1. The following question has been referred to this court under s. 256(1) of the I.T. Act, 1961, at the instance of the Revenue :
'Whether, on the facts and in the circumstances of the case, the value of 3,625 shares in the Indian company, Ralliwolf Ltd., of Rs. 100 each, issued to the non-resident assessee in consideration of supplying the drawings and information is of capital nature or of revenue nature ?'
2. The assessee in this case is a non-resident company, Wolf Electric Tools (Holdings) Ltd., hereinafter referred to as the Wolf company. The Wolf company was mainly concerned with the manufacture of electric power tools. It had evolved various production methods and a series of drawings, jigs, processes and Schedules of manufacture, It had extensive export trade and its export trade with India was mainly carried on through two agents in Bombay and Calcutta, since before 1933. In 1950 the sole agency of the Wolf company in India was taken over by Rallis India Ltd. (hereinafter referred to as 'Rallis'). In 1954-55 the Wolf company's export to India amounted to 10% of its total exports by volume and a larger percentage by value. The volume of export business with India represented the Wolf company's largest export market outside the countries where it maintained its own branches. In 1954 Rallis informed the World company that because of the Indian Government's policy of encouraging the setting up of local factories for making tools, unless the company undertook to manufacture in India, the whole of the Indian market would be lost.
3. In 1956 there was an agreement between the Wolf company and Rallis for the assembly and partial or complete manufacture of certain tools in India under the name 'Wolf' and this arrangement was to continue till a new company was promoted and commenced business. On October 31, 1958, M/s. Ralliwolf Ltd., hereinafter referred to as the 'Ralliwolf : was incorporated in India on the condition that Rallis would be the majority shareholders. The issued capital of Ralliwolf was of 20,000 shares of Rs. 100 each.
4. A reference to there agreements dated January 5, 1959, February 16, 1959, and August 19, 1959, is now necessary. The agreement dated January 5, 1959, was between Rallis India Ltd., and Wolf Electric Tools (holdings) Ltd., whereby Rallis agreed to take 55% of the issued share capital of Ralliwolf Ltd. and Wolf company agreed to take the remaining 45% of such share capital, i.e., 9,000 shares of rs. 100 each. The main object of Ralliwolf was the manufacture and marketing in India of portable electric tolls and components thereof. One of the terms of agreement of January 5, 1959, was that Wolf company had undertaken with Rallis to execute within three months from the date of the agreement, an agreement with Ralliwolf whereby in consideration of the issue to Wolf Company of 3,625 fully paid equity shares of Rs. 100 each of Ralliwolf Ltd., wolf company would, without further consideration or payment, supply to the company (Ralliwolf) certain electric tools and associated accessories as set out in the schedule hereto (hereinafter referred to as the selected tools) all present and future drawings, designs, schedules, technical knowledge and data relating to the selected tolls'. The remaining 5,325 shares were subscribed by the Wolf company in consideration of the transfer of certain plant and equipment to enable the Indian factory to commence work. The provisions of the agreement dated January 5, 1959, were implemented by the two other agreements.
5. The second agreement dated February 16, 1959, was between the Wolf company and Ralliwolf according to which in consideration of the issue of 3,625 shares in the capital of Ralliwolf the Wolf company was to provide and make available to Ralliwolf all present and future drawings, designs, schedules and technical knowledge and data necessary for the establishment, erection and installation of the factory and the production of selected tools. Wolf company was also to supply to Ralliwolf designs and layouts for the erection of plant including machinery and equipment and all other requisites and were to supply full data and specifications with drawings and instructions and all other information relating to the machinery and equipment necessary for the manufacture or assembly of selected tools. Wolf company was also to grant or assign to the company :
(a) all Indian patents held or to be held by Wolfs in relation to the selected tools and the benefit of all pending negotiations for acquisition of Indian patents;
(b) the full benefit of all future inventions which shall be made by Wolfs in connection with the manufacture or working of the selected tools in India;
(c) the exclusive right so far as Wolfs can confer the same to apply for an obtain Indian patents for the selected tools and any such future inventions as aforesaid and the benefit of all patents so obtained; and
(d) the benefit of all extensions and prolongation of the terms and privileges granted by any such patents as aforesaid.
6. This agreements was to remain in force for as long as the manufacturing and marketing agreement to be executed remained in force. This latter agreement was executed on August 19, 1959.
7. Under the agreement of August 19, 1959, entered into between Wolf company and Ralliwolf, it was agreed that the tools assembled or manufactured in India would be marketed only in India and Nepal but the Wolf company would consider promoting exports arose. By this agreement, Ralliwolf had undertaken to keep secret and not to divulge to any persons save as may be necessary in the implementation of the agreement any of the technical information, technical data, designs, drawings and the like supplied to it by the Wolf company and agreed to hold similarly bound its servants and agents or such other persons to whom it may make disclosures in implementation of the agreement. The Wolf company was initially to send to Ralliwolf one senior technician to be the methods engineer of Ralliwolf and these persons were to be in the direct employment of Ralliwolf under service contracts with Ralliwolf who were to be directly responsible for their maintenance and remuneration and all other matters connected with their employment. This marketing agreement was to remain in force for an initial period of ten years subject to renewal or modification.
