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Murray (inspector of Taxes) Vs. Imperial Chemical Industries Ltd. - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtKolkata High Court
Decided On
Reported in[1969]71ITR661(Cal)
AppellantMurray (inspector of Taxes)
Respondentimperial Chemical Industries Ltd.
Cases ReferredRustproof Metal Window Co. Ltd. v. Inland Revenue Commissioner
Excerpt:
- appeal from cross j.imperial chemical industries (hereinafter call 'i.c.i.') appealed to the commissioners for the special purposes of the income tax acts against the following assessments to income tax made under case i of schedule d in respect of its trade in fibres :1958-59, pounds 2,186,000 less pounds 1,815,000 capital allowances;1960-61, pounds 4,712,000 less pounds 2,118,000 capital allowances;and applied under section 341 of the income tax act, 1952, for an adjustment of its liability for the year 1955-56 by reference to a loss claimed to have been sustained therein in that year.the question for the commissioners determination on the appeal was whether certain sums received under provisions contained in agreements or heads of agreement entered into by i.c.i. with nine overseas.....
Judgment:

Appeal from Cross J.

Imperial Chemical Industries (hereinafter call 'I.C.I.') appealed to the Commissioners for the Special Purposes of the Income Tax Acts against the following assessments to income tax made under Case I of Schedule D in respect of its trade in fibres :

1958-59, pounds 2,186,000 less pounds 1,815,000 capital allowances;

1960-61, pounds 4,712,000 less pounds 2,118,000 capital allowances;

and applied under section 341 of the Income Tax Act, 1952, for an adjustment of its liability for the year 1955-56 by reference to a loss claimed to have been sustained therein in that year.

The question for the commissioners determination on the appeal was whether certain sums received under provisions contained in agreements or heads of agreement entered into by I.C.I. with nine overseas concerns were sums falling to be included as trading receipts in computing the amount of the assessments or the loss.

The relevant facts found by the commissioners were summarised in the judgment of Cross J. as follows :

In 1941, Mr. Whinfield and Dr. Dickson, two research chemists employed by Calico Printers Association Ltd. (C.P.A.), invented a method of producing terylene polymers and of so manufacturing them that they could be drawn cold to yield fibres of great strength and pliability, a high melting point and a low degree of solubility in powerful solvents. C.P.A. took out a number of patents in respect of this invention, both in the United Kingdom and in many overseas countries, but it was too small a company to undertake the development of the invention on a commercial scale. Towards the end of the war, it was suggested that I.C.I. might be prepared to develop into between the two companies on November 17, 1947, under which C.P.A., in return for royalties, granted I.C.I. for 20 years or the duration of the patents, whichever should be longer, an exclusive licence to exploit the rights of C.P.A. under its patents throughout the world, except in the United States of America, where C.P.A. under its patents throughout the world, except in the United States of America, where . had already arranged for the development of the invention by others. Clause 6 of the agreement expressly empowered . at its discretion to grant licence rights in respect of the patents to third parties.

In the course of the next few years, . expended much money and effort in the development of the invention. As a result of its own research, it took out a number of patents ancillary to the C.P.A. master patents; it established a pioneer plant at Huddersfield for the production of terylene polymer, where output had reached some 600 tons a year by 1952; and it also established a pioneer spinning plant at Hillhouse in Lancashire to manufacture yarn and fibre made from terylene polymer so as to supply Terylene to the textile trade and get guidance as to the forms in which it would be suitable for use by the trade. By the end of 1950, it was clear, not only to I.C.I. and C.P.A. but to the textile trade both here and abroad, that Terylene had enormous commercial possibilities. In November, 1950, I.C.I. authorised the expenditure of 8 1/2 million pounds on the construction of a full-scale terylene plant at Wilton, and, before it was completed, it was decided in April, 1953, to double its capacity so as to enable it to produce 10,000 tons a year. But even this was not more than enough to meet the domestic demand and I.C.I. was faced with the problem how best to meet the demand for Terylene outside the country. The alternatives open appeared to be either to set up plants in foreign countries and manufacture Terylene itself locally or to grant licences to selected foreign companies enabling them a manufacture equivalents of Terylene under the C.P.A. and I.C.I. patents. Even if I.C.I. had been itself prepared to face the huge capital expenditure involved in setting up sufficient terylene plants abroad to meet the foreign demand it was very doubtful whether at that time - 1952 or 1953 - Treasury approval would have been forthcoming. Accordingly, after prolonged consideration, I.C.I. decided to grant licences to manufacture equivalents of Terylene to five European companies who were thought by reason of their competence, financial stability and enthusiasm for the project to be best fitted to make good use of the licences. These companies were Rhodiaceta in France, Montecatini in Italy, Hoechst and Glanzstoff in Germany and A.K.U. in Holland. Heads of agreement were entered into between I.C.I. and these five companies in 1953 and 1954, and formal agreements implementing the heads were executed at various dates in 1956. There were a number of minor differences between these arguments which were referred to in detail in the case, but neither side sought to draw any distinction between them on the basis of those differences and Cross J. proposed to neglect them and to set out the relevant parts of one agreement as representative of all. For this purpose, he would take that between I.C.I. and A.K.U., executed on April 14, 1956. The relevant parts of that document were as follows :

