder] and its
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sublicensees to [the Canadian company] for its approval or disapproval prior to any release thereof...''
The second agreement was made 1 July 1976 between Clinique Laboratories Inc., a United States corporation, and Estee Lauder. By it the United States corporation granted to Estee Lauder ``the right and license to manufacture, use, distribute and sell [certain cosmetics] under the `CLINIQUE' and dependent trademarks owned by [the United States corporation]...''. Royalties were payable ``equal to three percent (3%) of the aggregate `Net Sales' (as hereinafter defined) of all [the cosmetics] sold by [Estee Lauder] during the term of this agreement''. It was provided that ```Net Sales' shall mean the gross volume of sales of the [cosmetics] by [Estee Lauder] under the TRADEMARKS, less (i) refunds for returned merchandise, and (ii) sales, excise, value added, purchase and similar consumption taxes...''. There was a requirement, similar to that in the first agreement which I have already set out, for submission of advertising and promotional materials by Estee Lauder for the approval of the licensor corporation.
The third agreement was made 1 July 1975 between Aramis Inc., a United States corporation, and Estee Lauder. By it the United States corporation granted Estee Lauder a licence ``to manufacture, use, distribute and sell [certain men's cosmetics and toiletries] under the `ARAMIS' and dependent trademarks...''. There was provision for a royalty ``equal to three percent (3%) of the aggregate `Net Sales' (as hereinafter defined) of all [the men's cosmetics and toiletries] sold by [Estee Lauder] during the term of this agreement''. There was a definition of ``Net Sales'' in the same terms as the definition contained in the second agreement. There was a similar provision in respect of advertising and promotional materials.
Both the second agreement and the third agreement referred to the use of the trade marks within territories extending beyond Australia but including Australia.
The technical service fees were governed by a single agreement, expressed to be ``made as of the 1st day of July, 1975'', between Estee Lauder International, Inc., a United States corporation (referred to as ``International''), and Estee Lauder. This agreement recited that ``International has greatly expanded its International Service Department so as to provide more comprehensive services in the fields of manufacturing processes and techniques, marketing and advertising techniques, techniques for the education and training of sales personnel, as well as with respect to accounting, financial and other administrative matters''. It provided that International would make available and supply to Estee Lauder ``expertise and consulting and advisory services'' which were listed in the agreement. These included product information and also advice on matters of administration, promotion, advertising, selling, training and finance. It was provided that:
``In full payment for all of International's services... [Estee Lauder] shall pay International in respect of each fiscal year a fee equal to three percent (3%) of [Estee Lauder's] net sales for that year.''
``Net sales'' was defined to mean ``gross sales less discounts, returns and allowances''. There was specific provision for International to obtain ``a statement prepared by [Estee Lauder's] independent certified public accountants or other source acceptable to International, setting forth in reasonable detail the computation of the aggregate fee payable for the preceding fiscal year..., which statement shall be final and binding upon the parties''. There was also provision for quarterly payments on account to ``be accompanied by a statement setting forth the amount of net sales and the computations involved in arriving at net sales and the payment on account''.
This agreement was expressed to ``be governed by and construed in accordance with the law of the State of New York applicable to agreements made and to be performed in the State of New York''.
It is to be noted that, although each of the agreements referred to the manufacture, as well as to the selling, of the products in question, the royalties and technical service fees were to be calculated on products sold by Estee Lauder, whether or not Estee Lauder had manufactured those products. In fact, I was informed, approximately five per cent of Estee Lauder's sales related to products manufactured by its overseas affiliates, which it imported into Australia.
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Counsel for the Commissioner drew attention to the varying terms of the definitions, contained in these agreements, of the sales figure on which the respective amounts of royalty or fee were required to be calculated. He disclaimed any attempt to apply the expressio unius principle as between agreements involving different parties, and entered into at different times; but he argued that the language was too intractable to permit sales tax or commission to be deducted from the gross sales figure in relation to those of the agreements which did not expressly advert to either of these items as deductions. According to this argument, in addition to what was actually paid as royalties and technical service fees, there should have been paid, except in respect of the Clinique and Aramis trade marks, amounts calculated at the appropriate percentages of the amounts of sales tax incurred by each sale; and, except in relation to royalties payable in respect of the Estee Lauder trade mark, there should also have been paid a percentage of the commission allowed to the selling agents through whom products were sold, for example, the proprietors of the David Jones or Grace Bros stores. It was claimed to follow that the assessment of the notional price for the purposes of sec. 18(2)(b) of the Act should take account of these additional amounts as costs which would have to be borne by the notional manufacturer.
I think there are great difficulties in the way of reaching this conclusion. It is true that the language of the agreements, which appear to have been drawn in the United States, and were certainly drawn at a time when Estee Lauder conducted its business as a wholesaler and not as a retailer, does provide some foothold for the argument advanced. However, each of the agreements also contains indications that it was intended to take as a measure the amount of net sales achieved; and, as counsel for Estee Lauder pointed out, the idea of swelling a sale price by including in it the amount of sales tax payable in respect of the sale is oddly at variance with the very nature of a sales tax. A sales tax is calculated on the ``amount for which the goods are sold''; it is not part of that amount:
Commonwealth Quarries (Footscray) Proprietary Limited v. F.C. of T. (1938) 59 C.L.R. 111 at p. 122.
