SMITHKLINE BEECHAM LABORATORIES (AUSTRALIA) LTD v FC of T
Judges:Hill J
Court:
Federal Court
Hill J
At issue between the parties is the right of Smithkline Beecham Laboratories (Australia) Ltd (``the applicant'') to deduct legal costs of $144,973.03 and $564,673.44 incurred by it in the years ended 31 December 1989 and 31 December 1990, being substituted accounting periods for the years of income 30 June 1990 and 30 June 1991 respectively. The costs in question were incurred by the applicant in respect of two applications brought in this Court, the one by the applicant (amongst other parties) against the Secretary, Department of Community Services & Health, and the other by Alphapharm Pty Limited (``Alphapharm'') against the Secretary, Department of Community Services & Health, to which the applicant was a respondent. The judgment in these proceedings is reported at first instance at (1990) 22 FCR 73. The applicant was unsuccessful in each of these proceedings. It then appealed unsuccessfully to the Full Court of this Court and the judgment of the full court of this Court is reported in (1991) 28 FCR 291. Although not relevant to the present proceedings, an application for special leave to the High Court was refused.
The background to this litigation may be shortly stated. The applicant, which is incorporated in the United Kingdom, markets in Australia, inter alia, pharmaceutical products under licence from related companies overseas. Those products are in the main the result of extensive research. Some of the products, in addition to being marketed in Australia, are also manufactured by the applicant. One such product is a product the active ingredient of which is cimetidine, sold in Australia under the trademark Tagamet through pharmacies and supplied in tablet and ampule form to the Commonwealth Serum Laboratories under the trademark Duractin.
In this judgment the word ``cimetidine'' is used to refer not only to the ingredient used in Tagamet and Duractin but also, as appropriate, to refer to these two products. Cimetidine was invented by employees of a related company, Smithkline & French Laboratories Limited, in the United Kingdom, which company is the holder of Australian letters patent number 460353 in respect of that product of which the applicant is licensee. The patent had a priority date of 15 February 1972 and as originally granted was therefore due to expire on 15 February 1988. However, in August 1987 proceedings were commenced in the Supreme Court of New South Wales for an extension of the term of that patent for a period of 10 years. In fact an order was ultimately made on 14 December 1992 extending that patent for a term of 6 years from 15 February 1988.
At the relevant time importation to Australia of cimetidine, being a therapeutic substance, was prohibited by virtue of regulations made under s. 50 of the Customs Act 1901 (Cth) (the Customs (Prohibited Imports) Regulations), unless approved by the Secretary, Department of Community Services & Health (``the Secretary''). In practice this meant that the product had to be approved for marketing by the Drug Evaluation Branch of the Therapeutic Goods Administration Division of the Department. To obtain that approval the applicant, on various occasions since 17 June 1975, delivered to officers of the Department, documents containing information relating to the chemistry and quality control of the products which it proposed to sell under the Tagamet or Duractin trademarks.
Some time in 1986, Drug Houses of Australia Pty Limited (``DHA'') applied to the Secretary for permission to market a cimetidine product upon the expiry of the patent in February 1988. It was that application which precipitated a letter of 8 April 1987 from the then managing director of the applicant, Mr Perrin, to the Secretary seeking an undertaking that
ATC 4631
information disclosed by the applicant in connection with the approval to market its own products not without the applicant's consent be used by the Department for its purposes, especially for the purpose of evaluating products other than those of the applicant. When this undertaking was not forthcoming, Mr Perrin wrote again to the Secretary seeking an undertaking that when considering any application for approval of clinical trials or for marketing cimetidine in Australia the Department would not, without the prior written consent of the applicant, use any confidential information in relation to cimetidine which had been disclosed by it to the Department. No undertaking being received to either of these requests, the applicant, in November 1987, commenced the proceedings in this Court to which reference has been made.The request for the undertakings and/or the commencement of the litigation had the effect of causing DHA to abandon its application to market a competitive product. This was an effect which was desired by the directors of the applicant and was the objective in view when the proceedings in this Court were commenced. However, another potential competitor, Alphapharm, a marketer of generic pharmaceutical products, applied on 14 July 1988 for a general marketing approval in respect of a brand of cimetidine in tablet form to be marketed under the name Cimet. According to the evidence the Alphapharm product might not have shared all of the same physical characteristics of the applicant's products.