'ARTICLE I

(A). The Agreement Products referred to in this agreement are : (i) flat singles continuous filament yarns, thrown single continuous filament yarns, towns, staple fibres and tops made of highly polymeric polymethylene terephthalates, the filaments or fibres of which have when in the drawn condition a greatest cross-sectional diameter not exceeding 2.0 mm.; (ii) monofils made of highly polymeric polymethylene terephthalates which have when in the drawn condition a greatest cross-sectional diameter not exceeding 2.0 mm.; and (iii) highly polymeric polymethylene terephthalates in basis forms, that is, in the earliest commercially saleable forms which will normally be discrete particles such as powders or granules. (B) The Manufacturing Licence Field is the processes and apparatus for the manufacture of : (i) terephthalic acid and polymethylene terephthalate-forming derivatives of terephthalic acid from paraxylene, including all products which are intermediate between paraxylene and polymethylene terephthlate-forming derivatives of terephthalic acid; and (ii) the agreement products. (C) The User Licence Field is the process and apparatus (exclusive of those in the manufacturing licence field) for using or treating agreement products, including the manufacture of textile articles from the agreement products, including the manufacture of textile articles from the agreement products. . . (E) C.P.A. means the Calico Printers Association Limited of Manchester, England. (F) The C.P.A. patents in The Netherlands, Belgium, Austria, Brazil, Czechoslovakia, Hungary, Poland and Spain owned by C.P.A., which are set out in the First Schedule hereto all of which are licensed exclusively to I.C.I. (G) the I.C.I. patent rights are the patents in The Netherlands, Belgium, Austria, Brazil, Czechoslovakia, Hungary, Mexico, Poland and Spain owned by I.C.I. which : (i) are set out in the Second Schedule hereto; and (ii) have resulted or will result from any patent application in the said countries set out in the Second hereto; and (iii) result from any patent application in the said countries based on any British patent application having a first filing date earlier than January 1, 1954, of which the subject matter is wholly or partly within the manufacturing or user licence fields.

ARTICLE II

Grant of patent licences in the manufacturing and user licence fields. 1. In return for the respective royalties set out in Article III below I.C.I. hereby grants to the licensee : (A) sub-licences under the C.P.A. patent rights; and (B) licences under the I.C.I. patents rights. Such sub-licences and licences shall be for the respective lives of the patents to which they relate and shall confer on the licences the following rights : (i) in The Netherlands and Belgium, exclusive rights for the manufacture, use, treatment, import and sale of the products of the manufacturing and user licence fields subject, however, to the provisions of clauses 2 and 3 of the article; and (ii) in Austria, Brazil, Czechoslovakia, Hungary, Mexico, Poland and Spain, non-exclusive rights. . . .

ARTICLE III

Royalties for sub-licences and licences granted under the C.P.A. and I.C.I. patent rights. 1. The consideration for the sub-licences granted under the C.P.A. patent rights will be a royalty payable as long as The Netherlands Patent Number 60,828 is in force by the licenses to I.C.I. in sterling in London on the net invoice value of all agreement products sold or utilised by the licences or any authorised sub-licences or imported under any sub-licence granted by the licensee to any third party at the following rates. (i) On the first 10,000,000 lb. of agreement products sold, utilised or imported in any agreement year, 5 1/4 per cent. (iii) On all agreement products sold, utilised or imported in such year in excess of 10,000,000 lb., 3 per cent. . . .