8. After August 19, 1959, when the Govt. of India approved the Ralliwolf manufacturing scheme, import licenses were issued for components from England in decreasing quantities as Ralliwolf took over the local manufacture of components on a progressive bas
9. In the assessment year 1960-61, the ITO brought to charge a sum of Rs. 1,45,000 being 40% of the face value of 3,625 ordinary shares in Ralliwolf in the hands of Wolf company, which was a non-resident company, on the ground that the shares are given in return for the obligation to provide drawings, etc., and confidential technical information for the establishment of the factory and production of selected tools for manufacturing in India. The ITO held that the value of 3,625 shares was of an income nature when a good portion of the money value of the shares was in consideration for the use of the non-resident company's patent rights in India and the value of such operation in India could be estimated at 40% of Rs. 3,62,500, i.e. at Rs. 1,45,000. This sum of Rs. 1,45,000 was brought to charge by the ITO under s. 5(2)(b) read with s. 9(1)(i) of the I.T. Act, 1961.
10. In the appeal filed by the assessee, Wolf company, the AAC took the view that the sum of Rs. 3,62,500 received by the assessee, Wolf company, was received in pursuance of the first agreement and what accrued to the Wolf company was in the nature of an income. He took the view that the assessee-company was not doing any business in India before and that the company had, therefore, not lost any of its assets as such but, instead of doing the business itself, it had sold its technique to an Indian concern and, therefore, the amount of Rs. 3,62,500 was received on revenue account. The AAC, however, held in favour of the assessee-company that no part of the sum of Rs. 3,62,500 accrued or arose or a could be deemed to accrue or arise during the relevant accounting year in India because the presence of the technicians who served the Indian company as employees by itself would not spell out a business connection or an operation performed on behalf of the foreign concern. Having regard to this finding, the appeal filed by the assessee-company was followed and the assessment order was set aside.
11. The order of the AAC was challenged by the ITO by an appeal before the Income-tax Appellate Tribunal. It may be stated at this stage that the question as to whether the value of 3,625 shares in Ralliwolf issued to the assessee-company in consideration of supplying the drawings and information was of a capital nature or of an income nature had come up in the assessment proceedings of the assessee-company in London before the High Court of Justice, Chancery Division, on a case submitted by the Commissioners for the special purposes of the I.T. Act.The Company was assessed to income-tax under Case I,Sch .D. of the Income-tax Act, 1952 (U.K.), on the basis that the value of 3,625 shares involved was a trading receipt. In appeal the company had contended before the Special Commissioners that the information in question was a capital asset of its trade and the disclosure thereof was an investment operation. Alternatively, it was contended that the shares were received as consideration under the agreement of August 12, 1959, under which the company had agreed to 'keep out of' India and Nepal as regards the selected tools, for ten years and this was described as a 'keep out' agreement. It was the case of the Crown before the Special Commissioners that the transaction was a method of increasing the company'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 ten years in respect of the selected tools only. The Special Commissioners held that the case fell within the decision of the House of Lords in Jeffery v. Rools-Royce Ltd.  40 TC 443;  56 ITR 580 and dismissed the appeal. The matter came before Pennycuick J. on a case stated and the decision of Pennycuick J. is reported as Wolf Electric Tools Ltd. v. Wilson  45 TC 326 . The effect of the agreement in pursuance of which the shares were received by the assessee-company was stated by Pennycuick J. thus (p. 337) :
'The effect of that transaction as regards the company was simply, it seems to me, to alter the company's capital profit-making structure : that is to say, instead of having its own goodwill in India as regards the selected tools, the company acquired a 45 per cent, interest in the new company and thenceforward derived its profit through those shares. If the transaction had embraced the entire Indian connection of the company, and if the share consideration had been expressed to be attached to a transfer of that connection - i.e., in effect, goodwill - it is perfectly clear that no element of taxable profit of the Crown. If it is suggested, then I think the answer would be plainly in the negative. One can illustrate that point, if illustration is necessary, by considering what would have been the position if, instead of Ralliwolf being owned as to 5 per cent. by Ralli and 45 per cent. by the company, the new Indian company had been a wholly-owned subsidiary of the company. In fact the transaction was not carried out in that simple manner. In three respects the transaction was different from a simple transaction of that kind. In the first place, the transaction was limited to the selected tools; in the second place, the transaction took the form of an exclusivity provision rather than of a transfer of goodwill; and, in the third place, the consideration was attached, and attached exclusively, to the obligation to supply information. I do not think that any of those features makes any difference in principle.'
12. Pennycuick J. held that it was plainly open to a trader to transfer his connection, either generally or in a limited area, quoad only some limited range of the goods manufactured by him and if the subject matter of the transfer was a capital asset, then the transfer was none the less the transfer of a capital asset, and the consideration a capital receipt, by reason of the fact that the asset was severed by the trader transferring one part and retaining the other. Pennycuick J. also pointed out that where a trader has an existing connection in a given country the correct label to give a transaction such as the present would be 'assignment of goodwill', and that an exclusivity or 'keep-out' provision is more appropriate where there is no existing connection. The learned judge observed that the reason why the exclusivity type of provision was chosen was that the 1959 transaction was confined to the selected tools, and that it would not have been appropriate to express the transaction as a simple transfer of the company's goodwill in India, and he found that there was no difference in substance between a provision for exclusion from India quoad the selected tools and a provision for transferring the goodwill of the company in India quoad the selected tools. He further pointed out that there was an obligation to supply information for which the consideration was the issue of shares given in connection with the transfer of a local connection represented on the face of it, and in the absence of any other special circumstances, ' the braking up of part of the capital asset consisting of the fund of confidential material rather than its retention intact and its exploitation' (p. 338). The learned judge observed that :
'It is perfectly plain that that would be so if the transaction were expressed to take the form of an assignment of goodwill coupled with an obligation to supply confidential information :'
13. Referring to the period of ten years provided by the 'keep-out' agreement, the learned judge observed that such restriction did not prevent a transaction from being in the nature of a disposal of capital because it was plain that after ten years the company's won connection would have, on its own, disappeared as regards the selected tools. The learned judge then pointed out that in a case such as the present, the whole arrangement must be looked at and the effect of the whole arrangement was that the trader received a new capital asset, viz., the shares in the foreign company (p. 340) 'in exchange for that which he previously had, namely, his connection or goodwill in the foreign country', and that the transaction was of a wholly capital nature. This decision of Pennycuick J., given on November 26, 1968, was before the Tribunal. It may be mentioned that the assessee-company has also filed a cross-objection and both the appeal and cross-objection were decided by the Tribunal by the common order dated September 4,1971. The Tribunal in its order referred to the finding recorded by Pennycuick J., and reproduced the relevant parts of the order and found itself in agreement with the view that 'transaction in question was in substance a parting by the non-resident company with part of its property for a purchase price, the property being its connection or goodwill in India and its fund of confidential material and the transaction was not of the nature of a technique for exploiting the Indian market to provide trading income.'
