The treatment of sums received for allowing other concerns to
use the taxpayer’s intellectual property depends on the
precise circumstances of the transaction.
In the case of Jeffrey v Rolls-Royce Ltd [1962] 40TC443 sums
received under agreements entered into with companies etc. in a
number of countries for the sale of ‘know-how’ relating
to aero-engine manufacture were held to be trading receipts.
During the manufacture of aero-engines Rolls-Royce had
engaged in metallurgical research and the development of
engineering techniques and acquired a fund of technical knowledge
commonly called ‘know-how’. During the period 1946 to
1953 Rolls-Royce entered into a number of agreements with foreign
governments and companies under which it agreed to supply
information necessary to construct certain engines which it had
developed and to license the other party to manufacture these
engines. For example, by an agreement with the Republic of China
the company undertook to license the Chinese to manufacture a
Rolls-Royce jet aero- engine and to supply the necessary
information and drawings; to advise them from time to time as to
improvements and modifications in manufacture and design; to
instruct Chinese personnel in their works and to release one or two
members of their own staff to assist in China with the manufacture
of the engine in consideration of the payment of ‘a capital
sum of fifty thousand pounds’ plus royalties. Agreements in
similar terms were entered into with the governments of Argentina,
Belgium and Australia and companies in France, the United States
and Italy. Some of these agreements provided for payment of an
annual technical liaison fee in addition to the
’capital’ sum.
Rolls-Royce contended that the sums received related to the
sale of a capital asset and were not trading receipts. The Revenue
contended that the sums received under the agreements were normal
receipts of a revenue nature of the trade or business carried on by
Rolls-Royce.
On page 492 Lord Reid explained why the money that
Rolls-Royce received was taxable income. Rolls-Royce had not
disposed of any capital asset; the company retained all of the
rights and knowledge in undiminished form. What Rolls-Royce had
done was to exploit its capital assets by granting licences and
teaching the licensees how to make use of them:
I cannot accept the contention that by each of these agreements the company sold a part of that capital asset and received a price for it. There is nothing in the case to indicate that that capital asset was in any way diminished by carrying out these agreements. The whole of its knowledge and experience remained available to the company for manufacturing and further research and development, and there is nothing to show that its value was in any way diminished. The company had not even given up a market which had been open to it. It could not sell its engines in these countries whether it made these agreements or not. If it had not made these agreements, it would have got nothing from these countries; by making them it was able to exploit its capital asset by receiving large sums for its use there. In essence, what it did was to teach the "licensees" how to make use of the "licences" which it granted.
Lord Reid also considered it important that Rolls-Royce had made a policy decision to exploit its assets in this way and had entered into a series of such transactions. Finally Lord Reid dismissed Rolls-Royce’s claim that these transactions were not a part of its trade of aero-engine and motor car manufacture:
…the facts of this case clearly indicate that this course of granting "licences" was merely an extension of its existing trade devised to meet the difficulty that it could not sell its engines in the countries of the "licensees". It was merely another method of deriving profit from the use of its technical knowledge, experience and ability. The company sought to rely on the fact that in the assessments appealed against its trade is described as "manufacturers of motor cars and aero engines", but I see no reason why there should have to be set out a full description of the taxpayer's trade, and this abbreviated description in no way misled the company.
You should note that Upjohn LJ distinguished Rolls-Royce from Evans Medical Supplies Ltd v Moriarty [1957] 37TC540 (see BIM35705) because (40TC at foot of page 486 and head of page 487).
Pearce LJ agreed with Upjohn LJ’s distinctions and added another. The payments in Rolls- Royce were for essentially transient knowledge whereas in Evans Medical (see BIM35705) there was a greater degree of permanence (40TC at the head of page 486):
The knowledge sold in this case is not some secret of permanent value sold by an owner who is transferring or terminating his business. Such a sale would clearly be the sale of a fixed asset.
Rolls-Royce did not give up any trade in the countries to which
it transferred know-how whereas Evans Medical lost its Burmese
trade.