The Secretary took the view that the Department could not proceed with Alphapharm's application because the applicant had obtained relief in the form of an interlocutory injunction restraining the Secretary from using the information supplied by the applicant to evaluate Alphapharm's product. That interlocutory relief had been granted on 10 November 1987. In consequence Alphapharm commenced its own proceedings in this Court claiming that the Secretary was at liberty to use the applicant's information for the purpose of determining Alphapharm's application for marketing approval and seeking an order in the nature of mandamus requiring the Secretary to determine its application in accordance with law. To these proceedings the applicant was joined as a respondent.
In the proceedings which the applicant had commenced, Smithkline & French Laboratories Limited, the company which had invented cimetidine and had originally supplied the applicant with the research material, was also an applicant. During the course of the proceedings there were joined as well other companies related to the applicant, being Smithkline Beecham Corporation, Laboratoire SmithKline & French SA and SmithKline Dauelsberg GmbH as some of the confidential information had been sourced from these other companies. The other companies did not take any active role in the proceedings.
As already indicated, the applicant's proceedings were unsuccessful before Gummow J. It is not necessary to consider in detail the reasons why that was so. Suffice it to say that the central issue in the case was whether the information in question was received by the Secretary in such circumstances as to import an obligation of confidence. His Honour held that while the information in question was supplied to the Secretary on the implicit understanding that it would be kept confidential in the sense that it would not be disclosed to any other pharmaceutical company, that did not preclude the Secretary using the information for his own purposes to evaluate the drugs of competitors in respect of which approval was sought. That decision was upheld by the full court. Additionally, a submission that the regulations in question were invalid as involving an acquisition of property on unjust terms in conflict with s. 51(xxxi) of the Constitution failed.
Although the case was opened before me on the basis that the object in view in commencing the litigation and pursuing it was an apprehension on the part of the applicant that recourse to the information might facilitate the speedier and less costly progress into the market of a competitor and that that object was not to stop competitors altogether, the evidence of Mr FJ Amor, a financial manager of the applicant at the time who had been ``intimately involved'' with the proceedings and who, although not then a director of the applicant was so now, made it clear that the contemplation in bringing the proceedings was that such proceedings would prevent the registration of any other product and in continuing those proceedings after Alphapharm had become a party it was expected, at least by Mr Amor and
ATC 4632
by the Board, that the Department of Health would be unable to evaluate applications made by potential competitors if an injunction were maintained. This conclusion is not particularly startling. As a matter of common sense, if research data potentially costing millions of dollars was needed for the evaluation of a product and that data was to be unavailable to a party seeking approval, the likelihood was that, as a commercial matter, that approval would not be granted to that party, or alternatively that the party would discontinue with its application because of the inability to fund expensive research itself.I find that the purpose of the applicant in commencing and indeed in prosecuting the proceedings, was a desire to exclude so far as this was possible competitors from gaining approval of competing products. I accept the applicant's submission that the applicant did not wish competitors to ride into the market, as it was put, ``on the coat tails'' of the information which the applicant had supplied to the Secretary and which information involved considerable expense and effort to obtain. But that is but the other side of saying that the applicant wished if possible to exclude competitors from being able to compete and to the extent that it was impossible so to do, to ensure that any competition was delayed for as long as possible. As Mr Amor said, the applicant was concerned to preserve the market share for its product. If a competitor were to obtain approval then the applicant's market share of the market in cimetidine products would be reduced and obviously with that reduction would come a reduction in its profit.
There was tendered the appeal books in the full court containing, inter alia, the transcript of evidence taken before Gummow J. In his cross- examination in those proceedings, Mr Perrin said that the concern of the applicant was with protecting the ``whole body of knowledge that surrounded our investment in cimetidine''. He saw his duty as being to afford the maximum protection of the ``asset'' being the information which the company was seeking to protect in the proceedings. He too agreed, however, that the effect of protecting the information by bringing the proceedings was effectively to keep generic competitors out of the market. The following interchange occurred between Mr Garnsey, counsel for the respondent in the proceedings, and Mr Perrin.
