T-1342-75
Canadian Industries Limited (Plaintiff)
v.
The Queen (Defendant)
Trial Division, Décary J.—Montreal, June 2,
1976; Ottawa, March 17, 1977.
Income tax — Calculation of income — Contract granting
licences to incorporate and use data, inventions and know-how
— Whether contract for services or contract of sale — Wheth
er consideration paid taxable as profit from plaintiffs busi
ness — Income Tax Act, R.S.C. 1952, c. 148, s. 4.
Plaintiff received $378,000 from the Government of the
United States of America under a contract licensing the latter
to incorporate and use the plaintiffs data, inventions and
know-how. No part of this sum was allotted to any particular
item, but the plaintiff claims that the contract was a contract of
sale and not of services and the income received was therefore
not profit from the plaintiffs business taxable under section 4
of the Income Tax Act.
Held, the appeal is dismissed. The licences granted were
necessary in order for the U.S. Government to make use of the
plaintiffs data and know-how and since they were not exclusive
licences they cannot be deemed to be an asset being given up by
the plaintiff. None of the components supplied by the plaintiff
under the contract was a capital asset and they cannot become
capital by combination. The income received by the plaintiff
was a fee for services and that income is profit arising from the
plaintiffs business and not income from the sale of assets.
Evans Medical Supplies, Ltd. v. Moriarty (1957) 37 T.C.
540; Commissioners of Inland Revenue v. British Salmson
Aero Engines, Ltd. (1938) 22 T.C. 29; Commissioners of
Inland Revenue v. Rustproof Metal Window Co., Ltd.
(1947) 29 T.C. 243; Murray v. Imperial Chemical Indus
tries Ltd. (1967) 44 T.C. 175; Jeffrey v. Rolls-Royce, Ltd.
(1962) 40 T.C. 443 and Musker v. English Electric Co.,
Ltd. (1964) 41 T.C. 556, applied.
INCOME tax appeal.
COUNSEL:
Philip F. Vineberg, Q.C., for plaintiff.
Jean Delage and Jean Potvin for defendant.
SOLICITORS:
Phillips & Vineberg, Montreal, for plaintiff.
Deputy Attorney General of Canada for
defendant.
The following are the reasons for judgment
rendered in English by
DÉCARY J.: This is an appeal to this Court from
a judgment of the Tax Review Board whereby an
amount of $378,000 received by plaintiff from the
Government of the United States of America, for
licence to use background data and for licence
under patents was held to be income under the
Income Tax Act (R.S.C. 1952, c. 148). The evi
dence produced before the Tax Review Board was
filed in Court.
Seven years earlier, on June 30, 1960, plaintiff
had acquired from A. B. Chematur, hereinafter
Chematur, a firm in Sweden of some twenty engi
neers, certain rights in four (4) patents, rights to
future patents, rights to data and know-how, all
pertaining to the production of TNT by continuous
process.
The said agreement reads as follows':
In the course of recent conversations between representatives of
our respective companies, we discussed the terms under which
you would be prepared to sell us information and rights under
your continuous TNT nitration and purification process. We
now wish to record our mutual understanding in this respect.
1. Chematur undertakes to communicate to C-I-L, as and
when C-I-L may so request, complete design and operating
information on its continuous TNT nitration and purification
process, including detailed flow sheets and detailed drawings
and descriptions of equipment.
2. In full consideration of the information supplied above,
C-I-L will pay Chematur a sum equal to Chematur's engineer-
in costs for supplying such information (including the time
devoted to writing reports on the technical aspects of the
process) plus 110% of such costs to cover overhead. The total
sum paid hereunder will be deducted from the price of such
equipment, designed by Chematur, as C-I-L may purchase
from Chematur. We understand you estimate that the nitration
equipment as itemized in your letter of 19th September, 1958,
but for a larger output of 1400 lb/hr, would now cost us
approximately $80,000 (Canadian), and that on a similar basis
the purification equipment would cost us in the vicinity of
$15,000 to $20,000 (Canadian).
' Underlining added.
3. Chematur shall grant to C-I-L non-exclusive irrevocable
licenses under any patent rights in Canada and any know-how
relating to the continuous TNT nitration and purification
process. Such licenses shall include the right for C-I-L to
export its products to any country other than Norway.
