[1993] FCA 606; (1993) 47 FCR 388

Practice And Procedure - Federal Court - damages - liability of the award of damages to capital gains tax - whether liability to capital gains tax should be taken into account in awarding damages - calculation of interest reduced because of delay.

Federal Court of Australia Act 1976 (Cth)

Murray v. Commonwealth of Australia (1986) 5 NSWLR 83;

Carborundum Realty Pty Ltd v. RAIA Archicentre Pty Ltd (1993) ATC 4418;

Zim Properties Ltd v. Proctor (1984) 58 TC 371

Solicitor for the Applicants: Vaughan Zarb and Capolupo

Solicitor for the Third Respondent: Maurice May and Co.

1. There be judgment for the first applicant against the second and third respondents in the sum of $657238.

3. The second and third respondents pay the first applicant's costs of the claims generally.

4. The first applicant pay the respondents' costs of the hearing on 24 November 1993.

NOTE: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.

DAVIES J On 30 September 1993, I handed down Reasons which set out my general findings on the claims made by Namol Pty Limited ("Namol") and Mrs Maria Nagy against the second and third respondents, Quinlara Pty Limited ("Quinlara") and Joseph Bailey. The applicants alleged breaches of copyright by both Quinlara and Mr Bailey and breaches of the fiduciary duty which Mr Bailey had owed to Namol as its director and employee. I found that the claims made by Namol had been established.

2. During 1985, Namol had been appointed sub-contractor for the manufacture, installation and glazing of architectural bronze doors and windows for the Commonwealth Bank Building in Martin Place, which was to be restored. To carry out those works, Namol prepared detailed working drawings required for the construction of the doors and windows. Copyright in those plans resided in Namol. In late 1985, Mr Bailey resigned as a director and employee of Namol. He arranged for the copying of Namol's drawings and he arranged for Quinlara to obtain the sub-contract in place of Namol. It is unlikely that Quinlara would have obtained that sub-contract had it not taken advantage of Namol's plans.

3. I assessed damages at $500,000, of which I said that perhaps $350,000 could be taken as representing compensating damages for infringement and $150,000 for additional damages for aggravated breach pursuant to s.115(4) of the Copyright Act 1968 (Cth). I thought that no additional sum need be added for Mr Bailey's breach of fiduciary duties. I directed that counsel should bring in minutes with respect to the interest sought and any adjustments that may be required by reason of the taxation laws.

4. Interest should be added in accordance with s.51A of the Federal Court of Australia Act 1976 (Cth). It is the usual practice of the Court when sitting in New South Wales to adopt the rates set out in Schedule J to the Rules of the Supreme Court of New South Wales. This is because those rates reflect commercial rates of interest, which is not the case for the rates prescribed in Order 35 r.8 of the Federal Court Rules. The practice has the policy advantage of ensuring that damages are awarded on the same basis whether a matter be instituted in this Court or in the Supreme Court of New South Wales.

5. Counsel for Namol sought interest from 1 January 1986. However, in my opinion, interest should not run until the date of the institution of these proceedings, 25 September 1990. Namol instituted proceedings in the Supreme Court of New South Wales on 29 October 1986 against the first respondent, A.W. Baulderstone Pty Limited, claiming damages for breach of contract or, in the alternative, a sum based on a quantum meruit claim for work done. The present proceedings were not instituted until after an arbitrator, the Honourable R.G. Reynolds QC, had brought in an award on those matters. It appears from reasons, which I delivered on 27 March 1992 on an interlocutory motion in the present proceedings, that the plans prepared by Quinlara came into Namol's hands about a fortnight before the hearing before the arbitrator. But the evidence before this Court does not show whether, at an earlier time, Namol knew or suspected that Quinlara's plans were similar.

6. It seems to me that it would be unfair to Mr Bailey, who may have to meet the damages award out of non income earning assets such as his house, to award interest during the long delay which occurred before these proceedings were commenced. By early January 1986, Namol was aware that Mr Bailey and the chief draughtsman of Namol, Mr John Dowsett, had joined Quinlara and that Quinlara was undertaking work on the Commonwealth Bank sub-contract.

7. I shall therefore award interest at the rates set out in Schedule J of the Rules of the Supreme Court of New South Wales from 25 September 1990 to the date of this order.

8. Interest should be awarded only on that element of the award which represents compensatory damages, that is to say, on the sum of $350,000. It is not the usual practice to award interest on exemplary damages. See Murray v. Commonwealth of Australia (1986) 5 NSWLR 83; (1988) Aust Torts Reports 80-207. Section 51A(3)(c) indeed expressly provides that interest shall not be awarded for exemplary or punitive damages. The damages here awarded under s.115(4) have that general character.