Mr Garnsey: ``Well, it would be correct to say, would not it, that the effective result of successful actions for breach of confidence in respect of the information that we are talking about would be to keep competitors out of the market for the indefinite future...''
Mr Perrin: ``That could well be one major outcome, one major effect.''
Mr Garnsey: ``And that was discussed and seen as a good thing, the discussions that you referred to?...''
Mr Perrin: ``Yes.''
This passage clearly enough confirms the evidence given by Mr Amor as to the applicant's underlying purpose of the proceedings being instituted and continued.
Two further factual matters remain to be noted. The applicant carries on business in Australia through two divisions. One of those divisions is concerned with pharmaceutical products, the other with animal health. In each of the divisions it is necessary to obtain registration of various products from government agencies. In each division there is some manufacture in Australia of products and goods either manufactured in Australia or imported by the applicant are marketed in Australia.
In the relevant income tax years in its pharmaceutical division the applicant manufactured some 26 pharmaceutical products and marketed in Australia 6 vaccines from overseas sources. Additionally it manufactured and marketed in Australia in the veterinary division 13 animal health products and a range of vaccines manufactured by a third party.
Sales of cimetidine products by the applicant represented 60.45% of its total pharmaceutical sales in the 1987 year and 47.5% of its total pharmaceutical sales in 1988. This percentage declined in 1989 to 33.15% and was 36.7% in 1990. Expressed as a percentage of the total Australian sales of the applicant, cimetidine represented 33.26% in 1987, 22.95% in 1988, 16.35% in 1989 and 18.18% in 1990. The sales of cimetidine expressed as a percentage of the total sales of the applicant, both in Australia and elsewhere, show that cimetidine represented 25.04% of total sales in 1987, 18.09% of total sales in 1988, 13.59% of total sales in 1989 and 14.58% of total sales in 1990. No information is given as to comparative
ATC 4633
profitability of cimetidine as against other products. Nevertheless, the conclusion can clearly be drawn that cimetidine was a very significant product in the applicant's business. It is more probable than not that in the event that the product itself in its two marketed manifestations had been lost to the applicant, that loss would not have been fatal in the sense that it would not have caused the business to cease, but it certainly can be said that the loss of that business would have had a quite significant impact upon the applicant.It is in these circumstances that the applicant submits that the expenditure on legal costs should be seen to be on revenue account and not an expenditure of capital or of a capital nature. The Commissioner, while maintaining that the expenditure on legal fees was in the circumstances capital, argues alternatively that the expenditure was incurred in order to serve the interests not only of the applicant but also of the other companies in the group of which the applicant was a member which were parties to the proceedings and especially the patentee. It is said that, as no basis for an apportionment has been suggested, the deduction must fail as the applicant would not have shown that the legal costs were incurred in gaining or producing the assessable income of the applicant or in carrying on the applicant's business.
This last submission of the Commissioner must be put to one side. It was never suggested to any witness that the legal proceedings were commenced or maintained or that the expenditure for fees thereon was incurred in order to serve the interests of others than the taxpayer. The matter not having been put, it seems to me to be unfair for the Commissioner once the proceedings are completed to make the submission, not permitting the witnesses of the applicant to affirm or deny it. In any event, I do not think as a matter of fact that the submission is maintainable.
The parties are in agreement that in determining the deductibility of legal expenses, regard must be had to the purpose for which those expenses were incurred. Where the expenditure sought to be deducted is expenditure incurred in the course of litigation, that requires consideration to be given of the purpose of the taxpayer in undertaking that litigation. As was said by Dixon J in
Hallstroms Pty Ltd v FC of T (1946) 8 ATD 190 at 195; (1946) 72 CLR 634 at 647:
``We are, therefore, remitted to a consideration of the object in view when the legal proceedings were undertaken, or of the situation which impelled the taxpayer to undertake them.''
In the same case, in a passage often quoted, Dixon J said (at ATD 196; CLR 648):
``What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process.''