4. If C-I-L builds the first TNT plant to commence operation
using the Chematur process then the following conditions will
apply:
(a) The grant of licenses to C-I-L pursuant to paragraph 3
above shall be royalty-free.
(b) Chematur will grant non-exclusive royalty-free licenses
under the process and any relevant patents to Imperial Chemi
cal Industries Limited, Great Britain, African Explosives and
Chemical Industries Limited, South Africa, Imperial Chemical
Industries of Australia and New Zealand Ltd., and Imperial
Chemical Industries (India) Limited, at their request, to use
the said process in their respective countries.
(c) C-I-L and Chematur will share equally license fees for any
future plants using this process to be built on the North
American continent by others than C-I-L. Each license fee will
be set by mutual agreement between Chematur and C-I-L,
taking into consideration the demonstrated advantages of the
process. C-I-L will negotiate all such license agreements itself
and will supply the licensee with complete design and operating
information in its own plant (excluding, however, the NITROPEL
operation). The licensee will have the right of either engineer
ing his own plant, basing himself on the information obtained
from C-I-L, or of obtaining Chematur's services therefor on
payment of Chematur's engineering costs plus 110% for over
head. The licensee will be free to purchase the necessary
equipment from Chematur or from any supplier of its choice.
C-I-L will, for an additional fee, train operators for the licensee
if so requested.
(d) In full consideration of the rights granted above, C-I-L will
supply Chematur with a complete set of working drawings and
operating data on the completed plant (excluding, however, the
NITROPEL operation) and the right to use such plant as a
reference.
5. Should the first TNT plant to commence operation using the
Chematur process not be the one built by C-I-L, then C-I-L
shall pay to Chematur, in addition to the payments referred to
in paragraph 2 above, and in consideration of the grant of
licenses pursuant to paragraph 3 above, a lump sum, non-recur
ring license fee based on performance and calculated from the
rates of efficiency obtained during a trial run. Such fee shall be
the equivalent of $250 for each kilogram of toluene required
under 495 kilograms per 1000 kilograms of refined TNT
produced, plus $250 for each kilogram of nitric acid required
under 1,150 kilograms per 1000 kilograms of refined TNT
produced. The above rates of efficiency shall be determined in
respect of the production of refined TNT having a minimum
setting point of 80.2° C, passing an Abel Heat Test of 20
minutes at 160° F and using a sellite purification process.
If this letter correctly sets forth the understanding between our
companies, will you please signify your acceptance by signing
and returning to us the duplicate copy attached.
If one scrutinizes the contract, it may be noticed
that:
1. Plaintiff acquires information and rights to the
continuous TNT nitration and purification process
and design and operating information on that
process;
2. The cost for such information to plaintiff is: (a)
Chematur's engineering costs plus (b) 110% of
such costs to cover overhead and (c) whatever sum
paid is deductible from the price of equipment;
3. Plaintiff acquires non-exclusive, irrevocable
licences under any patent rights in Canada and
any know-how pertaining to the continuous TNT
nitration and purification process;
4. (a) If plaintiff builds the first TNT plant the
licences referred to in the previous paragraph are
royalty-free; (b) Chematur will give, if requested,
non-exclusive, royalty-free licences to companies
related to plaintiff; (c) other licence fees to be
shared equally;
5. If the first plant to commence operating, using
the process is not built by plaintiff, Chematur shall
be reimbursed as in 2. For the licence under
patents and for the licence for know-how a lump
sum, non-recurring licence fee is to be paid, based
on performance and calculation from the rate of
efficiency obtained during a trial run. In para
graphs 4 and 5, the word "fee" is used.
The word fees or fee is used five (5) times in
that contract. In Exhibit R.1 there is a reference to
Clause 4.0 of the contract between Chematur and
plaintiff and in clause 4.0 the word fee is used,
whereas in the letter of August 9, 1967, the word
fee is not used. It seems to me that if the parties
themselves have used that word fee, they knew
very well the impact of the use of the word fee for
tax purposes and that use of the word fee should
be duly taken into consideration.
The rights of plaintiff, proprietary or other, up
to June 1967, pertaining to the TNT continuous
process, should be grouped: those that could be
used as of June 1960, being the rights to the
information, know-how and the non-exclusive
licences to the information and to that know-how
being developed by plaintiff from June 1960 up to
June 1967.