ARTICLE IX

Technical assistance. 1. For the purpose of enabling the licensee to design, erect, and operate a plant in The Netherlands and/or Belgium for the manufacture of agreement products I.C.I. will impart to the licensee before or as soon as practicable after January 1, 1954, all necessary technical information relating to the manufacturing licence field which it is free to disclose. For the purpose of assisting the licensee in selling, treating and using the agreement products I.C.I. will impart to the licensee before or as soon as practicable after January 1, 1954, all necessary technical information relating to the user licensee will be all such information which shall have come into I.C.I.s possession before January 1, 1954, and it shall be imparted by I.C.I. supplying to the licensee copies of relevant existing drawings, technical reports and data of I.C.I. and by allowing responsible members of the licensees technical staff access to appropriate pilot and commercial plants and laboratories of I.C.I. and giving them all facilities and advice so as to enable the licensee to put on the market the best possible saleable products. I.C.I. shall not, however, be under any obligation itself to design the licensees plant or to make special new drawings for the licensee. 2. I.C.I. agree that it will not from the date of this agreement to December 31, 1966, give such information in the manufacturing licence field as is furnished to the licensee under this agreement to any other person, firm or company in The Netherlands or in Belgium to enable any such person, firm or company to manufacture agreement products in The Netherlands or Belgium other than for use in the manufacture of films and further I.C.I. agrees that I.C.I. will as a condition of giving technical information in the manufacturing licence field in any agreement entered into with any third party in any field in any agreement entered into with any third party in any such agreement to keep such information secret and confidential (to the extent to which the licensee is required to keep the same secret and confidential hereunder) and not to use it in manufacturing operations in The Netherlands or Belgium except for the manufacture of films and except in the case of Society Rhodiaceta S.A. in Belgium for the conversion of flat singles continuous filament yarns and the conversion of tows into staple fibres or tops and the conversion of staple fibres into tops.

ARTICLE X

Sale of manufacturing and selling rights. 1. For the consideration mentioned below I.C.I. hereby covenants for itself and C.P.A. that during the period from February 2, 1954, until December 31, 1966, neither I.C.I. nor C.P.A. will themselves or either of them manufacture or sell nor aid any third party to manufacture or sell agreement products in The Netherlands, Belgium or Luxembourg except for use in the manufacture of films. I.C.I. hereby further covenants with the licensee that it is fully authorised and entitled on behalf of C.P.A. to enter into the foregoing convenient on behalf of C.P.A. 2. In consideration for the above covenants by I.C.I. the licensee will play to I.C.I. in sterling in London a net capital sum of pounds 400,000. The said capital sum of pounds 400,000 shall be payable in six equal instalments each of pounds 66,666 13s. 4d., the first such instalment being due and payable on January 1, in each of the five subsequent years, provided that the said capital sum of pounds 400,000 or any outstanding part thereof shall be payable over a shorter period or in one payment at the option of the licensee, which option may be exercised at any time on six months notice to I.C.I. in writing. If the licensee shall elect to exercise such option a discount will be allowed to the licensee at a rate to be agreed between the parties.'

Two points about the agreements merited special attention : First, the covenant in Article X, which could be called the 'keepout' convents by I.C.I., were not confined to manufacturing or selling under the patents but extended to manufacturing or selling products of a terylene character whether made under the patents or not. It was only plainly essential for the licensees to have the protection of such a covenant. In the first place, some method of making Terylene without infringing the patents might have been discovered, and, secondly, the patents themselves might be held to be invalid. The second feature of the agreement was that the whole of the lump-sum consideration was attributed to the covenant in Article X and no part of it to the obligation of I.C.I. to impart 'know-how' contained in Article IX. On that point, the case (paragraph 32) stated :

'This was not because it was agreed that such information was not of importance. I.C.I., if not the European companies, considered that it was important and of substantial value but was willing to undertake in the agreements to supply the information without any express consideration therefor, bearing in mind, inter alia, that this would assist the European licensee companies and so lead to royalties becoming payable sooner than might otherwise be the case.'

I.C.I.s sales of Terylene to Japan, which were only 18,000 lb. in 1955, had risen to 135,000 lb. by 1957, and I.C.I. came to the conclusion that the only practicable way of exploiting the Japanese market was to enter into licence agreements with Japanese companies. Accordingly, on February 7, 1957, I.C.I. entered into an agreement with two Japanese companies - Teikoku and Toyo. In this case, no heads of agreement were entered into beforehand. By this agreement, I.C.I. granted the two Japanese companies exclusive sub-licences of the C.P.A. master patents and exclusive licences of the I.C.I. patents in consideration of annual royalties. It undertook that it would impart to those companies certain technical information and would not, during the period from the date of the agreement until December 31, 1970, either manufacture in Japan or, subject to certain qualifications, sell in that country any agreement products. The date of the expiry of the relevant Japanese agreement, the undertaking regarding abstention from manufacture and sale appeared in one article (Article IX, the heading of which was 'Technical Assistance'). Article X (which was headed 'Capital payment') ran as follows :

