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Calcutta High Court
Rustproof Metal Window Co., Ltd. vs Inland Revenue Commissioners. on 31 July, 1947
Equivalent citations: 1948 16 ITR 57 Cal

JUDGMENT LORD GREENE, M. R. - The matter in controversy between the parties relates to a sum of Pounds 3,000 paid to the respondent company under an agreement under seal dated December 30, 1939, which I will call "the licence agreement." The Special Commissioners rejected the companys contention that this was not an income receipt and had been improperly included as such for the purpose of the assessment to excess profits tax against which the company was appealing. The decision of the Commissioners was reserved by Atkinson, J., who held that this sum was a capital receipt. Our only task is to decide which of those two decisions is right.

In order to decide the vexed question whether a receipt is of an income or a capital nature it is necessary to examine the facts with care and I must accordingly state as concisely as I can those which appear to me to bear more closely on the question. The original trade of the company, which was incorporated in the year 1935, was the manufacture of rustproof metal windows frames. Since 1939 the company had been increasingly engaged in war production, particularly the manufacture of ammunition boxes for the Admiralty. In 1935 the company had purchased from Mr. Williams letter patent relating to a galvanizing process which were assigned to it on January 31, 1936. The process was suitable for the treatment of the ammunition boxes required by the Admiralty. The licence agreement was made at the request of the Government, who were anxious to have other source of supply for ammunition boxes treated in accordance with the process. A company called Fisher & Ludlow, Ltd. (whom I will call "the licensee") had made a contract dated November 8, 1939, with the Director of Navy Contracts for the manufacture of ammunition boxes. This contract was not before us, but from its terms as stated in the licence agreement it appears that it was for the manufacture of Pounds 75,000 boxes. The parties to it were the company (called "the licenser") and the licensee. The second recital was in the following terms : "The licensor has agreed to grant to the licensee such licence to use the said invention as is herein contained in consideration of (a) the payment by the licensee of the capital sum of Pounds 3,000, and (b) the royalties hereinafter reserved and made payable."

The licence agreement then proceeded to witness that in pursuance of the said agreement and in consideration of the sum of Pounds 3,000 then paid by the licensee to the licensor, and of the royalties thereby reserved and made payable, and of the convenants and the agreements on the licensees part thereinafter contained the licensor "hereby grants unto the licensee full licence and authority to make use and exercise the said invention under the said letter patent within the United Kingdom and the Isle of Man for all purposes connected with the manufacture of ammunition boxes (but not of any other articles or products) during such period as may be required for the application of the said invention to not more than seventy-five thousand ammunition boxes to be manufactured by the licensee under contract No. C. P. 57394/39 dated the eighth day of November one thousand nine hundred and thirty-nine and made between the licensee and the Director of Navy Contracts or until the said contract shall be determined for any reason whatsoever whichever period shall be the shorter but so that under no circumstances shall this licence continue after the ninth day of August one thousand nine hundred and fifty." The Pounds 3,000 referred to in the recital and the witnessing part is the Pounds 3,000 in question in this appeal.

So far there are certain points to be noted. (1) The consideration expressed for the grant of the licence consists of (a) Pounds 3,000 (b) royalties; (2) these payments are described as the consideration for the grant of the licence alone; (3) the parties describe the Pounds 3,000 as a "capital sum", (4) the licence is strictly limited in character. It is a non-exclusive licence. It is limited both in space and in time, it is limited to the use of the patented process in connection with ammunition boxes and those boxes are not only limited in number to Pounds 75,000 but are confined to the boxes which are subject-matter of the licensees contract with the Director of Navy Contracts.

There follow a number of covenants contained in numbered paragraphs. Paragraph I contains the licensees convenient to pay at quarterly intervals a royalty of three pence per box. It is followed by a proviso to the effect that if the licensees contract with the Director should be determined by the Government before all the 75,000 boxes had been treated with the process the licensor should pay to the licensee a sum bearing the same proportion to Pounds 1,000 as the number of the boxes not so treated should be to Pounds 75,000. Paragraph 2 contains a convenient by the licensor to erect at the licensees works at the licensees expense the plant and machinery necessary for the treatment of ammunition boxes with the process with provisions as to what was to happen to the plant and machinery at the expiration or determine action of the licence. The concluding sentence of this paragraph is as follows : "During the continuance of this licence and at all times hereafter the licensee shall use its best endeavour to keep secret the manner of using the said invention and any further invention or discovery falling within the scope of clause 12 hereof and the methods of applying the same and the licensee shall not disclose any information whatsoever regarding the same to any person firm or company other than the licensor."