14. The transaction was thus held to be of a wholly capital nature and the value of the shares was treated as capital receipt.
15. On the question as to whether any operation of business was carried out in India by the assessee-company, the Tribunal took the view that apart from the deputation of two technicians to India, there was no evidence of any other operation of the non-resident's activities in India, that the nature of the services contemplated under cl. 5 of the agreement of August 19, 1959, by way of supply of technicians would be only incidental and the extent thereof could not be very high, and that this aspect of the matter had not been investigated at all by the ITO or by the AAC and the matter had not been investigated at all by the ITO if found necessary at a later stage. Thus, the appeal filed by the ITO was dismissed and the cross-objection filed by the assessee-company was followed.
16. Arising out of this order of the Tribunal the question reproduced above has been referred under s. 256(1) of the I.T. Act, 1961. The main question which has been argued extensively before us is whether the value of the shares received by the assessee-company must be treated as of a revenue nature or whether it partakes of capital nature. Mr. Joshi appearing on behalf of the Revenue has contended that the assessee-company cannot be said to have parted with any capital asset but the shares are received by the assessee-company as a return for the services rendered in the form of making available the necessary know-how to Ralliwolf and that the assessee-company has really exploited its know-how. The learned counsel for the Revenue has relied on the finding recorded by the AAC that the assessee-company was not doing any business in India before and it was contended that on this finding the case sought to be made out by the assessee-company that there was an outright sale of a capital asset and, therefore, the shares were received on capital account must be rejected. The learned counsel for the Revenue has relied on the decision of Goulding J. in Coalite & Chemical Products Ltd. v. Treeby  48 TC 171 .
17. Mr. Dastur appearing on behalf of the assessee has contended that the assessee-company had existing trade in India through established agencies and it knew very well that the market in India is likely to be lost unless the assessee-company undertook to manufacture those goods in India. The learned counsel has pointed out that the present case would be governed by the ratio of the decision out that the present case would be governed by the ratio of the decision of the House of Lords in Evans Medical Supplies Ltd. v. Moriarty  37 TC 540 ;  35 ITR 707. The learned counsel has also relied on the decision of Pennycuick J. in the case of the assessee and it was pointed out that, as held by Pennycuick J., the shares were received in exchange for the Indian connection or the goodwill which the assessee had in India. It was sought to be argued by Mr. Joshi on behalf of the Revenue that the statement of the case submitted for opinion of the High Court by the Special Commissioners in England showed that oral and documentary evidence was given in those proceedings and that as no such evidence has been given in the proceedings out of which the present appeal arises. The matter will have to be decided merely on the reading of the relevant agreements.
18. Both the learned counsel appearing on behalf of the Revenue and the assessee have extensively argued the question as to whether on facts in the present case the value of the shares acquired by the assessee must be treated as a capital receipt or a receipt on revenue account. Extensive reference was made to the three decisions of the House of Lords, viz., (1) Evans Medical Supplies Ltd. v. Moriarty  37 TC 540 ;  35 ITR 707, (2) IRC v. Rools-Royce Ltd.  40 TC 443;  56 ITR 580 and (3) IRC v. English Electric Co. Ltd.  41 TC 556. Apart from the decision in Evans Medical Supplies' case referred to above, two other decisions in which the earlier decisions have been considered have also been referred to in the course of arguments. Those are the judgment of Walton J. and the judgment of the Court of Appeal in John & E. Sturge Ltd. v. Hessel  51 TC 183 respectively, and the judgment of the Lord President in Thomsons (Carron) Ltd. v. IRC  51 TC 506.
19. In ascertaining whether the value of the shares in Ralliwolf acquired by the assessee-company should be treated as receipt on revenue account or on capital account, we must apply the well-known and oft-repeated test laid down by Bankes L. J., in British Dyestuffs Corporation (Blackley) Ltd. v. IRC  12 TC 586 where, at p. 596, it was observed thus :
'The real question is, looking at this matter, is the transaction in substance a parting by the company with part of its property for a purchase price, or is it a method of trading by which it acquired this particular sum of money as part of the profits and gains of that trade For that purpose one has to look at the nature and substance of the transaction and the agreement as a whole.'
20. Before applying this test and before construing the effect of the agreement, it becomes necessary to decide the question as to whether know-how can properly be described as a capital asset. Know-how, which has been described as an 'ugly phrase' in Thomsons Ltd.'s case  51 TC 506 (Ct. of Sess), covers a variety of technical knowledge. Lord Russell had described as an aspect of trading ability in the judgment in the Court of Appeal in John & E. Sturge Ltd.'s case  51 TC 183, and it was observed by Lord Johnston in Thomsons Ltd.'s case, 'there is ample authority for the proposition that the imparting of 'know-how' per se is not to be regard as the disposal of a capital asset any more than is the disposal of trading stock' and Lord Justice Russell's judgment in John & E. Sturge Ltd.'s case  51 TC 183 and the decision of the House of Lords in English Electric Company's case  41 TC 556, were cited in support.