It may be recalled that in Hallstroms the taxpayer had expended money on legal fees to oppose the extension of a patent of a competitor. The majority of the Court found the expenditure to be deductible but it is the judgment of Sir Owen Dixon in dissent which has in later cases been referred to with approval. In
Broken Hill Theatres Pty Limited v FC of T (1952) 9 ATD 423; (1951-1952) 85 CLR 423 the High Court had to consider the deductibility of expenditure on legal fees to oppose the grant of a licence under the Theatres and Public Halls Act 1908-1946 (NSW) which would have had the consequence of permitting a competitor to show motion pictures at Broken Hill in opposition to the taxpayer. Not only was Hallstroms case distinguished, but the view of Dixon J disapproving the decision of Lawrence J in
Southern (HM Inspector of Taxes) v Borax Consolidated Limited [1941] 1 KB 111 was specifically affirmed. That affirmation carried with it presumably the disapproval of the judgments of Latham CJ and Williams J, two of the majority in Hallstroms, both of whom relied, at least to some extent, upon Southern v Borax Consolidated Limited.
But whatever the correctness on its facts of Hallstroms case, there can be little doubt that expenditure incurred to preserve or to protect a business as such will ordinarily be expenditure of capital: cf
ATC 4634
FC of T v Consolidated Fertilizers Limited 91 ATC 4677 at 4687-4688; (1991) 101 ALR 385 at 399-400 per Spender and Lee JJ. On the other hand, where legal costs are incurred in defending the taxpayer and its officers from criticism of its methods of trading, the outgoings will clearly be on revenue account:
FC of T v Snowden & Willson Pty
The resolution of the question whether an outgoing is of capital or revenue is often greatly assisted by reference to the judgment of Dixon J in
Sun Newspapers Limited & Associated Newspapers Limited v FC of T (1938) 5 ATD 87; (1938) 61 CLR 337. In that case his Honour referred (at ATD 94; CLR 360) to the distinction between income and capital as dependent upon the distinction between the profit yielding subject on the one hand and the process of operating it on the other. Relevant to the distinction, as his Honour points out, is a difference between an outlay which is recurrent, repeated or continual on the one hand, and an outlay which is final or made ``once and for all'' on the other. Expenditure made to bring into existence or procure an asset or advantage of a lasting nature to enure for the benefit of the profit-earning subject would ordinarily be on capital account as distinct from expenditure which falls:
``within the very wide class of things which in the aggregate form the constant demand which must be answered out of the returns of a trade or its circulating capital...''
(at ATD 95; CLR 362).
In the classic statement (at ATD 96; CLR 363) his Honour said:
``There are, I think three matters to be considered, (1) the character of the advantage sought, and in this its lasting qualities may play a part, (2) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (3) the means adopted to obtain it; that is by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment.''
In the present case the expenditure in question was incurred to prevent, so far as possible, a competitor obtaining marketing approval and thereby being in a position to compete with the applicant, with the subsidiary motive that if this was not possible competition would at least be delayed. Such expenditure could not be regarded as recurrent except in the sense that the risk of a competitor arising may always be theoretically present. The chief object of the expenditure was thus to preserve from impairment and dislocation that part of the goodwill of the business of the applicant as was concerned with the cimetidine products so as to prevent a loss of market share.
No capital asset was acquired by the expenditure. But it is not necessary for a capital asset to be acquired for expenditure to be on capital account: Broken Hill Theatres (supra) at ATD 424; CLR 434 and
John Fairfax & Sons Pty Ltd v FC of T (1959) 11 ATD 510 at 511-512; (1958-1959) 101 CLR 30 at 36 per Dixon J and ATD 522-523; CLR 53-55 per Menzies J. Had the litigation been successful it is highly likely that the advantage sought of freeing the applicant from competition in respect of this product would have been virtually permanent as without access to information of the kind provided to the Secretary by the applicant the possibility of the Department being able satisfactorily to evaluate generic products similar to cimetidine would have been quite remote.
It was presumably for these reasons that counsel for the applicant was compelled to concede that if cimetidine had been the only product of the applicant or if it had been essential to the survival of the company, its whole fabric, then the legal costs incurred would have been on capital account. However, it was submitted that because, on the facts, the contribution to sales of the applicant of the product cimetidine, while not insignificant were not critical to the company's very existence, the expenditure should be seen as expenditure essential to the maintenance of the business and thus on revenue account.