'The licensees will pay to I.C.I. in sterling in London such a capital sum as after the deduction of Japanese tax will amount to one million thirty-five thousands pounds (pounds 1,035,000). The said capital sum shall be payable in five equal instalments each of two hundred and seven thousand pounds (pounds 207,000), the first of such instalments being due and payable within thirty days after the effective date of this agreement and the remaining four instalments being due and payable at intervals of six months thereafter. As regards each of the said instalments, one-half (pounds 103,500) shall be payable by Teikoku and one-half (pounds 103,500) shall be payable by Toyo.'

The agreement contained no provision stating expressively in respect of what consideration this capital sum was to be paid. In this connection, the case stated :

'As regards the agreement entered into by I.C.I. with the two Japanese companies, the technical information which I.C.I. supplied thereunder helped them to make a quick start and was undoubtedly of considerable value of them. While it was the intention of I.C.I. that the Japanese Article X payments should be related to the covenants contained in Article IX(9) of that agreement, it was not the case that there was any understanding between the parties to this effect. Nor did we have before us any evidence which we could regard as establishing that there was any understanding between the parties of any kind as to the allocation of Article X payments as between technical assistance and the Article IX(9) covenants, or as establishing the actual values of the consideration moving from I.C.I. under those two heads respectively. The values which I.C.I. would attribute to the two heads would almost certainly differ from the values which the Japanese companies would attribute to them, and it may well be that it would not be possible to find any basis for determining satisfactory separate values under these heads.'

I.C.I. at all times accepted that the royalty payments under the various agreements should be included in its accounts as trading receipts. It contended, however, before the commissioners that the sums expressed to be payable under the agreements with the European companies in consideration of the sale manufacturing and selling rights (i.e., the 'keep out' covenants) and the sums payable under Article X of the agreement with the Japanese companies should not be treated as trading receipts but as receipts on capital account.

The commissioners in their decision given on January 10, 1964, held that the payment under Article X of the Japanese agreement should be apportioned and one-half attributed to the 'keep-out' covenant. They held that the sums expressed to be payable in respect of the 'keep-out' covenants must be taken to have been paid for the consideration set out in the relevant clauses and nothing else and the sums did not fall to be treated as income receipts in computing I.C.I.s trading profits. The commissioners held that the decision in Margarson v. Tyresoles Ltd. applied to the sums payable under the covenants and that they were capital receipts.

The parties having agreed the figures on the basis of the commissioners decision in principle, the commissioners allowed the appeal and claim, adjusting the assessments appealed against as follows : 1958-59, assessment increased to pound 2,350,899 (agreed capital allowances pound 2,350,899); 1960-61 assessment increased to pound 4,917,316 (agreed capital allowances pound 4,106,341), and allowing relief from income tax under section 341 for the year 1955-56 in the sum of pound 1,157,488 7s. (tax).

On appeal by the Crown, Cross J. held that I.C.I.s rights in the patents were part of its fixed capital, that the agreements involved the disposition of substantially the whole interest of I.C.I. in the patents in the various countries supported by 'keep-out' covenants, and that the part paid in the form of capital attributed to the 'keep-out' covenants was capital for tax purposes.

The Crown appealed.

W. A. Bagnall Q.C. and J. Raymond Phillips for the Crown. Taking the A.K.U. agreement as defining the rights of the parties, there was an exclusive licence for a royalty, know-how for no separate sum and keep-out covenants for a lump sum.

It is wrong to say that there is in this case a dichotomy between fixed and circulating capital, since it is first necessary that there should be an asset to sell; here there was no asset to dispose of. There is an essential difference between the exclusive fight of the owner of a patented process and goodwill, and on the other hand the right every individual has to trade where he pleases. Where there is sale of patent rights held as an investment there would be a capital receipt which would not be taxable apart from section 318 of the Income-tax Act, 1952.

But it is wrong to assume that this transaction was the sale of an asset. Bankes L.J. put the right test on British Dyestuffs Corporation (Blackley) Ltd. v. Inland Revenue Commissioners. The sum paid was consideration for obligations undertaken by I.C.I. in the exploitation in the course of its trade of his patent and licence rights. The granting of exclusive licences is not the same as an assignment by I.C.I. of all its rights.