21. The position with regard to the actual nature of know-how first came up for consideration in Evans Medical Supplies case  37 TC 540;  35 ITR 707 . In that case, the Even Medical Supplies, which was the manufacturer of pharmaceutical products and had a worldwide trade, carried on business in Burma, through an agency. However, when in 1953 the Burmese Govt. itself established an industry in Burma for the production of pharmaceutical and other products and the company itself secured a contract from the Burma Govt. to assist the Government in setting up this industry, the company had undertaken to disclosure secret processes to the Burma Govt. and to provide other information in consideration of the payment of a capital sum of pound 100,000. The company also had undertaken to provide certain services to manage the proposed factory in return for an annual fee, which was admitted to be subject to tax. No similar agreement had been entered into by the company with any other foreign Government or any foreigner. The claim of the company was that pound 100,000 was a capital sum received either for the sale of fixed capital or for granting to the Burma Govt. an exclusive license and that, in any event. It did not arise in the course of trade. The Special Commissioners construed the agreement as one for the provision of services and held that pound 100,000 are properly included in computing the company's profits for income-tax purposes. The Chancery Division  31 ITR 466, held that the sum in question was a capital payment. The Court of Appeal : 33ITR700(Cal) unanimously held that there was evidence to support the Special Commissioners' finding that the sum of pound 100,000 arose to the company as a receipt of its trade but that the sum in question to the extent that it was attributable to the disclosure of secret processes was capital receipt, and the case was ordered to the disclosure of secret processes was capital receipt, and the case was ordered to be remitted to the Commissioners to determine the part so attributed. The House of Lords  35 ITR 707 dismissed the Crown's appeals and allowed the company's cross-appeal restoring the order of the Chancery Division. There was a difference of opinion on the question as to whether the company had parted with the capital asset for a purchase price. Lords Simonds and Tucker were of the opinion that the company had parted with the capital asset for purchase price. Lord Denning considered that there was nothing wrong in the Commissioner's finding that the amount in question was a payment for services, but that it was not received in the course of the company's existing trade of wholesale druggists, etc., and, therefore, could not be brought into the assessment of the company's existing trade for 1954-55. Lord Morton agreed with the judgments in the Court of appeal and Lord Keith was of the opinion that there was ample evidence that the company was trading in know-how and that it was no more than a legitimate extension of their existing trade.
22. Upjohn J., who had delivered the judgment in the Chancery Division 37 TC 540, :31 ITR 466, referred to the meaning of 'know-how' given by Lord Evershed M.R. in Stevenson, Jordan and Harrision Ltd. v. Macdonable and Evans  1 TLR 101, where 'know-how : was described as follows :
''Know-how' seems to me to indicate something essentially different from secret and confidential information. It indicates the way in which a skilled man does his job, and is an expression of his individual skill and experience.'
23. Upjohn J., then observed (p.473 of 31 ITR) : 'But the word 'know-how' is a modern and very useful colloquial expression of no precise meaning and, when used in the agreement in the context of the recitals and not in relation to the expertise of an individual workman, is very apt and appropriate to include the company's knowledge of processes of preparation, packing and preservation of their products, especially having regard to the importance of such matters in tropical countries.'
24. These observations were made with reference to the terms of the agreement between the Govt. of Burma and Evans Medical Supplies Ltd. The finding recorded by Upjohn J. was that the company was not exploiting its business in the only sense in which that words is relevant, that is, of carrying on its trade of wholesale druggists in Burma, but in and by the agreement it entered into the entirely new activity of acting as adviser of the Burmese Govt. by assisting to set up a completely new industry there which involved the disclosure to the Government of secrets never disclosed to any one before, and also involved the gradual cessation of its own wholesale trading activities, there, for it was found as a fact that the company's Burmese agency will become progressively less important as the Government factory in Burma comes into production. Upjohn J., observed that he secret processes bore a marked analogy to patent rights and copyright. The learned judge also took the view that the industry in Burma, established by the skill and know-how of the company could embark on an export trade which could compete with the company's own products in other countries. In that sense the company was dissipating its asset, and it must be remembered that a secret process once communicated to another is in jeopardy; if it gets into the wrong hands, the grantor has no protection. The learned judge observed that even if it be a necessary ingredient to support a capital payment to show some dissipation of a capital asset, that element was also present. Thus, the payment of pound 100,000 was held to be a capital payment. As already pointed out, the Court of Appeal : 33ITR700(Cal) held that the amount represented a receipt of the trade of the company.
25. Now when the matter went to the House of Lords 37 TC 573; 35 ITR 707, Viscount Simonds took the view that the company had parted with a capital asset and received for it a capital sum. What the company had parted with, according to Viscount Simonds, would be clear from the following observations (p.718 of 35 ITR) :
'The company parted with something for which the Government was prepared to pay no less than pound 100,000. Its possession had secured for the company a substantial share of the Burmese market : its loss will mean, in the words of the Commissioners, that 'the company's Burmese agency will become progressively less important', or, in other words, that the company has parted with an asset which was the source, or one of the sources, of its profit.'