The value of the practical application of the
patents, information and know-how acquired by
plaintiff was increased once its team had had
access to the patents and other rights originated by
Chematur. These rights were much more valuable
by the time the Government of the United States
of America was licenced, that is, by June 30, 1967,
because they had passed from the state of theory
to the one of practical application. The greater
team of plaintiff could see to the application of
these rights more easily than the smaller team of
Chematur.
The contract with the Government of the United
States of America provides for: (a) licence to use
the background data, (b) non-exclusive, non-trans
ferable licences under patents or applications for
patents and inventions owned or controlled or to be
owned or to be controlled, (c) technical assistance
and (d) know-how.
Since 1960, plaintiff was selling TNT produced
through continuous process to the United States of
America. That country was in fact plaintiff's larg
est military customer; the rest of the production
was sold to the Canadian Armed Forces. The
Canadian sales were so negligible compared to
those to the United States of America, plaintiff's
biggest client, that the latter could be said to be
the only one.
The agreement being quite extensive, I shall
quote only what I think is essential to grasp the
problem at issue.
The first paragraph reads as follows 2:
PATENT AND DATA SUBLICENSE AGREEMENT
THIS CONTRACT, effective this 30th day of June, 1967 by the
UNITED STATES OF AMERICA (hereinafter called the Govern
ment) and CANADIAN INDUSTRIES LIMITED (hereinafter called
the Contractor), a corporation organized and existing under the
2 Underlining added.
laws of Canada and having a principal place of business in
Montreal in the Province of Quebec, Canada.
WHEREAS, the Government's prime Contractor operating under
Contract Number W-11-173-AMC-37(A) has entered into a
Sub-Contract No. 397, dated 30 June 1967 ....
The four patents of Chematur are:
WHEREAS, the Contractor warrants and represents that under a
license Agreement between Contractor and Aktiebolaget
Chematur, Stockholm, Sweden, a corporation of Sweden, dated
27 June 1960, Contractor has a license, together with the
exclusive right to grant sub-licenses, including the within
license, under United States Patent No. 3,034,867, issued 15
May 1962 to Erik Samuelsen for Continuous Trinitrotoluene
Manufacture... ; under United States Patent No. 3,087,971,
issued 30 April 1963 to Erik Samuelsen for Method for Trini-
trotoluene Manufacture ... ; under United States Patent No.
3,087,973, issued 30 April 1963 to Erik Samuelsen for Contin
uous Trinitrotoluene Manufacture .. ; and under United
States Patent No. 3,204,000, issued 31 August 1965, to Erik
Samuelsen for Manufacture of Nitrotoluenes.
The next paragraph reads:
WHEREAS, the Contractor warrants and represents that it is in
possession of certain background data originated by Contrac
tor, including data claimed by Contractor to be proprietary,
pertinent to the process of continuous manufacture of TNT
developed by Contractor prior to the effective date of this and
the aforesaid Contract No. 397 .. .
WHEREAS, the Government desires to construct and operate or
have constructed and operated continuous TNT plants having a
unit capacity of at least fifty (50) tons of TNT per day,
and....
Paragraph 1(a) of the agreement reads:
ARTICLE 1. LICENSE GRANT
(a) Contractor agrees to and does hereby grant and convey to
the Government, ... an irrevocable non-exclusive license to use
by or for the Government in the United States of America for
governmental (non-commercial) purposes only, all or any part
of the background data:
originated by contractor prior to the date of execution of the
license herein, including any such background data claimed
by Contractor to be proprietary, pertinent to the aforesaid
process for the continuous manufacture of TNT and devel
oped by Contractor prior to the effective date of this and the
aforesaid Contract No. 397; and
any and all such data which may be developed by Contractor
under the terms of the aforesaid Contract No. 397 to con
struct a plant to meet Government requirements of at least
fifty (50) tons of TNT per day, said TNT of a grade
commensurate with Government specifications; said license
to cover data to be delivered at a time and place designated
by the Government and to include, but not limited to, the
following:
(1) Copies of all publications, reports, memorandums, docu
ments and other writings relating in whole or in part to the
design, construction, operation and maintenance of the pro-
cess for the continuous manufacture of TNT and of the
apparatus and plant therefor.
(2) Detailed design drawings sufficient to teach the complete
construction and operation of a plant embodying Contrac
tor's process for continuous manufacture of TNT.
