Rolls-Royce Ltd v Jeffrey (Inspector of Taxes), Same v Inland Revenue Commissioners
[1962] 1 All ER 801(Judgment by: Lord Radcliffe)
Between: Rolls-Royce Ltd
And: Jeffrey (Inspector of Taxes)
Between: Same
And: Inland Revenue Commissioners
Judges:
Viscount Simonds
Lord Reid
Lord RadcliffeLord Morris of Borth-y-Gest
Lord Guest
Subject References:
Income Tax
Income
Payment of lump sums for imparting technical knowledge
Whether income or capital receipt
Case References:
British Dyestuffs Corpn (Blackley) Ltd v Inland Revenue Comrs - (1923), 129 LT 538, affd CA; (1924), 12 Tax Cas 586; 28 Digest (Repl) 25, 105
Butterworth v Page - [1935] All ER Rep 943; 153 LT 34
sub nom Handley Page v Butterworth - 19 Tax Cas 328; 28 Digest (Repl) 26, 111
Davies v Shell Co of China Ltd - (1951), 32 Tax Cas 133; 28 Digest (Repl) 37, 165
Doncaster Amalgamated Collieries Ltd v Bean - [1946] 1 All ER 642; 175 LT 10
sub nom Bean v Doncaster Amalgamated Collieries Ltd - 27 Tax Cas 296; 28 Digest (Repl) 121, 467
Edwards v Bairstow - [1955] 3 All ER 48; [1956] AC 14; 36 Tax Cas 207; [1955] 3 WLR 410; 28 Digest (Repl) 397, 1753
Haig's (Earl) Trustees v Inland Revenue Comrs - [1939] SC 676; 22 Tax Cas 725; 28 Digest (Repl) 126, 373
Moriarty (Inspector of Taxes) v Evans Medical Supplies Ltd, Evans Medical Supplies Ltd v Moriarty (Inspector of Taxes) - [1957] 3 All ER 718; 37 Tax Cas 540; [1958] 1 WLR 66; 28 Digest (Repl) 268 112
Rustproof Metal Window Co Ltd v Inland Revenue Comrs - [1947] 2 All ER 454; [1947] LJR 1479; 177 LT 657; 29 Tax Cas 243; 28 Digest (Repl) 438, 1916
Van den Berghs Ltd v Clark - [1935] All ER Rep 874; [1935] AC 431; 104 LJKB 345; 153 LT 171; 19 Tax Cas 390; 28 Digest (Repl) 117, 450
Judgment date: 1 March 1962
Judgment by:
Lord Radcliffe
My Lords, I think that the issue of these appeals depends on a right appreciation of just two matters. One is the nature of this asset of the appellants which is conveniently comprehended in the word "know-how": the other is the nature of the considerations given by them in exchange for the payment of the sums of money which are the subject of this dispute.
First, as to "know-how". I see no objection to describing this as an asset. It is intangible: but then so is goodwill. It would be difficult to identify with any precision the sources of the expenditure which has gradually created it and, patents apart, I would not have thought of it as a natural balance-sheet item. But it is a reality when associated with production and development such as that of Rolls-Royce, and a large part, though not the whole of it, finds its material record in all those lists, drawings, and manufacturing and engineering data that are specified in the various licence agreements.
It is fundamental to the appellants' case that we should categorise this asset as being part of their fixed capital. Indeed their argument proceeds from the premise that it is fixed capital. This, I think, is to start from too assured a base. An asset of this kind is, I am afraid that I must use the phrase, sui 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 specialished production organisation and, although I think it correct to describe it as fixed capital so long 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" from the more straightforward elements of fixed capital. For instance, it would be wrong to confuse the physical records with the "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 the 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 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. I do not therefore think that this appeal can be decided by the simple set of propositions. "'Know-how' is an item of fixed capital. A lump sum received by a trader on a sale of such an item should not go to his income account. It makes no difference that the item is disposed of, by several separate transactions divided from each other by time intervals."
Now as to the licence agreements. I will take the agreement with the Chinese National Government as typical, since the essential features of all are the same. To begin with, it is not well described as a licence. Putting aside the actual patents which are found by the Case Stated to have been such as to have "very little store" set by them in this context (in fact there were no Chinese patents), there is really no licensing done at all. Whatever else the lump or capital sums payable under the agreement are paid for, it is not for a licence in the ordinary sense; it is for the making available, the imparting, for the "know-how", both as recorded in the drawings and other data and as conveyed by direct instruction, advice and information. If one analyses the various things that the appellants are to do in return for the money they are to get they all come down to forms of instruction and advice. By cl 2 they are to supply "complete drawings and manufacturing and engineering data and information adequate and reasonably necessary to enable the commission to manufacture" the particular Rolls-Royce engine selected. No doubt the things to be supplied are tangible objects, but then so are text-books, formulae or recipes. They are teaching at long range.