26. Viscount Simonds thus took the view that the company had parted with its property for a purchase price and when he said 'its property', he meant a capital asset. An argument was advanced on behalf of the Crown in that vase (p.719 of 35 ITR) that 'even if the divulging of a secret process to the whole world could be regarded as parting with a capital asset, the same could not be said of divulging it to the other'. This argument was rejected in the following words (p.719 of 35 ITR) :
'This does not make sense. The whole value of the secret might conceivably not be lost at once to the original owner, but that its value must be greatly diminished is obvious : in the present case it is doubtful whether within a measurable time it will have any value at all, at any rate so far as the Burmese market is concerned.'
27. Lord Tucker agreed with the view of Viscount Simonds.
28. Lord Keith took the view that there was no difference between trading in know-how consisting of a secret process and any other king of know-how. Dealing with different situations in which a trader may decide to sell the secret prices, he observed as follows (35 ITR at p.724) :
'A person in trade or business who has a secret process which he decides to sell may do so in various situations.He may be retiring from business and selling his business to a purchaser Obviously this is a capital transaction that attracts no tax. Again, he may remain in business, but being unable from lack of capital or otherwise to develop his secret proves he may sell it outright to another trader. That again would be the sale of a capital asset which would not attract tax. A third type of case would be where the trader imparts his secret knowledge to some other trader, but retains the right to sue it in his own business and, it may be, to share it further with other traders. In such a case it may be said that the secret knowledge is no longer secret knowledge. But that is not perhaps strictly accurate. It is not so secret as it was, but it may still retain a value. And if a trader, having developed some secret process, made a practice of turning it to profit by selling it like a commodity to other interested parties, possibly with restrictive conditions attached, there would seem to be no sound reason for saying that he was doing anything other than trading in 'know-how'. Like stock-in-trade, it might ultimately run down. But in the manifold opportunities of commercial and trading life it might remain a source of profit for a very considerable time. The point to be emphasised is that there is really no difference between trading in 'know-how' consisting of a secret process and any other kind of 'know-how'. I would observe that trading in 'know-how' is not quite the same thing as turning one's property to a profitable use. A man may rent his house, or license the use of his patent, without being engaged in trade. With either the trader or the property-owner similar considerations may come into play in deciding whether a receipt is a capital or a revenue receipt, but where the receipt is a receipt in the course of trade that may be sufficient to turn the scale in favour of holding a receipt which has the appearance of a capital receipt to be a revenue receipt.'
29. Lord Keith held on facts that the company was trading in know-how.
30. Lord Denning dealt with the question as to the position of know-how for tax purposes and observed as follows (p.731 of 35 ITR) :
'What, then is the position of 'know-how' for tax purposes 'It is undoubtedly a revenue-producing asset. The possessor can use it to make things for sale : or he can teach it to others for reward. But he cannot sell it outright. It is rather like the 'know-how of a profession man. He can use it to earn fees from his clients : or he can teach it to pupils for reward : and so produce revenue. But he cannot sell it as a capital asset for a capital sum. He cannot sell his brains. So with a company which has special manufacturing skill and experience but has no secret processes. Its 'know-how' is inseparable from the 'know-how'of its staff and servants. It cannot prevent them using it any more than it can prevent them using their own brains : see Herbert Morris Ltd. v. Saxelby  1 AC 688, It cannot sell it as a capital asset. IT can only use it or teach it. Even with a company which owns secret processes, the supply of 'know-how' is not like the sale of goodwill or a secret process, for such a sale imports that the seller cannot thereafter avail himself of the special knowledge with which he has parted : see Tergo v. Hunt  AC 7; and it may then rightly be regarded as the sale of a capital asset : see Handley Page v. Butterworth  19 TC 328. But the supplier of 'know-how' always remains entitled to use it himself, as was the case here.'
31. Lord Denning thus declined to treat know-how as capital asset. The result of the decision of the House of Lords in Evans Medical Supplies' case  37 TC 540;  35 ITR 707, thus was that there as no final determination of the question as to whether know-how could be treated as capital asset.
32. The question again cropped up in Rolls-Royce case  40 TC 443;  56 ITR 580 . In Rolls-Royce case the Rolls-Royce company, as a result of research and development of engineering techniques, acquired a fund of technical knowledge commonly called 'know-how', and during the period 1946 of 1953 it had entered into a number of agreement was 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. By an agreement of license with the Republic of China, the company undertook to supply necessary information and drawings to enable the Chinese to manufacture Rolls-Royce jet aero engines. The company was to advise them from time to time as to improvements and modification in manufacture and design. It was also to instruct the 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. Such agreements were entered into with several other governments. The contention of the Revenue was that the sums received in pursuance of the agreements were normal receipts of a revenue nature of the trade or business carried on by the company. The Special Commissioners had allowed the appeal of the company and their decision was upheld by Pennycuick J. Pennycuick J. referring to the observations of Lord Simonds in Evans Medical supplies case  37 TC 540;  35 ITR 707, had taken the view that the company having a capital asset consisting of technical knowledge, or 'know-how', communicated that asset to another party, with the natural consequence that at least as regards the territory of that party the asset must lose the whole or the greater part of its value, and this would amount to disposition of the part of the capital asset itself. The lump sum consideration being the price of the capital asset, it represented receipt of capital in the hands of the company and ought not to be brought into account in the computation of its revenue. Pennycuick J. thus positively held know-how to be a capital asset.