There was some suggestion, in the argument presented for Estee Lauder, that the undeviating conduct of itself and its affiliates, in paying and accepting royalties and technical service fees on the basis of calculations which did not treat sales tax or commission as part of the price upon which the percentages payable were calculated, supported a construction of the documents that left these amounts out of consideration. But as Lord Morris of Borth-y-Gest said in
L. Schuler A.G. v. Wickman Machine Tool Sales Ltd. (1974) A.C. 235 at p. 260:
``If on the true construction of a contract a right is given to a party, that right is not diminished because during some period either the existence of the right or its full extent was not appreciated.''
See also
James Miller & Partners Ltd. v. Whitworth Street Estates (Manchester) Ltd. (1970) A.C. 583 at p. 603;
Codelfa Construction Proprietary Limited v. State Rail Authority of New South Wales (1982) 149 C.L.R. 337 at p. 348. Of course, so far as the contract to be construed according to the law of New York is concerned, I do not know whether that law would authorise a different approach to the problem of construction, and I note Lord Denning's expostulation in
Port Sudan Cotton Co. v. Govindaswamy Chettiar & Sons (1977) 2 Lloyd's Rep. 5 at p. 11 that the rule of English law ``is contrary to the rule in every other civilised system of law''; but there is simply no evidence of New York law in this case.
The real significance of the way in which royalties and technical service fees have been invariably calculated, over a period of many years, relates much more directly to the ultimate question in the case. For the agreements are only evidentiary of costs to be taken into account in determining, under sec. 18(2)(b) of the Act, ``the amount for which the manufacturer could reasonably be expected to purchase identical goods from another manufacturer if the other manufacturer had in the ordinary course of his business manufactured the identical goods for sale and had sold them to the first-mentioned manufacturer by wholesale''. When the matter is looked at from this point of view, the way in which the parties have in fact interpreted the agreements, over such a long period, is of more assistance than dubious technical rights no one, except the Commissioner, has ever attempted to assert. In measuring what ``could reasonably be expected'', I shall have regard to the royalties
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and technical service fees actually sought and paid.Before leaving this aspect of the matter, I draw attention to the special term of the technical service fees agreement providing for the production of a certified statement of the fees for each fiscal year, which ``shall be final and binding upon the parties''. So far as that agreement is concerned, if the statements it envisaged were provided, there is no doubt about Estee Lauder's position. I do not think sec. 18(2)(b), on its true construction, requires me to assume the hypothetical manufacturer would have to bear technical service fees which Estee Lauder itself does not have to bear.
The next question arises out of Estee Lauder's contention that no part of the royalties represents a cost of the manufacture of the goods. Estee Lauder relies on the fact that the royalties are payable as a percentage of net sales (as defined). It is said that the royalty does not attach at the moment of manufacture, but only at the moment of sale. Furthermore, it is pointed out that all sales attract the royalty, including sales of imported goods.
But each of the royalty agreements makes it quite clear that the royalties, notwithstanding their manner of calculation, are paid in respect of the grant of an exclusive right to manufacture, use, distribute and sell (though the word ``distribute'' is not to be found in the first agreement) the particular products under the particular trade mark. The overwhelming bulk of the products involved represents goods manufactured in Australia in pursuance of these agreements. A hypothetical manufacturer, of the kind I have held sec. 18(2)(b) envisages, who manufactures identical goods under conditions similar to those which apply to the taxpayer, would have these rights. He would require to be entitled both to manufacture and also to sell, since it is his hypothetical sale to Estee Lauder with which the section is concerned. Counsel for Estee Lauder pointed out that a manufacturer could be envisaged, and I referred to this in my previous judgment, who was possessed of only a non-exclusive licence to manufacture the goods. But the question is what could reasonably be expected. If Estee Lauder's affiliates granted such a licence, I do not think it could reasonably be expected that they would take upon themselves the burden (which there is no suggestion they have ever in fact assumed) of apportioning the royalties between wholesaler and retailer, and arranging for their separate collection. There would be no need to incur the inconvenience of individual arrangements with retailers in respect of the trade marks; the right conferred on the manufacturer to use the trade marks would enable him to sell the goods to retailers for display and sale under the marks:
Estex Clothing Manufacturers Pty. Limited v. Ellis and Goldstein Limited (1967) 116 C.L.R. 254;
Pioneer Kabushiki Kaisha v. Registrar of Trade Marks (1977) 137 C.L.R. 670;
R. & A. Bailey & Co. Ltd. v. Boccaccio Pty. Ltd. (1986) 4 N.S.W.L.R. 701.
As I have indicated, there was a somewhat belated argument that, if I considered the royalties should be related to the manufacture the section requires me to hypothesise, I should nevertheless apportion them between the use of the trade marks by the hypothetical manufacturer and their use by Estee Lauder as retailer. It follows, however, from the foregoing discussion that, in my opinion, what could reasonably be expected is that the manufacturer of the identical goods envisaged by the section would bear the expense of royalties at the rate in fact paid by Estee Lauder, and would build those royalties into the price at which he would sell the goods by wholesale.