The inventions or discoveries falling within the scope of clause 12 are inventions or discoveries made by the licensee during the continuance of the licence. In connection with this provision paragraph 6 should be mentioned in which the licensee covenants not to challenge the validity of the patent and not, after the termination of the licence and during the subsistence of the patent, to use the patent or any special or secret information or methods of user in connection therewith disclosed by the licensor to the licensee. In paragraph 9 the licensor covenants in return for reasonable remuneration to give to the licensee reasonable assistance and supervision. Paragraph 11 contains the common convenient by the licensor during the continuance of the licence to communicate to the licensee any new inventions it may make or acquire relating to the galvanizing of metal as applicable to ammunition boxes and permit the licensee to use the same within the territory covered by the licence without further payment. In paragraph 12 the licensee convenants to disclose to the licensor any additions to or improvement in the said invention which it shall make or discover during the continuance of the licence. Paragraph 14 provides for the cessation of royalty payments in the event of the patent being declared by the court to be invalid but any right to recover "the said capital sum of Pounds 3,000 or any part thereof" expressly excluded. The remaining clauses are not of particular importance.

It was argued by counsel for the Crown that the decision of the Special Commissioners upon a question of this kind ought not to be disturbed unless it could be said that they had misdirected themselves in law. This, I think, is to put the matter too high. Great weight should no doubt be given to their view but the courts have on many occasions acted on the principle that the decision of Commissioners on the question whether a receipt is of a capital or an income nature is open to review, and I propose so to treat it in this case. It is a question which is to be answered upon a consideration of all the relevant facts. Counsel for the company called attention to the facts that the parties themselves in the agreement call the Pounds 3,000 a capital sum and that a contrast is drawn in the agreement itself between that sum and what are called royalties. They then argued that a lump sum paid in respect of the future user of a patent which is not based upon the calculation of a royalty of so much per article manufactured in accordance with the patent must necessarily be of a capital nature. A lump sum paid for the right to a patent, as distinct from a lump sum built up of payments of royalty based on actual user, cannot, it is said in its nature be income in the hands of the licensor. In the present case, they said, the sum of Pounds 3,000 was payable whether or not a single ammunition box was treated with the process under the licence and the provision for payment by the licensor to the licensee in the event of a determination of the licensees contract by the Government which is contained in paragraph 1 is limited to Pounds 1,000 at the most. It is better to state the proposition submitted in counsels own words which were as follows : "In the case of a lump sum paid for a non-exclusive licence, unless it can be found to have been arrived at by reference to royalties or returns for a specified quantitative future user, such lump sum must be of a capital nature." I will deal presently with the authorities which were said to have established this proposition. But before doing so I propose to examine it on its merits.

It must be remembered that although royalties in the sense of payments received by the patentee of a stated sum for each article or for a number of articles produced by the licensee in accordance with the invention will in general (if not always) be of an income nature it does not follow that a payment received for the permitted user of a patent which does not fall within that definition is not an income, receipt in the hands of the patentee. The tax is concerned with income, whatever its nature may be, provided, of course, in the case of excess profits tax, it is a receipt of a trade or business with which that tax is concerned. If a receipt is an income receipt it matters not that it is not a royalty in the sense above stated, or in not arrived at on a royalty basis, for example, by a mere aggregation of royalty payments. If I may say so with respect Atkinson, J., appears to have attributed some magic force to the word royalty, and to have thought that unless the consideration for licence was royalty in the above sense or was built up of royalties it must necessarily be of a capital nature. Returning to the argument of counsel for the company, I cannot understand why it should be said, as the proposition implies and was specifically argued, that a sum received in respect of the right to use a patent which is payable whether or not the patent is in fact used and without reference to any question of user must necessarily be a capital receipt.

A sum received in consideration of the grant of the right to use a patent, whether user does or does not take place, is surely just as capable of being an income receipt as a sum received in consideration of the grant of the right to use any other kind of property, for example, a motor car. Whether or not it is an income or a capital receipt must, I should have thought, be ascertained by reference to all the relevant circumstances and not by some fixed rule of law such as is suggested.