33. This decision was reversed by the Court of appeal and Pearce L.J. Made it clear that the knowledge sold did not constitute sale of a capital asset. He observed as follows (p. 486 of 40 TC) :
'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. The knowledge sold in this case is in the main, the transient by-product of advancing engineering science. It accrues automatically from the company's business of manufacture, and in a comparatively short time it is superseded and loses its value. It is ever growing, ever changing, It is the kind of knowledge which can easily merge its character of a fixed asset into that of a trading asset. The secret knowledge is the more transient since it becomes more quickly obsolete. That which is not secret is the valuable practical experience of years, but such knowledge is the more transient since it becomes more quickly obsolete. That which is not secret is the valuable practical experience of years, but such knowledge partakes less of the nature of a fixed asset. It consists in the power to communicate the knowledge possessed by a well trained, efficient and experience staff. It could find no place in any balance-sheet. So far as part of the lump sums are paid in respect of the imparting of knowledge, they are sums regularly received as an ingredient in the company's policy of making manufacturing agreements to secure royalty revenue. To such agreements the disclosing of technical knowledge is unnecessary adjust, but it is a means rather than an end. None of these considerations is conclusive in itself, but hey have cumulative weight.'
34. In our view, this would be the correct nature of know-how, which is but knowledge and which is overgrowing and ever changing and which is really in the nature of a trading asset.
35. These observations were concurred with by Lord Justice Upjohn, and Lord Justice Donovan also rejected the argument that know-how is a fixed capital asset. He observed (p.487 of 40 TC) :
'The process of research and new discovery is unending. Again, to speak of a fund of 'know-how' possessed by the company as one of its fixed capital assets is not an exact description of the situation. The company is served by its staff, and it is in the brains and hands of its staff that knowledge, skill and experience reside. What the company can do is to make these things available to some third party if it so decides : and it is the ability to do this which is really the company's asset. Moreover, when the company does this it does not part with the knowledge so communicated, as it would part with factory premises if sold. It simply shares it s knowledge with others.'
36. The appeal of the company was thus allowed. When the Rools- Royce case  40 TC 443;  56 ITR 580, came to the House of Lords in appeal by the company, the decision of the court of Appeal was upheld. Viscount Simonds, who had taken the view that know-how is a capital asset in Evans Medical Supplies case  37 TC 540;  35 ITR 707, adopted the view of Pearce L.J. that (p. 582 of 56 ITR), 'what the Chinese Government received and the company gave were technical knowledge, plans, a license and facilities for the interchange of staff' and observed that 'these things cannot be regarded as fixed capital asset' and the communication of them as disposal of that asset. Expounding his view in the Evans Medical Supplies' case, viscount Simonds observed that the facts in the Evans Medical Supplies' case were complicated but the inference was there drawn that the capital sum in question was paid for the communication of secret processes to the Burmese Govt. with a resulting total loss to the company of its Burmese trade. He then observed (p. 583 of 56 ITR) :
'In the circumstances of that case, regard in particular being had to the fact that the transaction was an isolated one of its kind, the conclusion was inevitable that the so-called capital sum was a receipt of a capital nature. The analogy of secret processes to patents was drawn to enforce this conclusion. The decision did not establish, or purport to establish, a principle that whenever, and however often, a company communicates what is called 'know-how' to a third party and received what is called a lump sum for it, that sum is for tax purposes a capital receip.'
37. Viscount Simonds had thus made it clear that the Evans Medical Supplies' case  37 TC 540;  35 ITR 707, cannot be treated as an authority for the proposition that whenever know-how is communicated to a third party, lump sum received therefore should be treated as a capital receipt. The Houses of Lords unanimously decided that the appeal of the Revenue should be dismissed.
38. Lord Radcliffe declined to treat know-how as fixed capital asset. Pointing out that it was fundamental to the company's case that know-how should be categorised as part of its fixed capital, he found that know-how was an asset; it was intangible but that it would be difficult to identify with any precision the sources of expenditure which have gradually created it. Referring to the nature of know-how as an asset he observed (40 TC at p. 493; 56 ITR at p. 585) :
'An asset of this kind is - I am afraid that I must use the phrase-sue generis. It is not easily compared with factory or office buildings, warehouses, plant and machinery, or such independent legal rights as patents, copyright or trade marks, or even with goodwill. 'Know-how' is an ambience that pervades a highly specialised production organisation, and, although I think it correct to describe it as fixed capital so longs as the manufacturer retains it for his own productive purposes and expresses its value in his products, one must realise that in so describing it one is proceeding by an analogy which can easily break down owing to the inherent differences that separate 'know-how' itself, which is the valuable asset; for, if you put them on a duplicator and produce one hundred copies, you have certainly not multiplied your asset in proportion. Again, as the facts of the present appeal show, 'know-how' has the peculiar quality that it can be communicated to or shared with others outside manufacturer's own business without in any sense destroying its value to him. It becomes, if you like, diluted, and its value to him may be affected; though in my view it begs the question to say that that value is necessarily reduced because the asset is used for outside instruction. These considerations lead to me to say that, although 'know-how' is properly described as fixed capital by way of analogy, it is the kind of intangible entity that can very easily change its category according to the use to which its owner himself decides to put it. I am not sure that it is too much to say that it is his use of it that determines the category. It is not like a single physical entity which must be employed for production or else broken up : it is more like a fluid in store which can be pumped down several channels.'
39. Rolls-Royce case  40 TC 443;  56 ITR 580 , can be taken as an authority for holding that know-how per se is not a fixed capital asset but that it can change its category according to the sue to which the owner himself decides to put it. Lord Radcliffe also ruled out the applicability of the ratio of Evans Medical Supplies' case  37 TC 540 :  35 ITR 707, on the same ground as was done by Viscount Simonds.