The remaining question is whether a similar situation applies to the technical service fees, or whether, as is primarily contended by Estee Lauder, there should, in respect of those fees, be an apportionment. (A secondary argument was put, somewhat faintly, that no amount should be allowed.) On this issue, evidence was given by Mr Mortlock, the company's director of finance, putting forward a suggested basis for a division of the technical service fees in the same proportions in which the services themselves were divided between manufacturing activities and selling activities. Mr Mortlock computed the number of hours spent over a particular period by employees of Estee Lauder's overseas affiliates in giving information concerning manufacturing to Estee Lauder's technical staff, and the number of hours taken up with demonstrations of selling techniques and the like. On this footing, he calculated that 13 per cent only of what was done in pursuance of the technical service agreement was related to manufacturing. He then attempted to compare the work done under
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the agreement on a quite different basis. This time, he chose to look at the number of memoranda generated by the overseas affiliates, to provide information for the assistance of Estee Lauder, over a given period. This comparison suggested that 40 per cent of the memoranda were related to manufacturing and the balance to other matters such as sales and administration. He then averaged the two results, to propose an apportionment of 26.5 per cent to manufacturing.These exercises were purely statistical; no attempt was made to assess the relative merits of memoranda or lecturing hours, or the complexity or importance of what was conveyed. Such comparisons seem to me to make no sense. It is as if you could compare the instant of discovery when Archimedes cried out ``Eureka'' with the hour spent by a salesman working out a sales talk, in order to conclude that, because the talk took longer, it must be of greater value than what Archimedes revealed! If I came to the conclusion that the technical service fees should be apportioned, for the purposes of the application of sec. 18(2)(b), I should be quite unable to find, in these exercises, any rational justification for the adoption of any particular figure. A court, no less than an administrator, is required to act on material having a logical connection with the issue:
R. v. Deputy Industrial Injuries Commissioner; Ex parte Moore (1965) 1 Q.B. 456 at p. 488. To count the hours spent, or the papers sent, in order to make a judgment on what is involved here, would be as meaningless as to adopt the procedure suggested by Lord Diplock (then Diplock L.J.) of spinning a coin or consulting an astrologer.
At the time when the technical service fee agreement was entered into, as well as at the times when the respective royalty agreements were entered into, Estee Lauder conducted its business as a wholesaler. When Estee Lauder ceased to be a wholesaler, and undertook more extensive activities in connection with selling in its new role as a retailer, neither the technical service fees nor the royalties were increased. The terms of the royalty agreements requiring submission of advertising material for approval, which I have set out, demonstrate the concern of the international group with matters related to selling, as well as with manufacturing. There is simply nothing to suggest it could be reasonable to expect, if another manufacturer were permitted to manufacture the products in question in Australia, that it would not be required to accept, and to pay for, the technical services provided by the international group on the same basis which applied to Estee Lauder, both when it was a wholesaler and subsequently. After all, the business of a wholesaler is not to be cut off at the end of the production line; it must involve some sort of selling of the product.
Certainly, some wholesalers (such as the company referred to in my earlier judgment as Kolmar) do not maintain the elaborate promotional organisation which is a feature of the business of others. But in assessing what costs could be expected to be built into the price to be determined under sec. 18(2)(b), I cannot lose sight of the fact that the technical service fees paid by Estee Lauder were not related to the quantity of services provided. This is demonstrated both by the fact that the fees did not rise when Estee Lauder changed its method of operation, and also by the fact that the agreement fixes them at a flat percentage of all sales. In those circumstances, and in the absence of any evidence to the contrary from any executive involved in the fixing of the fees, I conclude that, irrespective of whether it operated as a wholesaler or as a retailer, Estee Lauder had to bear these royalties and technical service fees, and that it could not reasonably be expected the notional wholesaler would be able to produce identical goods without incurring the obligation to meet both the royalties and the fees. If the notional wholesaler is to be seen as manufacturing the goods under conditions similar to those which apply to Estee Lauder, these amounts are borne by Estee Lauder as a condition of its manufacturing the products in Australia, just as they were borne by it when it was a wholesaler. In my earlier judgment, I excluded expenses borne by it in its new role as a retailer, the statutory test being a notional wholesale price; but it seems to me that the proper conclusion with regard to the royalties and technical service fees, on the evidence, is that they are inescapable expenses incurred to enable manufacture to take place in Australia. Furthermore, no evidence has been led which would provide any basis upon which any particular part of these royalties and fees could properly be apportioned, so as to limit the amount attributable to manufacture.
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Certain other issues originally raised in connection with the short minutes have, I understand, been resolved between the parties. The only order I make now is that I direct Estee Lauder to bring in further short minutes on a date to be fixed, when I shall also hear the parties as to the appropriate order in respect of costs.
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