(3) Data describing step-by-step procedures for operating
and maintaining said plants, safety procedures and known
hazards, material and operating balances, process conditions
and unique process steps, results of efficiency tests conducted
by Contractor, operating problems experienced or anticipat
ed by Contractor, critical special relationships of equipment,
control and instrumentation design, and waste disposal
features.
(4) Information identifying critical design features of said
process and equipment, and critical material quantities and
concentrations including means for increasing the capability
of units by varying equipment capacities and numbers of
material concentrations and quantities.
PROVIDED, that nothing contained in this Article 1(a) or else
where in this contract is intended to imply or be construed as
granting a license to the United States Government or others
under any patents or patent applications of any country other
than the United States of America.
That paragraph has been quoted at length
because it describes and identifies the main object
of the contract, to wit, the licence to the Govern
ment of the United States of America to use data
plaintiff has gained in the past and data to be
acquired in the future.
Subparagraph (b) of paragraph 1 reads as
follows:
(b) Contractor further agrees to and does hereby grant and
convey to the Government, as represented by the Secretary of
the Army, an irrevocable, non-exclusive, nontransferable
license under any and all United States patents and applica
tions for patent of Contractor based on inventions now owned
or controlled by Contractor or with respect to which Contractor
on the date of execution of the license herein has the right to
grant licenses, or inventions to become the property of or
controlled by Contractor or with respect to which Contractor
will acquire the right to grant licenses for a period of ten (10)
years from the date of the aforesaid Contract No. 397, which
form an integral part of the process which is the object matter
of the aforesaid Contract No. 397 as said process exists at the
effective date of this and said Contract No. 397 and as it was
be modified to meet Government requirements of at least fifty
(50) tons of TNT per day, to practice by the Government for
governmental (non-commercial) purposes only, and to cause to
be practiced for the Government for such purposes only, any or
all of the inventions thereof in the use of any method, in the
manufacture, use and disposition of any product, and in the
disposition of any plant or part thereof in accordance with
law....
That paragraph is concerned with four (4) pat
ents upon which plaintiff has a licence; any other
United States of America patents that plaintiff
may own or control in the future; application for
same and the obligation toward the United States
of America for a period of ten (10) years from the
date of Contract No. 397.
Plaintiff may have to provide personnel, sub-
paragraph (d):
(d) Contractor pursuant to the provisions of the aforesaid
contract No. 397 will provide the Government or its selected
Contractor with any technical assistance, in the form of person
nel or otherwise, necessary to scale-up the design of Contrac
tor's existing facilities for the continuous manufacture of TNT
to design an operable plant capable of producing at least fifty
(50) tons of TNT per day, said TNT to be of a quality and
grade in accordance with Government specifications.
Article 4 provides for payment:
ARTICLE 4. PAYMENT
The Government in consideration of this license subject to the
availability of funds, shall be obligated to pay the Contractor a
total capital sum of Six Hundred Thousand Dollars ($600,000)
for the incorporation and use of said data, know-how and
inventions in the construction and use by the Government of
plants or facilities for said continuous manufacturing process,
said total capital payment of Six Hundred Thousand Dollars
($600,000) to be made as follows: One-half ('h) on the effective
date of Contract No. 397; and the remaining one-half ('h) upon
acceptance of the data specifically called for in the aforesaid
Contract No. 397. The stated total capital sum will be payment
in full for the receipt and use of said data in accordance with
the terms of this agreement, and additional plants or facilities
shall be free from any obligations for payment on the part of
the Government.
The payment is for use and for incorporation,
that is, in my view, to have access to the data,
know-how and inventions and to blend it in the
construction and use for the plants and facilities.
We have, in above Article 4, the first instance
where the expression "know-how" is used in the
contract. I think that one may look at a dictionary
to see how "know-how" is defined.
In A Supplement to the Oxford English
Dictionary 3 we read at page 538:
3 1976 Vol. II—H-N.
Orig. U.S. [f. vbl. phr. to know how (Know v. 12).] Knowledge
of how to do some particular thing; technical expertness, practi
cal knowledge.
And in Webster's Third New International
Dictionary 4 we read at page 1252:
esp.: technical knowledge, ability, skill or expertness of this sort
(the company needed to use all of its ingenuity and know-how
to succeed in laying the oil lines).