Counsel for the company contended in the first place that his proposition, besides being based on sound reasoning (a statement with which I do not agree) is to be extracted from the decision of the House of Lords in Mills v. Jones. I am quite unable to agree. That case was decided on the simple ground that once it was found (as the Commissioners had found) that the amount of future user included in the sum awarded was negligible there was an end of the case. No proposition such as that contended for by counsel for the company is involved in the decision. He next argued that his proposition was established by the decision of Mackinnon, J., (as he then was) in Desoutter Bros., Ltd. v. Hanger & Co., and that this decision had been approved by this Court in Nethersole v. Withers. I do not read the judgment of this court in the Nethersole case as affirming or approving any such proposition. The object of the reference made to the Desoutter case was to show that a certain principle suggested for deciding this class of case could not be accepted, since decided cases showed that it had not been acted upon. The Desoutter case was one of such cases. The next case referred to for this purpose in the Nethersole judgment was Inland Revenue Commissioners v. British Salmson Aero Engines, Ltd., a decision of this court in which again the court had not proceeded on the suggested principle. The reference in the Nethersole case to the fact that in the Desoutter case the sum in question had no reference to actual user was, I think, merely intended to refer to what was a characteristic of that case.

It cannot, I think, have been intended to lay down or approve any rule to the effect that where the payment has no reference to actual quantified user it must necessarily be a capital payment. That the receipt of a sum which is based on actual user points more strongly (and it may be conclusively) to its being of an income character is true. The fact that a sum received has no reference to actual user, but is merely paid for the right to use, is no doubt a relevant matter to be taken into account along with any other relevant consideration. But that this court in the Nethersole case never intended to say that it was a conclusive fact is we think, clear from what it said was decided by the Salmson case. The passage is as follows (175 L. T. at p. 111) : "This decision is a clear authority, so far as this court is concerned, that a lump sum payment received for the grant of a 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. It 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."

If I have any comment to make on this language it is that the concluding sentence possibly puts the point too high in favour of capital. It is, however, qualified by the crucial words "if there is nothing else in the case which points to an income character." Lastly, the proposition of counsel for the company is clearly inconsistent with the Salmson case itself. The sums which the court in that case held to be of an income nature were paid for the right to use the patent. They had no reference to and were not based on any particular quantum of user and were payable whether or not any user did in fact take place.

The other main argument submitted by counsel for the company was one which Atkinson, J., appears to have accepted. As counsel put it to us it was, if I correctly understood it, to the following effect. The case is not, he said, a simple case of a grant of a non-exclusive licence granted for a lump sum; there is in it the element of the secret knowledge of the licensors as to the application of the process to ammunition boxes. He argued in the first place that the Pounds 3,000 was, on the true construction of the licence agreement, the consideration paid by the licensees for the communication to them of this secret knowledge and that it was therefore a capital receipt. This argument cannot, in my opinion, be accepted, It is quite impossible to link the 3,000 in this way with the alleged communication of secret knowledge.

Counsel for the company then argued that as the agreement contemplated that in using the licence the licensees would have communicated to them or would acquire information of a secret nature as to the use of the patented process the result would be to diminish the value of the patent and that the effect of the licence would therefore be to diminish the value of the companys capital asset, namely, the patent. The Pounds 3,000 therefore cannot be said to be wholly an income receipt. The appreciation of Atkinson, J., of this argument was as follows : The case he said, was one of a secret process of which the company had a monopoly both in fact and in law. At the expiration of the period of the patent the company, but for the licence, would be the only people with the necessary knowledge of how to use and apply the process. After this licence the monopoly would be no longer theirs since there would be a rival firm, namely, the licensee, knowing just as much about it as they knew themselves. This, he said, showed that the value of their business asset, that is the patent, would have been greatly depreciated by the grant of the licence.

With the greatest respect I am unable to agree with this. There was no evidence that there was anything special about this patent, nor is it correct to speak of a patented process as a secret process. Disclosure in the specification is a condition of validity. If the suggestion is that there was some secret concerning the right way to use the patent which did not appear in the specification the result would, of course, be that if this secret method of user was the best way of using the patent known to the patentee at the date when his complete specification was left at the Patent Office [Patents and Designs Act, Section 25 (2) (j)], the patent would be bad. We are not entitled to make any such assumption. If the suggestion is that the company had and was proposing to communicate to the licensee some secret method of using the patent which it had invented or acquired since the lodging of the specification there is no evidence that any such secret method existed, nor does the licence itself contain any suggestion that it did.

Lastly, the suggestion may mean that the licensee by the mere fact of using the patent and being shown how to use it by the company would be in a better position than somebody starting to use the patent for the first time without having the benefit of practical instruction or experience. This, no doubt, would normally be so, although such an advantage might be of little value. There are many patents which are applied more efficiently after some experience of their practical application or some practical instruction by the patentee then they could be by a person who had merely read the specification. But the acquisition of practical knowledge of this kind is not the same thing as the acquisition of the knowledge of a secret process. It is nothing more than what normally happens in the case of a licence; a person who has used the patent is likely to the more knowledgeable and efficient in its use then a person who has not. But the acquisition of this practical instruction given to the licensee be said to depreciate any business asset of the licensor.