40. What was the nature of know-how as an asset was again considered in Musker v. English Electric Co. Ltd.  41 TC 556 . The company, in the course of carrying on its trade of engineering manufacturers, acquired a fund of specialised information and technique in engineering processes. In 1949, the company entered into an agreement to design and develop a marine turbine and to license its manufacture by a limited number of companies in the United Kingdom, Australia and Canada. Later, the company entered into agreements with the Governments of Australia and an American aircraft manufacturing corporation under which it licensed them to manufacture the Canberra bombers which it had designed and developed. All the three agreements, inter alia, provided for the imparting of 'manufacturing technique' to the licensees and in consideration of this, the company received specified lump sum payments. The question was whether these payments should be treated as trading receipts. They were in fact assessed as trading receipts, but in appeal the Special Commissioners held that the sums received were of a capital nature. On a case stated, Pennycuick J. held in favour of the Crown and the matter was taken to the Court of Appeal. In the Court of Appeal, Lord Denning held that while making the agreements in question, the company was able to exploit its capital asset, that is, its know-how by receiving large sums from its licensees for the use of it and upheld the decision of Pennycuick J. holding that the case was covered by the decision in Rolls-Royce's case  56 ITR 580 . Danckwerts L.J. and Russell L.J. agreed with Lord Denning. Taking the view that the manufacturing technique is a known - how, Lord Denning observed as follows (41 TC 556, 582) :
''Know-how' is an intangible asset, just as intangible as goodwill and just as worthy of recognition. It is a revenue-producing asset, just as goodwill is. 'Know-how' can be put to sue so as to produce revenue in two ways. The manufacturer can use it himself to make things for sale and make profit in that way; or he can teach it to others, so that they can make their own things, in which case he gets paid for the knowledge and information which he imparts to them. His fees and rewards are then revenue in his hands. I assume, of course, that the manufacturer, although teaching it to others, still retains the knowledge himself and intends to go on using it himself and making things from it. So long as he does this, he retains his capital asset himself and is only using it to produce revenue. But 'know-how' can be used to produce a capital receipt. It can be sold outright and being in a capital fund. This happens when a trader or manufacturer sells his goodwill or 'know-how' outright to a purchaser, withdraws from the business himself, and agrees not to sue the 'know-how' or goodwill to the prejudice of the purchaser. The purchase price he receives is then capital in his hands.'
41. The company then appealed to the House of Lords.
42. Viscount Radcliffe held that the case was fully covered by the principle in Jeffrey v. Rolls-Royce Ltd.  40 TC 443;  56 ITR 580 , observing that there are two considerations which govern cases of the kind before him and which go to long way destroying the force of the analogies by which the appellant's argument seeks to prove that the transactions under review were sales of fixed assets, and that receipts arising from them ought to be treated as receipts on capital account. It was observed as follows (41 TC 556, 585) :
'One is that in reality no sale takes place. The appellant had after the transaction what it had before it. There is no property right in 'know-how' that can be transferred, even in the limited sense that there is a legally protected property interest in a secret process. Special knowledge or skill can indeed ripen into a form of property in the fields of commerce and industry, as in copyright, trademarks and designs and patents, and where such property is parted with for money what is received can be, but will not necessarily be, a receipt on capital account. But imparting 'know-how' for reward is not like this, any more than a teacher sells his knowledge or skill to his pupil. Admittedly the appellant was not in the same position after each transaction as before it. It had 'up-dated the background knowledge' of a possible competitor, to sue the graphic phrase of one of its witnesses. Conceivably, by so doing it had affected for the worse its trading potential in some fields and in some respects, but the significance of that is almost unavoidably theoretical at the time when the transaction has to be judged, and the consequences are far too speculative to allow the imparting of 'know-how' to be treated for that reason as the disposal of a 'capital' asset analogous with the sale of all or part of an undertaking.
The other point is that 'know-how', though very naturally looked upon as part of the capital equipment of trade, is a fixed asset only by analogy and, as it were, by metaphor. The nature of receipts from it depends essentially, I think, upon the transaction out of which they arise and the context in which they are received. Where, as in Evans Medical Supplies Ltd. v. Moriarty  37 TC 540;  35 ITR 707 . 'know-how' is imparted as one element of a comprehensive arrangement by virtue of which a trader effectively gives up his business in a particular area, the moneys paid for the 'know-how', whether or not independently quantified, may properly rank as capital receipts. But the Rolls-Royce case provides a different context, in which the imparting is no more than a service, of however special a kind, attendant upon an activity that arises out of the appellant's. trading.'
43. Lord Donovan also took the view that the case was covered by the decision in Rolls-Royce case. Lord Donovan gave an illustration of a manufacturer who was carrying on a continuing business but agreeing to teach a revival manufacturer how to make a particular product efficiently and economically in return for a reward. It was pointed out that such reward was really a remuneration for the service and would not be capital but income 'unless there were some exceptional circumstance pointing the other way - always a necessary qualification to make in this field. ' Pointing out that for an industrialist the natural way of regarding such a transaction was that there was a sale of know-how, which was a part of an asset and the price was a capital receipt, Lord Donovan observed as follows (41 TC 556. 587) :
'I do not criticise this line of approach, For the industrialist at any rate it is a natural way of regarding the transaction; he, understandably will look upon his found of accumulated knowledge as being a vital part of his capital equipment. Yet what the appellant has done is essentially no different from what the manufacturer did whose case I have taken as an example. It has taught for reward, as Roll-Royce taught for reward; and just as that reward was held to be trading income in the hands of Rolls-Royce Ltd., so also must the reward accruing to the appellant, There is here no exceptional circumstance which gives that reward the character of capital.'