In A. & E. Plastik Pak Co., Inc. v. Monsanto
Company 5 Merrill C.J. says at pages 714-15:
[5] The agreement between Monsanto and A. & E. on its face,
appears to be a license of technology or "know-how"* to which
restraints of competition are attached as conditions of the
license. Thus, on its face, it does not appear to be an agreement
between competitors not to compete, for absent the licensed
know-how, A. & E. is in no position to compete.
* Know-how has been defined to include "accumulated tech
nical experience and skills which can best, or perhaps only, be
communicated through the medium of personal services."
Creed & Bangs, Know-How Licensing and Capital Gains,
Patent, Trade-Mark and Copyright J. of Research and Educa
tion 93 (1960).
In the matter of Evans Medical Supplies, Ltd.
v. Moriarty (H. M. Inspector of Taxes) 6 I find
very useful to read the remarks of Lord Denning
as to what "know-how" may consist of, at page
587:
The Case refers to the agreement under which the £100,000
was paid. It was paid as an entire sum for a specified consider
ation. The consideration was the imparting of information and
technical data, all of which may be summed up in the new and
expressive word "know-how". The Court of Appeal would seek
to divide it into two parts: (1) information about secret pro
cesses; (2) information about other things. The information
about secret processes had in the past been kept confidential to
Evans Medical and their staff, and was especially valuable on
that account. The information about other things was technical
knowledge which was not secret but was no doubt valuable in
that it could only be obtained from firms who were expert in it.
I can see no sensible distinction between money paid for
information of secret processes and money paid for the other
information. The only difference is that in the one case the
money was paid for information which up till then had been
secret, being obtainable only from the one firm: whereas in the
other case it was paid for information which was scarce, being
obtainable from three or four firms. But the money was paid
for the same sort of thing in either case. At any rate, the parties
" 1, Latest Unabridged.
5 396 F.2d 710 (1968).
6 (1957) 37 T.C. 540.
to this agreement did not seek to draw any distinction between
the two. £100,000 was paid for the lot. It was a single payment
for "know-how". The Case Stated follows suit. It does not
attempt to divide the £100,000 into parts.
In the instant case, there is no apportionment of
the amount received as consideration by plaintiff.
In my view, these remarks by Lord Denning are
appropriate for the present instance, at pages
588-89:
The way I look at it is this. Evans Medical were faced with a
difficult problem. The Burmese Government were determined
to make these products themselves. This would mean that
Evans Medical would be forced out of the Burma market or at
any rate would lose a good deal of business there. Their
goodwill in that country would be diminished in value. But that
would not be due to any sale by them of a capital asset. It
would take place no matter which of the competing firms
obtained the contract. To make up for this coming loss of
market, Evans Medical did a sensible thing. They secured the
contract to supply the "know-how" to the Burmese Govern
ment. This did not purport to be—and was not in fact—a sale
of secret processes. All that Evans Medical did was to tell the
Burmese Government about those processes so that they could
use them too. Evans Medical still retained the right to use the
processes themselves and stipulated that the Burmese Govern
ment should not divulge the information without their consent.
So regarded, the supply of information about the secret pro
cesses was nothing more nor less than the supply of "know-
how"—a particularly valuable part of it, no doubt—but still the
supply of "know-how". And that is how the parties to this
agreement treated it. They drew no distinction between it and
the other kinds of "know-how" to be supplied in return for the
£100,000.
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. ... 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
from using it any more than it can prevent them using their
own brains: see Herbert Morris, Ltd. v. Saxelby, [1916] 1 A.C.
688, at page 704. 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 Trego v. Hunt, [1896] A.C. 7, at
pages 24-5; and it may then rightly be regarded as the sale of a
capital asset: see Handley Page v. Butterworth, 19 T.C. 328.
But the supplier of "know-how" always remains entitled to use
it himself, as was the case here.
I find it not possible for me not to compare the
present instance to the Evans Medical Supplies,
Ltd. case. In the present instance, the consider
ation is said to be paid for data, km—, how and
inventions but like the Evans Medical Supplies,
Ltd. case no part of the total sum paid is allotted
to any item in particular.
It is labeled a "non-exclusive licence" to use
background data, a "non-exclusive licence" on
four (4) patents and the right to be provided
technical assistance.