9. Accordingly, before taking tax into account, the award will consist of the elements of $350,000 compensatory damages, interest thereon of $157238.7, and $150,000 under s.115(4), a total of $657238.

10. Counsel for Namol submitted that the damages should be made up of the $500,000 damages and interest $508,046.55, a total of $1,008,046.55. Counsel calculated that interest from 1 January 1986 at the rates prescribed under Order 35 Rule 8 of the Federal Court Rules. This requires adjustment as I have mentioned, but for the purpose of further discussion, it is useful to refer to counsels' figures. Counsel submitted further that liability to capital gains tax should be taken into account and submitted that the rate of capital gains tax would be 33%, the ordinary rate of company tax. Counsel submitted that there would be no deduction for cost and impliedly submitted that Namol had no deductible losses to take into account. On this footing, counsel sought to arrive at a figure which, when taxed at 33%, would leave the applicant with a net of $1,008,046.55. The total sum required, on counsels' calculation, was $1,504,845.50.

11. The effect of counsels' submission was that the compensatory damages of $350,000 added to the aggravated damages of $150,000 and interest of $508,046.55 should be then increased by a further sum for the potentiality of capital gains tax. A 50% addition for capital gains tax was required because, on counsels' submissions, once the overall damages were subject to capital gains tax, then capital gains tax would be payable not only on the original amount of the award but also on the sum included to compensate for capital gains tax.

12. Counsel further submitted a complicated order providing for the payment into Court of the tax element, or the delivery of a duly executed and binding irrevocable covenant issued by a satisfactory trading bank whereby the bank covenanted to pay to the first applicant a sum not less than the tax element. On this payment in or delivery, judgment as to the tax element was to be stayed pending final determination of the liability of Namol for tax in respect of the judgment. The proposed order giving effect to this was some 4 pages in length.

13. As for the reasons I shall set out, I do not propose to alter the award of damages for the potentiality for capital gains tax thereon, I need not express concluded views on the operation of the relevant provisions of the capital gains legislation. Nevertheless, it may be useful to make some general observations with respect to that legislation and with respect to an award of damages to take that legislation into account.

14. The first observation I would make is that adjustments of awards of damages for taxation ought to be made on proper evidence. In the present case, there is no affidavit or even a written opinion before the Court as to the likely potential of Namol for capital gains tax upon the damages awarded in this matter. I have the firm view that, if capital gains tax is to be taken into account, there should be at least an opinion of an experienced tax practitioner as to the likely tax consequences of the judgment and as to the basis on which that opinion is held.

15. Secondly, I would comment that the order submitted by counsel for Namol is so extraordinary and so inconsistent with the approach of the common law to the assessment of damages, which is to award a fixed sum having regard to the probabilities of the case, that I am satisfied that no court would adopt it. In this respect, I take comfort from the experience in the United Kingdom which has had capital gains tax legislation since 1965. I have not been referred to any decision in the United Kingdom which has adjusted an award of damages for capital gains tax purposes as counsel for Namol seeks to do in the present case.

16. I cannot accept that it is in accordance with the ordinary principles of assessing damages to include a contingency of the type proposed by counsel. Ordinarily, damages are assessed on the probabilities of the case. But if risks or possibilities have to be taken into account because they are part of the matrix of relevant facts, then a court must do the best it can and will adjust the award to take account of that risk or possibility. It is inconsistent with common law principles to make a conditional order either providing for an additional award should a certain event occur or reducing or providing for a reduction of an award should an expected event not come to pass. In the circumstances of the present case, I am of the view that the ordinary common law principles should be applied.

17. Moreover, I do not accept the submission of counsel for Namol that the amount of all judgments for compensation for loss resulting from the wrong or default of another are, or the amounts paid pursuant to such judgments are, chargeable to capital gains tax under the provisions of s.160M(1) and (3) or under s.160M(7) of the Act. In my opinion, the capital gains tax legislation is concerned with imposing tax on gains arising from the holding or the use or the exploitation of assets or, under s.160M(6), from the creation of an asset which is vested in another person. It is foreign to the context and purpose of the capital gains provisions to regard them as applying to the ordinary circumstance of compensation for loss brought about by the act or default of another person.

18. Neither the charging provisions nor the provisions dealing with the ascertainment of the cost base are appropriate to such a circumstance. Thus, in dealing with costs, s.160ZH(1) refers inter alia to the amount of any consideration in respect of the acquisition of the asset, the amount of the incidental costs to the taxpayer of the acquisition of the asset and the costs incurred in establishing, preserving or defending the taxpayer's title to or right over the asset. These provisions are not apt to include damage to an asset caused by the wrongful act or default of another. Indeed, s.160M(7) specifically excludes by para (d) most of the costs and expenditure referred to in s.160ZH. If counsel for Namol were correct, compensation awarded for loss would be likely to be brought to account as a taxable gain without any regard being had to the loss and damage which it compensates. If so, the result would be inconsistent with the general intent of the legislation that only net gains are chargeable to tax.