[RUSSELL L.J. The substance is that I.C.I. has done the equivalent of assigning its rights]

The grant of an exclusive licence without a Keep-put covenant is not the disposition of an asset. So far as the keep-put covenant is wider than the exclusive licence, it is only a temporary restriction on the right to trade.

The know-how cases show the correct approach : see Inland Revenue Commissioners v. Roll-Royce Ltd., per Viscount Simonds, Lord Reid, and Lord Radcliffe. One way of exploiting a patent is to manufacture and sell under it : another is to grant licences. The granting of sub-licences was part of the overall business of the fibres division. In Musker v. English Electric Co. Ltd., lump sum received for know-how were held to be income receipts : see per Lord Radcliffe. The ratio of Moriarty v. Evans Medical Supplies Ltd. was that far from exploiting the existing business in Burma, the company was bringing it to an end. In Inland revenue Commissioner v. British Salmson Aero Engines Ltd. no one looked at the real question, namely : 'What was the nature of the receipt in the hands of the French Company ?'

[Russell L.J. They must have assumed that the other side of the picture was the same; the French company were the manufacturers.]

The case does not preclude the court from finding for the Crown. It does not decide that such a payment must be capital, it only rejects the argument that under the circumstances of that case it must be income. Margerison v. Tyresoles Ltd. was in reality a case of a sole agency agreement or in the nature of a premium for an agreement to share gross receipts; it is quite different from a sale of goodwill. Wrottesley J. did not decide that any case of a lump sum for a keep-out covenant must be capital; such a covenant takes its character from the circumstances. [Reference was made to Nethersole v. Withers.]

In the present case it is most important that I.C.I. were trading and that on the terms of the agreement the lump sums were not connected with an anticipated quantum of user. In Beare v. Carter the problem was whether the taxpayer was carrying on the profession of an author. For the lump sums to be properly partly capital there must be the element of disposition of an asset.

[RUSSELL L.J. What if I.C.I. had assigned the rights outright on similar financial provisions ?]

Then the lump sums would have been capital. [Reference Metal Window Co. Ltd. v. Inland revenue Commissioner.]

It is necessary to consider the whole of the arrangements made by I.C.I. for exploiting their rights; they had world-wide rights, practical considerations dictated that they be exploited in different ways in different countries. It is not right to say that because an assignment of the patents could have been capital and the grant of an exclusive licence is the same therefore the lump sums received are capital. If the patents had been assigned an asset would have disappeared from the balance-sheet. Looking at these operations, are the transactions just part of I.C.I.s trade or are they the giving up of part of it ?

F. Heyworth Talbot Q.C. and Neil Elles for the taxpayer, I.C.I. There is nothing strange about the idea that the way in which a taxpayer arranges his transactions may effect his tax liabilities : see per Romer L.J. in lnland Revenue Commissioner v. Ramsay. In cases such as the present the revenue does not lose unless there is a foreign element; if the receipt is not liable, the payer cannot deduct.

Under the European agreements the lump sums were receivable soley in consideration of covenants not to manufacture or sell the agreement products in the territories. The grant of exclusive licences would have left I.C.I. free to manufacture and compete outside the patent; they might have found another method. This right to manufacture without infringing the patents was in the nature of capital asset. A lump sum received in sterilisation could not be other than capital. [Reference was made in Inland Revenue Commissioner v. British Salmson Aero Engines Ltd., and Margerison v. Tyresoles Ltd.]

To discover the consideration for the lump sum it is necessary to look first at the agreement. Only if it is spurious is it proper to look behind it : see per Upjohn J. in Evans Medical Supplies Ltd. v. Moriarty.

It is argued that the lump sums were only a part of the total consideration for the grant of exclusive licences, the exclusivity being somewhat enlarged. But the right enjoyed by I.C.I. as patentee and licensee were fixed capital assets. If I.C.I. had been paid completely in the form of a lump sum for the effective transfer that would have been capital. It is the same if part is a lump sum. Take the example of a lease. If I.C.I. had to a pay lump sum for the right to produce in Russia that would not be a revenue payment, the present case is the correlative. The European companies were sufficiently impressed by the chance of I.C.I. competition to insist on the covenants. Commercial reality governed the apportionment of consideration.

There is no doubt here but that the rights were fixed capital assets. [Reference was made to Nethersole v. Withers.] Patent rights are always fixed capital assets unless the owner is dealing in them. It if of course always possible for the owner of a capital asset to hire or sell it in such a way that he receives income instead of capital, but that is not the case here with the 'keep-out' covenants.

Bagnall Q.C., in reply. The ability of a company to trade where it will is not a right that can be capital.