In support of his submission, counsel for the applicant referred to the decision of the full court of this Court in
Magna Alloys & Research Pty Ltd v FC of T 80 ATC 4542 per Brennan J at 4554 and per Deane and Fisher JJ at 4562. In the first of those passages, Brennan J in holding that the legal expenditure in that case incurred in defending various charges brought against the directors and agents of the company was not on capital account said:
``The capital of the business was in no way increased by the expenditure incurred. True it is that the expenditure protected the reputation and goodwill of Magna's business, but the attack which was made arose out of the day to day selling activities of that business and it was the business purpose of vindicating the methods by
ATC 4635
which it was conducted that brings the expenditure within sec. 51(1).Though goodwill is a capital asset of a business it is frequently earned and maintained by the daily activities of those engaged in the business. The valuable if intangible asset of goodwill frequently grows out of activities the cost of which is a charge on revenue account (see Sun Newspapers, supra, at pp. 360, 361). Expenditure incurred in attempting to vindicate the business methods of the taxpayer, overcoming the obstacle to its trading, which had been raised by the prosecutions is properly to be regarded as a cost on revenue account.''
The second passage cited was from the joint judgment of Deane and Fisher JJ in which their Honours said:
``Except in the most indirect way, the criminal proceedings imperilled neither the business nor the capital assets of the taxpayer. As the learned judge at first instance pointed out, the gross revenue of the taxpayer continued to increase despite the difficulties with which the taxpayer was faced. The criminal proceedings in respect of which the outgoings were incurred arose out of the day to day business activities of the taxpayer. The outgoings did not involve the acquisition of any enduring or tangible asset. They represented expenditure incurred in carrying on the taxpayer's business which should properly be seen as being of a revenue character.''
That there will often be difficulty in characterising expenditure as capital expenditure or income expenditure where the expenditure is concerned to defend the taxpayer from competition is clearly illustrated by the decision of the full court of this Court in Consolidated Fertilizers Limited (supra). In that case the taxpayer expended money for legal fees in protecting confidential information being communicated to another party, a prospective competitor. The full court split on the question of whether the expenditure was capital. The majority, Spender and Lee JJ, saw the company as seeking to protect the confidential information in the ordinary course of the conduct of its business. The taxpayer was, importantly, already in possession of the knowledge and information but in order to maximise its prospective profits from that information it responded to the business threat with which it was faced. In those circumstances, as their Honours said (at ATC 4688; CLR 399):
``Any expenditure thereon would be within a class of outgoings generated by the constant demands the business had to be ready to meet. The actual recurrence of expenditure upon such a purpose need not take place nor be expected as likely for such expenditure to be in the nature of revenue... It is enough that there be a potential for such an outgoing to be met by the business.
In the present case CFL expended funds on repelling claims designed to provide an inducement for the renegotiation of commercial arrangements. The fees were incurred to allow CFL to continue its business activities without the hindrance... being applied by Cardarelli.''
There was, as their Honours said (at ATC 4688; CLR 399-400), a distinction to be made between:
``... expenditure incurred for the purpose of preserving and protecting a business as such, being expenditure for a particular purpose on an isolated occasion, and expenditure which the nature of business may require as part of the prudent management thereof.''
Davies J, on the other hand, dissenting, was of the view in the circumstances of the case that the expenditure was capital. His Honour recognised that expenditure to protect confidential information was not necessarily capital, for it could be a part of the regular operation of the business to protect such an item. Where his Honour differed with the majority was that in his Honour's view the litigation was devoted to maintaining monopolistic rights to technology. Thus his Honour said (at ATC 4684; CLR 394):
``I look upon the case as one where CFL's capital rights were imperilled and where the legal costs were incurred to consolidate and confirm rights of a capital nature, rather than as one where the outgoings were incurred in the process by which CFL used its capital to obtain regular terms, that is, in the course of the operations by which it carried on its business. The distinction in this, as in other cases, is a fine one but the expenditure seems to me to have the flavour of capital rather than of revenue.''
ATC 4636
The applicant sought to rely on the comments of the majority in that case, submitting that the present case should be seen as one not of defending the capital structure of the entire business of the applicant, pharmaceutical and veterinary, with a multitude of products, but rather as what Professor Parsons in his discussion of the area in Income Taxation in Australia, Law Book Company Limited, 1985 at par. 7.66-7.68 refers to as ``maintenance expenses'' rather than ``defence expenditure''. But as Professor Parsons in the passage cited says, and as the judgment in Consolidated Fertilizers Limited makes clear, by maintenance expenditure is meant expenditure which is in the relevant sense recurrent. This means not that the expenditure may in fact recur but rather that it is one of a broad class of expenditure which must be answered out of the returns of trade.