There are supplementary obligations. By cl 10 the appellants are to give the commission advice as to further improvements and modifications in the engine's manufacture and design, so far as they lawfully can. Again, cl 14 binds them to receive and instruct in their works persons nominated by the commission with a view to rendering them capable of constructing the engine; and under cl 16 the appellants undertake to release one or more competent members of their staff for temporary secondment to help in construction work in China. Finally, cl 23 grants to the commission an option, in effect, to acquire the "know-how" on any future type of gas-turbine aircraft engine, provided that acceptable terms are offered to them by the appellants.
The money which the appellants get in return under the agreement consists of a "capital" sum payable by instalments and recurring sums described as royalties. They are only royalties in the sense that the measure of these recurrent payments is taken to be so many pounds sterling per engine manufactured in China and a fixed percentage on the commercial selling price of all spare parts so manufactured. The "capital" sum is what is now in question. I do not think it possible to attach any significance to the qualifying adjective. If we did, revenue appeals on this particular issue would soon settle themselves. Presumably it did not matter to the commission how the sum was described: on the other hand it certainly did not bind the appellants, when they had received the money, to apply it in any particular way in their accounts or otherwise. I think that one has to be on one's guard in cases of this kind against supposing that such adjectives as "capital" or "lump" contribute anything to the solution of the issue. "Capital" here seems to refer merely to the fact that the moneys are to be paid outright against complete delivery of the drawings and other documents, regardless whether any production followed or not. A "lump" sum is merely a non-recurring payment of money, but the adjective does not afford a good guide to the decision whether there is taxable income or not. A man keeping a tobacco shop who sells a packet of cigarettes receives a lump sum as the purchase price of his property and I suppose that we should add that his trading stock is part of his capital; but no one would doubt that, just the same, the money he gets should find its way into his accounts for the purpose of ascertaining his trading profit.
I have not been able to see why these "capital" receipts should not be brought into account in the assessment of the appellant's trading profits. It seems to me that, so long as they kept their "know-how" to themselves, they used it for the manufacture of their own engines and its value was expressed in the successful sales which they achieved of those products. I dare say that they would have preferred, ideally, to reserve their "know-how" solely for the purposes of their own manufacture. I am not sure of that, when I read some of the chairman's speeches at the annual meetings. However that may be, it is clear that they saw that, having the "know-how", they could derive profit from the manufacture of their engines, even by others, in parts of the world where they either could not or would not sell or manufacture them themselves, provided only that they equipped those others with the requisite expertise. So they turned the "know-how" to account by undertaking for reward to impart it to the others in order to bring about this alternative form of manufacture.
My Lords, in my opinion, moneys so obtained arise from the appellants' trade as "manufacturers of motor cars and aero engines". I appreciate their point that such moneys are not derived from their own operations of manufacture and therefore, if assessable at all, must be attributable to a new and separate trade consisting of the exploitation of "know-how" for reward. But this, with all respect, is a verbalism and I think that the respondents were right in saying that the appellants' new way of exploiting "know-how" was no more than a development of their direct manufacturing trade and did not rank or need to rank as a separate business. In my view that expresses the reality of the matter, since, as manufacturers, the appellants were interested to promote the production of their engines for reward to themselves, and it was a question of trading policy by which method they secured this result, by manufacturing and selling on their own or by selling to others the essential secrets of manufacture.
The argument before us naturally turned largely on the applicability or the reverse of the decision of this House in Moriarty (Inspector of Taxes) v Evans Medical Supplies Ltd and I have no doubt that the conclusions of the Special Commissioners and of Pennycuick J were largely determined by the belief that the present case was governed by the earlier decision. I wish that the endless complexities of commercial and industrial life did not so often throw up combinations of factors which, while appearing to have close resemblance to each other, turn out on final analysis to have some significant divergence. I can only say that the circumstances that we have here do not present themselves to me as having the same essential features as those that destinguished Moriarty v Evans Medical Supplies Ltd . What weighed with the majority judgments in that case was that the company had sold to the Burmese government a secret process on which the success of its business in Burma had to depend and it had, in effect, disposed altogether of its Burmese trade. To do that was to dispose finally of part of its fixed capital and moneys received in return were not trading receipts. The case was regarded as being an equivalent to Butterworth v Page, in which the owner of a secret process had destroyed his property by making it available to the world. I do not read the agreements that we have here as amounting to a disposal of something that was fixed capital in that sense, if only because the information made available is only that bearing on the production of a single type of engine.
I would dismiss these appeals.