Where a payment is compensation for a temporary deprivation of the ability to earn profits it is an income receipt : see London and Thames Haven oil Wharves Ltd. v. Attwool. This case is in substance the same. [Reference was made to Glenboig Union Fireclay Co. Ltd. v. Inland Revenue Commissioners.]

LORD DENNING M.R. In the 1950s Imperial Chemical Industries Ltd. were exploiting a new fibres material which they called Terylene. They manufactured it on a large scale at Wilton, but they could not make enough to meet the world demand. So they granted exclusive licences to foreign companies in various countries. In each licence they covenanted that they would not themselves enter the market for that country. They covenanted to 'Keep-out' of that country. In return for these 'Keep-out' covenants, they received considerable sums are part of the profits of I.C.I. which should be brought into tax. The amount of tax involved is over pound 1 million.

The detailed facts are set out in the case stated and in the report at first instance, and I need only pick out the salient points. The master patents for Terylene were owned by the Calico Printers Association, who granted I.C.I. an exclusive licence to exploit them and to grant sub-licences to others. The ancillary patents were owned by I.C.I. themselves. I.C.I. were unable themselves to exploit the world market for Terylene. So they granted sub-licences to five European companies and two Japanese companies.

A typical sub-licence was that granted by I.C.I. to a Dutch company covering the Netherland and Belgium. (1) I.C.I. granted to the company an exclusive licence to use the major patents (owned by C.P.A.) in return for a royalty based on the net invoice value of the Terylene products sold or utilised. (2) I.C.I. granted an exclusive licence to use the ancillary patents (owned by I.C.I.) in return for a royalty of pound 10,000 a year for 10 years. (3) I.C.I. agreed to provide 'know-how'. No separate consideration was stated for 'know-how' because I.C.I. expected to get their return by way of the royalties coming in sooner. (4) I.C.I. agreed to get their 'Keep-out' of the Netherlands, Belgium, and in addition, Luxembourg, and not to operate there in the patented article Terylene or in products similar to Terylene for the period of the patent and a little longer. In return for this 'keep-out' covenant, the licensee agreed to pay the sum, described as a capital sum, of pound 4,00,000 payable by six equal annual instalments, but the licensee had the option of discharging the annual instalments by one payment.

The terms for the Japanese company were similar, except that the 'know-how' and 'keep-out' covenants were combined in return for a capital sum of pound 103,500. This was attributed by the commissioners as to one-half for 'know-how' and one-half for the 'keep-out' covenant. This apportionment was accepted by the Crown.

The question for decision is as to the pound 400,000 payable for the 'keep-out'covenant by annual instalments. was it as trading receipt and taxable as part of the income of I.C.I. or was it a capital receipt which is not taxable In considering this question, I would point out that this 'keep-out' covenant is nit a covenant 'in gross.' It does not stand by itself. It is ancillary to the grant if a licence. Its effect can best be understood by remembering the difference kinds of licence with which we are familiar. An ordinary 'licence' is a permission to the licensee to do something which would otherwise be unlawful. It leaves the licensor at liberty to do it himself and to grant licences to other persons also. A 'sole licence' is a permission to the licensee to do it, and no one else, save that it leaves the licensor himself at liberty to do it. An 'exclusive licence' is a permission which is exclusive to the licensee, so that even the licensor himself is excluded as well as anyone else.

A 'keep-out' covenant is a covenant which bolsters up an exclusive licence. It makes express that which would otherwise be implied. The licensor covenants expressly with the licensee that he will not enter on the domain which he has granted to the licensee. In the present case the 'keep-out' covenants are somewhat wider than the exclusive licence in area, time and products. But this makes no differences to the tax position. The receipts by I.C.I. bear the same character - capital or income - no matter whether the 'keep-out' covenant is co-extensive with the licence or somewhat wider than it.

In these circumstances I do not think it would be correct to consider a 'keep-out' covenant as thing by itself. The essence of the transaction in each case is that I.C.I. granted to the foreign company an exclusive licence to use the patents in the county concerned for the term of the patent : and in return received remuneration in the shape of : (1) A royalty payable on the net invoice value of products sold or utilised (this was for use of the master patents of C.P.A.). (2) A royalty of a fixed sum payable each year(this was for use of the ancillary patents of the I.C.I.). (3) A lump sum payable by instalments over six years (this was said to be for the 'keep-out' covenant.