19. I agree with the general thrust of the remarks of Harper J. in Carborundum Realty Pty Ltd v. RAIA Archicentre Pty Ltd (1993) ATC 4418. As presently advised, I am of the view that judgments for compensation for loss do not ordinarily fall within the capital gains legislation. Thus, if a private vehicle was damaged in an intersection collision and if the owner sued and recovered the cost of repairs, I am of the view that the events including the judgment would be totally outside the concern of the capital gains tax legislation. No element of gain would be involved, merely financial loss which was compensated for by an order of a court.

20. That is not to say that, in appropriate cases, awards of damages will not be the subject of capital gains tax. If an award reflects compensation for a gain that would have been made but for a wrongful act or default, then there is no reason in principle to regard the sum awarded or the payment thereof as having other than the same character as the gain would have had. See, eg., Zim Properties Ltd v. Proctor (1984) 58 TC 371. Likewise, if the wrongful act or default results in the entire loss or destruction of an asset or of a part of an asset so that the event attracts the attention of the capital gains legislation by virtue of s.160N, then compensation for that loss or destruction would, I assume, be within the ambit of capital gains tax. In the present case, there is no such circumstance.

21. I do not read s.160ZB(1) as being inconsistent with the point I have been putting. Parliament may well have intended to make it clear that compensation for personal injuries, which would include compensation for other than financial loss of a capital nature, and compensation for matters such as defamation affecting a person in his or her professional vocation would not be the subject of capital gains tax. The reason for making such express provision may be that, without it, it could be thought that compensation for other than financial loss resulted in a chargeable gain.

22. I am therefore not satisfied that the award of damages in the present case would be subject to capital gains tax or that it would accord with the principles upon which the assessment of damages proceeds to make any adjustment in respect thereof.

23. I now turn to three reasons why, in any event, I would not make any allowance for capital gains tax in the circumstances of the present case:-

(i) The $350,000 compensatory damages were calculated by

reference to profits from the exploitation of the copyright

in the plans which were lost by reason of the respondents'

actions. In assessing the $350,000, I made no allowance for

income tax on the profits which Namol would have earned from

the carrying on of that sub-contract. As Namol would have

been subject to income tax on any income derived from that

sub-contract, and as its financial returns from the use of

the plans would have been reflected in that income, and thus

subject to income tax, it is not inconsistent with the award

for compensation to accept that Namol should pay capital

gains tax upon that $350,000. The overall result of the

different bases of taxation would not be the same but there

is no material before the Court which would enable any

precise quantification of the different liabilities to be

made. Thus, in Pennine Raceway Limited v. Kirklees

Metropolitan Council (No 2) (1989) STC 122, it was held

that, although there was no certainty in that case as to the

type of tax that would be levied, whether capital gains tax

or income tax, it was not necessary for the Court to decide

such a matter in the assessment of damages.

(ii) Secondly, I think there is no need to adjust the award for

any possible capital gains tax on the element of $150,000

constituting the award for aggravated default. That award

is not an award of compensation but is imposed to reflect

the Court's view of the seriousness of the respondent's

conduct. The sum is imposed because of the respondents'

conduct, not because of loss suffered by Namol. If the tax

laws require the payment of capital gains tax on that sum,

then that is simply what the laws of the land provide.

(iii) Similarly, there is no need to adjust the award by reason of

the fact that Namol may have to pay capital gains tax upon

the interest element of the award. If Namol received that

interest as interest it would be subject to income tax. It

will not be so subject to income tax simply because the

interest figure is included in one overall lump sum which

does not have the character of income. See McLaurin v.

Federal Commissioner of Taxation [1961] HCA 9; (1961) 104 C.L.R. 381. But

if capital gains tax is payable on the interest element,

that is not a reason for adjusting the award. The Court

does not aim to ensure that Namol will receive the interest

element tax free.

24. In the circumstances of the particular case, therefore, it would not be appropriate to make any allowance for capital gains tax.

25. For these reasons, there will be judgment for the first applicant against the second and third respondents in the sum of $657238. The application by the second applicant will be dismissed. The second and third respondents should pay the first applicant's costs generally of its claim against them. However, the first applicant should pay the respondents' costs of the hearing this day, as the motion to have an element included in the judgment for potential capital gains tax has been refused.