The fact that the legal expenditure concerned only the confidential information (and thereby indirectly the goodwill) of one product does not, in my view, require the conclusion that the expenditure is on revenue account. It is true that in determining whether an amount received is income where it is paid for the termination of some contract, the outcome may differ depending upon whether the contract brings to an end the entire business enterprise of the taxpayer, on the one hand (
Californian Oil Products Limited (In Liq) v FC of T (1934) 3 ATD 10; (1934) 52 CLR 28), or whether it related to but one of many activities of a taxpayer:
Van Den Berghs v Clark [1935] AC 431 and cf
Anglo-French Exploration Co Limited v Clayson (1956) 36 TC 545 at 557;
Heavy Minerals Pty Limited v FC of T (1966) 14 ATD 282; (1966) 115 CLR 512 and
Allied Mills Industries Pty Limited v FC of T 88 ATC 4852 and on appeal, 89 ATC 4365.
But while those cases are not necessarily irrelevant, the distinction depends in part upon the role the contract plays in the business enterprise of a taxpayer. In Californian Oil Products the whole capital structure of the business was brought to an end by the payment. That was not the case in Heavy Minerals (see per Windeyer J at ATD 284; CLR 517). So in
The Federal Coke Company Pty Limited v FC of T 77 ATC 4255, Brennan J at 4273 expressed the view that it was the character of the asset itself in respect of which the payment was received which gave character to the receipt in the hands of the recipient. His Honour expressed the enquiry to be ``whether the congeries of the rights which the recipient enjoyed under the contract and which for a price he surrendered was a capital asset''.
The applicant's submission cannot be accepted in the broad way it is put. For example, the mere fact that legal expenses were incurred in defending one of a number of patents or in extending the life of one of a number of patents would not mean that the expenditure was, for that reason, on revenue account. The application of the tests set out in Sun Newspapers would ordinarily lead to the conclusion that the outgoing in such a case was an outgoing of capital.
Looking at the matter commercially, the applicant had a large body of confidential information comprising scientific and marketing research which would justify the description of property in ordinary parlance, if not the legal meaning of that word: cf
JV (Crows Nest) Pty Limited v Commr of Stamp Duties (NSW) 85 ATC 4198;
Pancontinental Mining Limited v Commr of Stamp Duties (Qld) 88 ATC 4190 and
Moriarty v Evans Medical Supplies [1958] 1 WLR 66;
Musker v English Electric Co Limited (1964) 41 TC 556 and
Rolls-Royce Limited v Jeffrey [1962] 1 WLR 425. This body of knowledge contributed greatly to the goodwill of the applicant because without it it would be very difficult, if not impossible, for a competitor to obtain permission to market a competing product.
The applicant was concerned not to protect this body of knowledge from third parties as such because there was no risk to it that the Secretary would disclose the information directly to competitors. The concern was to preserve the commercial monopoly which the applicant had from competition. It is true that the applicant also had a legal monopoly, so far as the patent is concerned, so that a product which infringed that patent could, until the patent expired, be prevented from coming into the market. But of course there were two possibilities. The patent might, when it expired, not be renewed, or a product could be devised which was sufficiently different so as to ensure that the generic product did not infringe the patent. By what was once and for all expenditure the applicant hoped to preserve its goodwill in the product, if not forever, certainly for a substantial length of time. The expenditure to enable this to happen was for that reason, in
ATC 4637
my opinion, not expenditure on maintenance, as submitted by the applicant, but expenditure in relation to the very business structure of the applicant itself and thus expenditure of capital.I would accordingly dismiss the applications in respect of each year and order the applicant to pay the Commissioner's costs of them.
THE COURT ORDERS THAT:
(1) Application in each of matters NG710 of 1992 and NG711 of 1992 be dismissed.
(2) Applicant to pay respondent's costs of the applications.
This information is provided by CCH Australia Limited Link opens in new window. View the disclaimer and notice of copyright.