Now I.C.I. are not dealers in patent rights or patent licences. When they granted this exclusive licence, they were to my mind disposing of a capital asset. If this had been an assignment of patent rights, there could be no doubt that I.C.I. would be disposing of a capital asset. I see no difference in this regard between an assignment of patent rights and the grant of an exclusive licence for the period of the patent. It is the disposal of a capital asset. But this does not determine the quality of the money received. A man may dispose of a capital asset outright for a lump sum, which is then a capital receipt. Ir he may dispose if it in return for an annuity, in which case the annual payments are revenue receipts. Or he may dispose of it in return for annuity, in which case the annual payments are revenue receipts. Or he may dispose of it in part one and in part for the other. Each case must depend on its own circumstances. But it seems to me fairly clear that if,and in so far as, a man disposes of patent rights outright (for example, by an assignment of his patent,or by the grant of an exclusive licence) and receives in return royalties calculated by reference to the actual user, the royalties are clearly revenue receipts. If, and in so far as, he disposes of them for annual payments over the period, which can fairly be regarded as compensation for the user during the period, then those also are revenue receipts (such as the payment of pound 2,500 a year over 10 years in Inland Revenue Commissioners v. British Salmson Aero Engines Ltd., and of course, the royalties of pound 10,000 a year in the present case). If, and in so far as, he disposes of the patent rights outright for a lamp sum, which is arrived at by reference to some anticipated quantum of user, it will normally be income in the hands of the recipient (see the judgment of Lord Greene M.R. in Withers v. Nethersole ; approved by Lord Simon in the House of Lords). But if, and in so far as, he disposes of them outright for a lump sum, which is arrived at by reference to some anticipated quantum of user,it will normally be income in the hands of the recipient (see the judgment of Lord Greene M.R. in Wither v. Nethersole; approved by Lord Simon in the House of Lords). But if, and in so far as, he disposes of them outright for a lump sum which has no reference to anticipated user, it will normally be capital (such as the payment of pound 25,000 in the British Salmson case). It is different when a man does not dispose of his patent right, but retains them and grants a non-exclusive licence. He does not then dispose of a capital asset. He retains she asset and he uses it to bring in money for him. A lump sum may in the those cases be a revenue receipt : see Rustproof Metal Window Co. Ltd. v. Inland Revenue Commissioner, per Lord Greene M.R., who emphasised that it was a non-exclusive licence there. Similarly, a lump sum for 'know-how' may be a revenue receipt. The capital asset remains with the owner. All he does is to put it to use.

Applying these criteria, in the present case it is quite clear that the royalties for the master C.P.A. patents and the royalties for the ancillary I.C.I. patents were revenue receipts . That is admitted. So far as the lump sum is concerned, I regard it as a capital receipt, even though it is payable by instalments. I am influenced by the fact : (1) that it is part payment for an exclusive licence, which is a capital asset; (2) that it is payable in any event irrespective of whether there is any user under the licence. Even if the licensees were not to use the patents at all, this sum would still be payable; (3) that it is agreed to be a capital sum payable by instalments ; and not as an annuity or a series of annual payments.

In these circumstances I am quite satisfied that the lump sum was a capital receipt and I.C.I. are not taxable upon it. I find myself in entire agreement with the judgment of Cross. J. and I would dismiss the appeal.

Davies L.J.I. agree. A clear statement of the law on this matter is to be found in a passage in Lord Greene M.R. judgment in the Nethersole case, to which my Lord has referred. It may be convenient perhaps to quote that passage . The Master of the Rolls, having referred to the British Salmson case proceeded in these terms :

'This decision is a clear authority, so far as this court is concerned, that a lump sum payment received for the grant of as patent licence for a term of years may be a capital and not a revenue receipt; whether or not it is so must depend on any particular facts, which, in the particular case, may throw light upon its real character, including, of course, the terms of the agreement under which the licence is granted. If the lump sum is arrived at by reference to some anticipated quantum of user it will, we think, normally be income in the hands of the recipient. If it is not, and if there is nothing else in the case which points to an income character, it must, in our opinion, be regarded as capital. This distinction is in some respects analogous to the familiar and perhaps equally fine distinction between payments of a purchase price by instalments and payments of a purchase price by way of an annuity over a period of years.'

One might add that the case to which Lord Greene M.R. was referring there, the British Salmson case, in many respects has similarities to the one at present before this court. As my Lord has said, that passage in Lord Greenes judgment was quoted and approved by Lord Simon in the House of Lords in the same case.