The only person to whom such practical knowledge can be of use is a person entitled to use the invention comprised in the patent. During the currency of the patent no one but the patentee or a licensee from him is entitled to use the patent. It is clear, therefore, that during the currency of the patent the fact that this practical knowledge has been acquired by or communicated to the licensee could not in any way affect the value of the patent. After the expiration of the patent the patented process can be used by the public and the presumption must, I think, be, in the absence of evidence to the contrary, that the specification contains the necessary directions as to its use. That a member of the public using the process would be in a better position momentarily at any rate, to use it to the best advantage if he had obtained some practical knowledge than an uninstructed beginner may be conceded. But this is true in the case of many if not most, patents.

The argument, in fact, goes too far, for it would mean that there was an element of capital depreciation of business assets in many or perhaps most grants of licences. Every patentee who has granted a licence will find that on the expiration of the patent his licensee is, or may be for a time at any rate, in a better position to compete with him than other members of the public who on the expiration of the patent are minded to use the invention; and the more licensees he has granted the more such privileged competitors he will have. But I have never before heard it suggested that this implies that the licensor has suffered a capital loss. On the contrary, if there is in any case any substance in the suggestion that a licence puts the licensee in a better position to compete with the licensor after the expiration of the patent it can be no more than a necessary incident of the grant of the licence, and a necessary consequence of the exploitation of the patent for profit during the period of its validity.

That what I have said represents the real position is, I think, recognised by the parties themselves. In paragraph 6 of the licence agreement the licensee covenants that it will not after the termination of the licence "and during the subsistence of the said Letters Patent make any further use of the invasion "or any special or secret information or methods of user in connection therewith disclosed by the licensor to the licensee." The company, therefore, so far as use of secret information by the licensee is concerned, did not stipulate that it should not be used after the expiration of the patent. In paragraph 2 there is a perpetual covenants by the licensees to use their best endeavours to keep secret the manner of using the invention. This does not appear to me to assist the argument in any way. The inventions or discoveries the manner of using the invention. This does not appear to me to assist the argument in any way. The inventions or discoveries the manner of using which the licensees by the same paragraph covenant to keep secret after the expiration of the patent are, as I have already said, inventions or discoveries not by the licensors but by the licensees. The argument, therefore fails to convince me.

I will now turn to the real question in the case, namely, whether, having regard to all the relevant circumstances, the receipt is of a capital or of an income nature. In my opinion it is of an income nature and the Special Commissioners came to the right conclusion. The licence is a non-exclusive licence and the companys right to exploit the patent by the grant of other licensee is therefore unimpaired. It is granted for a specific purpose only, namely, to enable the licensee to fulfill a particular contract. The right which it confers is to use the invention for a number of boxes up to the limit of 75,000. It is not therefore even a right to use it for an unlimited number of boxes. The time during which the licence is to continue is limited to the time required for the application of the process to the contractual number of boxes. There seems to me to be non capital element in a receipt of this nature in those circumstances.

The only considerations on the other side, once the companys arguments above discussed are rejected, are that the parties themselves called the Pounds 3,000 a capital payment and the agreement separates the Pounds 3,000 from the payments which are described as royalties. I cannot attach to these considerations sufficient importance to outweigh those on the other side. The fact that parties call the Pounds 3,000 a capital sum cannot make it a capital sum if it is not. The word capital is a mere label attached to the Pounds 3,000 with an eye, no doubt, to tax considerations. The fact that the agreement separates the Pounds 3,000 from the royalties is nothing more than a drafting necessity, having regard to the fact that the latter are based on the actual number of boxes treated with the process, while the former is paid for the right to apply the process to any number of boxes up to 75,000. If a patentee negotiating with an intending licensee who wishes to obtain the right to manufacture up to stated number of articles in accordance with the patent states his terms to be a lump sump down and a royalty of so much per article I can see no reason why the mere division of the price into those two separate elements should by itself necessarily produce the result that the sum down must be regarded for tax purposes as a capital receipt. Such however, is the argument; but I cannot accept it. In my opinion the appeal succeeds, and the decisions of the Special Commissioners must be restored.

COHEN, L. J. - I have had the opportunity of reading though the draft of the judgment that the Master of the Rolls has just delivered and I agree so entirely with the reasons that he has stated that I do not desire to add any reasons of my own for agreeing that the appeal should be allowed.

ASQUITH, L. J. - I also entirely agree, and I do not wish to add anything.

Appeal allowed.

Leave to appeal to the House of Lords.