In the case of Murray v Imperial Chemical Industries Ltd
[1967] 44TC175 the UK company granted licences or sub-licences to
seven overseas companies. ICI held an exclusive licence from Calico
Printers Association Ltd to exploit throughout the world (except in
the United States ) the rights under a number of patents taken out
by Calico Printers Association Ltd in respect of a process for
manufacturing a man-made fibre. ICI was empowered at its discretion
to grant sub- licences in respect of the patents to third parties,
and itself took out a number of ancillary patents in respect of the
same process.
ICI granted sub-licences in respect of the original, and
licences in respect of the ancillary, patents to five western
European and two Japanese companies. The agreements with the
European companies provided, inter alia, for royalties on the basis
of sales, etc., and for ICI to give the licensees technical
assistance without any separately expressed consideration. They
also contained a covenant by ICI, for itself and Calico Printers
Association Ltd, in consideration of lump sums payable in
instalments, that for a stated period neither ICI nor Calico
Printers Association Ltd would manufacture or sell, or aid any
third party to manufacture or sell, in the licensees' territory,
products (whether made under the patents or not) of a character
similar to those made under the patents. The agreement with the
Japanese companies was on similar lines but in terms such that the
lump sum payable thereunder was found to be payable half for
technical assistance and half for a covenant against competition.
The Court of Appeal found that the covenants against
competition, being ancillary to patent licences granted for the
term of the respective patents, were part and parcel of
transactions which, taken as a whole, constituted dispositions by
ICI of part of its fixed capital and so the lump sums received were
not income.
In the case of Wolf Electric Tools Ltd v Wilson [1968]
45TC326 a UK company disclosed certain ‘know-how’ to an
associated foreign company in return for shares therein. The issue
was whether the value of shares was capital or income.
Wolf carried on business as mechanical and electrical
engineers. In particular, it manufactured electric power tools, in
which it had an extensive export trade. About 1950 its sole agency
in India was taken over by Rallis India Ltd, an Indian company,
which bought from the company on a principal to principal basis. In
1954, when the company's exports to India represented over 10% of
its total exports, Rallis India Ltd informed the company that,
because of the Indian government’s policy of encouraging the
setting up of local factories for making tools, the whole market
would be lost unless Wolf undertook to manufacture tools in India.
Preliminary arrangements to that end were made in 1956, and in 1958
Ralliwolf Private Ltd was incorporated in India to carry on
Wolf’s trade in tools selected for manufacture there; the
government of India consented to the formation of Ralliwolf Private
Ltd on condition that Rallis India Ltd took a majority
shareholding, which in the event was 55%. In 1959 Wolf subscribed
for the remaining 45% (9,000 Rs. 100 shares) of the issued capital
of Ralliwolf Private Ltd, in consideration, as to 5,375 shares, for
the transfer of plant and equipment for the Indian factory, and as
to 3,625 shares, for the supply of drawings, designs, technical
knowledge, etc. Wolf also agreed with Ralliwolf Private Ltd to
‘keep out’ of India and Nepal, as regards the selected
tools, for 10 years.
Wolf contended that the information in question was a capital
asset of its trade and the disclosure thereof an investment
operation; alternatively, that the shares were received as
consideration for the ‘keep-out’ agreement. The Revenue
contended that the transaction was a method of increasing Wolf's
income as mechanical and electrical engineers by using know-how to
the best advantage in a market which might otherwise be closed, and
that the ‘keep-out’ agreement amounted, not to an
outright sale, but merely to an assignment for 10 years in respect
of the selected tools only.
On page 340 Pennycuick J in the High Court took the view that
the effect of the entire transaction was simply to alter Wolf's
capital profit-making structure. So that, instead of having its own
goodwill in India as regards the selected tools, Wolf acquired a
45% interest in Ralliwolf Private Ltd and thence forward derived
its profit through those shares.
In a case such as the present, the effect of the whole arrangement - and I must look at the whole arrangement - is that the trader receives a new capital asset, namely, the shares in the foreign company, in exchange for that which he previously had, namely, his connection or goodwill in the foreign country. That is a transaction of a wholly capital nature.
The transaction was on capital account and the money received was not taxable income.