As I think, Cross J. applied the law, as one would have expected, with complete accuracy in the present case, I would refer to a passage in his judgment, where he said :

'The contention of the Crown before me, as before the Commissioners, was that the various agreements were simply the mode in which I.C.I. chose to exploit some of its patent rights in the course of its trade and that the lump-sum payments were simply part of the total consideration for all the obligations undertaken by I.C.I. Even if there were no authority on the point, I, for my part would not have accepted this argument. The rights which I.C.I. possesses in the C.P.A. patents and its own ancillary patents were not part of its circulating capital abut were fixed capital assets of its business. If it had sold those rights in different countries outright for capital sums, those sums could not have been treated as trading receipts. But the agreements in question contained in substances dispositions of the whole interest of I.C.I. in the patents in the various countries supported by the 'keep-out' covenants. A transaction of that sort does not seem to me to be in the least like the imparting of know-how for reward and if the parties chose to arrange that part of the consideration received by I.C.I. should take the form of a capital payment, and be attributed to the keep-out covenants I do not see why that part should not be capital for tax purpose.'

I agree with that.

Mr. Bangnall concealed throughout this case for the Crown, as I understood his submission, that if the transaction in the present case had taken the form of an out-and-out assignment by I.C.I. of their patent to the Dutch company, the Japanese company, or various other companies, whether for a lump sum, payable by instalments or not, that would be a capital receipt. It seems to me that the present transactions is in substance the same as that. This was a sub-licence of the patent for the whole of the life of the patent. That seems to me to be precisely the same as the sort of transaction which the Crown conceded would result in a capital receipt and not a revenue receipt.

I therefore agree that the judgment of Cross J. was correct in every respect, and I would dismiss the appeal.

RUSSELL L.J. Without doubt the exclusive licences under the C.P.A. patents, and the allied out subsidiary I.C.I. patents, were fixed capital assets of I.C.I. They were in fact the foundation of the Fibre Division. The Crown admits that if, to take the agreement with A.K.U. touching Holland and Belgium as an example, I.C.I. had assigned to A.K.U. the C.P.A. exclusive licences and I.C.I. patents in relation to those countries upon the same terms of payments, the sums of pound 400,000 would have been not a receipt but a receipt on capital account arising from a disposition of fixed capital assets. And similarly in other contracts the subject of this appeal. But the Crown contends that the outcome is the exact opposite because I.C.I. only granted sub-licences under the C.P.A. exclusive licences and licences under the I.C.I. patents, and has, therefore, not disposed of or realised its fixed capital assets.

But in considering whether I.C.I. have made such a disposition, regard must be had to the reality of the situation. Taking again the Dutch and Belgian example : before the agreement with A.K.U., I.C.I., by virtue of its exclusive licences from C.P.A. and its own subsidiary patents, had the right for the whole life of the patents (a) to make us and vend in those countries in accordance with the patents, and (b) to prevent all others from so doing. It was that group of rights that constituted the whole value of this part of its fixed capital from which profits were to be expected to grow. The result of the contract with A.K.U. was that the whole of this group of rights was disposed of for ever by I.C.I. and effectively vested in A.K.U. In exchange I.C.I. acquired a contractual obligation on the part of A.K.U. to pay a sum of pound 400,000, and in addition royalties related directly to the extent of user in the case of the C.P.A. patents and consisting of an annuity in the case of the I.C.I. patents. I.C.I. had deprived itself completely of all ability thereafter to turn that part of its fixed capital to account whether by direct use of the inventions or by licensing for reward. It had effectively transferred that ability to another; and that ability had been that part of its fixed capital in part for a sum (pound 400,000) which of itself, unlike the royalties, did not bear the stamps of a revenue receipt. I entirely agree with Cross. J. on this point.

Since this in my view wholly disposes of the appeal, I prefer to say nothing either way on the alternative method of putting the case for the taxpayer, which was the ground upon which the special commissioners decided the case : namely, that I.C.I. depraved itself for a period by the agreement of the right or ability or potential ability to make use and vend 'agreement products' in, for example, Holland and Belgium; that this right or ability was part of its fixed capital; and that the pound 400,000 was expressly under the contract the consideration for this deprivation. But, as Cross J. pointed out, and indeed the Crown urged, this aspect of the case was ancillary to the patent rights, and indeed a sin qua non of such disposition (especially in the possible event of the patents proving vulnerable or a new method being discovered by I.C.I.), and, therefore, cannot effect adversely the taxpayers contentions on the first point.

I, also, would dismiss the appeal.

Appeal dismissed with costs.

Leave to appeal refused.

Solicitors : Solicitor of Inland Revenue; J. S. Copp.


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