44. Lord Donovan pointed out a distinction between the case of English Electric Co. and the case of Evans Medical Supplies Ltd.  35 ITR 707 , and the distinction lay in the fact that in Evans Medical Supplies Ltd'. s case, the transaction was in effect the disposal by degrees of the company's branch business in Burma.
45. The legal position on these authorities, therefore, is that know-how is not strictly a fixed asset and the nature of receipts from the know-how would essentially depend upon the transactions out of which the receipts arise and the contest in which the receipts are received. If the imparting more, the receipt must be treated as a revenue receipt. But when consideration is received for imparting know-how in association with the disposal of a capital asset, then the receipt will have to be treated as a capital receipt. The position, in our view, is admirably summed up by Walton J. in John & E. Sturge Ltd. v. Hessel  51 TC 183, in the following words :
'Accordingly, there is no ground for treating it (know-how) in any way differently form the rendering of any other service by the trader who imparted for consideration, the receipt is a trading receipt. However, the disposal is capable of earning an entirely different aspect if it is found, not as a disclosure of 'know-how' on its own, but combined with some other transaction of which it is a part, albeit an important part, which nevertheless does represent the disposal of some capital asset of the trader concerned. Thus, if 'know-how' is imparted as apart and parcel of the disposal of a branch of the trader's business, as in Evans Medical Supplies Ltd. v. Moriarty  37 TC 540;  35 ITR 707 or Wolf Electric Tools Ltd. v. Wilson  45 TC 326 , to which I have already referred, then, as Lord Radcliffe said, the moneys paid for the 'know-how' may property rank as a capital receipt. Per contra, if the disposal is not accompanied by the disposal of a branch of the trader's business or some capital asset to which it can property be regarded as incident, then it appears to me, as it did to my brother Goulding J. in Coalite and Chemical Products Ltd. v. Treeby  48 TC 171 , that the consideration paid must be a receipt of the trader's trade. That is not to say that there may be other sets of circumstances in which the disposal of 'know-how' forms but one part which may yet amount when viewed in the round to the disposal of a capital asset, but so far there is none to be found in the books and nobody has suggested any convincing illustrations of any such other transactions.'
46. Having regard to this legal position, Mr. Joshi appearing for the Revenue contended that the agreements between Ralliwolf and Wolf company must be considered as a transaction in which know-how was imparted for the benefit of Ralliwolf and, therefore, the value of the shares received by Wolf company must be treated as receipt on revenue account. In order to take the present case out of the ratio of the decision in Evans Medical Supplies Ltd'. s case  35 ITR 707 , reliance was placed on the finding recorded by the AAC in his order dated January 31, 1967, that 'the non-resident concern has not lost any of its assets as such. It was not doing any business in India before.' The learned counsel for the Revenue, therefore, contended that if Wolf company had no business in India, then imparting of know-how to Ralliwolf cannot be treated as a part of a composite transaction, the effect of which was that the business of the company in India was to cease.
47. Mr. Dastur, the learned counsel for the assessee, has contended that the Tribunal has in terms of para. 15 accepted the view of Pennycuick J. in the case of the assessee-company, Wolf electric Tools Ltd. v. Wilson  45 TC 326 , that the assessee-company was parting with a part of its property for a purchase price. Pennycuick J., who had considered the effect of the agreements in question, had observed as follows (p. 337) :
'The effect of that transaction as regards the company was simply, it seems to me, to alter the company's capital profit-making structure : that is to say, instead of having its own goodwill in India as regards the selected tools, the company acquired a 45 per cent. interest in the new company and henceforward derived its profit through those shares. If the transaction had embraced the entire Indian connection of the company, and if the share consideration had been expressed to be attached to a transfer of that connection - i.e., in effect, goodwill - it is perfectly clear that no element of taxable profit would have been involved.'
48. Later, the effect of the agreements was again set out as follows (p. 340) :
'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.'
49. The transaction was thus held by Pennycuick J. as of a wholly capital nature and the appeal filed by the World Electric Tools Ltd., against the assessment made by the Special Commissioners that the value of 3,625 ordinary shares of Ralliwolf Pvt. Ltd. should be included in the profits of the company was set aside.
50. The Tribunal in its order has extracted a part of the observations of Pennycuick J. and has agreed with the view taken by the Pennycuick J, that the transaction is in substance a parting by Wolf company with its property fro the purchase price, the property being its connection or goodwill in India and its fund of confidential material and the transaction was not of 'the nature of technique for exploiting the Indian market to provide trading income'. In view of the finding recorded by the Tribunal that the effect of the transaction was that Wolf company had parted with its property, being its connection or goodwill in India, the finding recorded by the AAC, on which the learned counsel for the Revenue was relying, will not be of any assistance to him, Even otherwise, it will not be correct to say that the assessee-company did not have any business in India. The statement of the case recites that in 1954-55, the company's exports of India amounted to 10% of its total exports by volume and even greater percentage by value and that this volume of business with India represented the assessee-company's largest export market outside the countries where it maintained its own branches. If this business was given up as a part of the arrangements arrived at under the agreements in question in our view, the vase would be covered by the ratio of the decision in Evans Medical Supplies Ltd's case  35 ITR 707. Therefore, the view taken by the Tribunal that the value of the shares must be rested as a capital receipt cannot be said to be contrary to law.
51. Accordingly, the question referred is answered by holding that the value of 3,625 shares in the Indian company, Ralliwolf Ltd., of Rs. 100 each issued to the non-resident assessee-company in consideration of supplying the drawings and information is of capital nature and not of revenue nature. The question is thus answered in favour of the assessee and against the Revenue. The Commissioner shall pay the costs of this reference.