To my way of thinking, the data and assistance
are definitely services to be rendered and the
licences on the four (4) patents not being exclu
sive, the plaintiff does not impart any asset which
in fact would impoverish it. I believe that the
licences to the patents are necessary for the
application of the data and the technical assistance
is strictly for services.
The components being each one of a nature that
connotes services, none can be considered as being
a capital item and I therefore fail to see how the
three together, because in the same contract, can
become capital.
The name used to describe a payment is not
decisive. In Commissioners of Inland Revenue v.
British Salmson Aero Engines, Ltd.', we read
these remarks of Finlay J. at page 35:
Mr. Needham has contended that the decision of the Special
Commissioners as regards these sums of royalties was wrong.
He said, and he rightly said, that the circumstance that they
were called "royalties" in the agreement is not decisive. It is not
decisive, I entirely agree, but I must say that while one is of
course entitled, and indeed bound, to look at the thing to
ascertain the real substance of the matter, the fact that people
who, after all, know all about it choose in their agreement to
refer to these annual sums—for annual they are, I think—as
"royalties", is a matter not to be entirely neglected. Mr.
Needham says that whatever they are called, they are simply
the purchase price of a thing sold. Now if I rightly follow that
argument, it depends upon the fact that here there was granted
the licensee an exclusive right. I am unable to adopt the view
which Mr. Needham urged upon me as to that. If I rightly
7 (1938) 22 T.C. 29.
follow his argument, supposing there had simply been granted a
right, not exclusive, to construct and use, then in that event
there would not have been a sale of property and royalty, if
royalty there were, would have been appropriately taxed. I
cannot regard the fact that this is an exclusive right as turning
a licence into a sale of property; it seems to me to be not the
reality of the thing.
In the instant case, the word fee is used in the
contract with Chematur and then in a letter there
is a reference to it. Plaintiff and Chematur know
the right word to be used.
It is interesting to note on the same page of
C.I.R. v. British Salmson Aero Engines (supra),
what is a grant of a licence to construct and use:
I would add this, that if, contrary to my view, it could be
regarded, not as a licence to use but as a sale of the whole
substratum, so to speak, of the business, of the whole property,
that would not conclude the question, because it is quite clear
that there may be a sale of property in consideration of an
annual payment. The question would therefore remain. But, in
my opinion, when one looks at it, this is really the grant of a
licence to construct and use. That is the primary object and
that is the meaning of the thing.
I do believe that we have here a licence to
construct and use.
In Commissioners of Inland Revenue v. Rust
proof Metal Window Co., Ltd. 8 , as Atkinson J.
says, there was no change, as in the present case,
in the patent (page 253):
The patent remained what it was before, something out of
which he was making money by manufacturing the articles or
using the processes, as in this case, and that user continued to
be of precisely the same character after the licence had been
granted. Therefore I think on that point the Crown is entitled
to succeed.
Concerning, as here, a lump sum paid for a
non-exclusive licence, we read these remarks of
Lord Greene M.R. at page 267:
Returning to the argument of Counsel, 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
8 (1947) 29 T.C. 243.
relevant circumstances and not by some fixed rule of law such
as is suggested.
As to practical knowledge, Lord Greene says at
pages 269-70:
There are many patents which are applied more efficiently
after some experience of their practical application or some
practical instruction by the patentee than they could be by a
person who had merely read the specification. But the acquisi
tion 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 be more
knowledgeable and efficient in its use than a person who has
not. But the acquisition of this practical knowledge by a
licensee cannot, as it appears to me, be said in any sense to
affect a depreciation of the value of the patent, nor can
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 had 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
patent 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 a business asset
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 licences 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.
Secret information is also discussed ibid.:
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 covenant 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 which the
licensees by the same paragraph covenant to keep secret after
the expiration of the patent are, as I have already said, inven
tions or discoveries not by the licensors but by the licensees.
The argument, therefore, fails to convince me.
In Murray (H. M. Inspector of Taxes) v.
Imperial Chemical Industries Ltd. 9 , there is a
reference to fixed capital in connection with these
rights by Russell L.J. at page 214:
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
£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 trans
ferred that ability to another; and that ability had been that
part of its fixed capital. The substance of the matter was that
I.C.I. disposed of a part of its fixed capital in part for a sum
(£400,000) which of itself, unlike the royalties, did not bear the
stamp of a revenue receipt. I entirely agree with Cross J. on this
point.
I do not believe that here there is anything that
can be said to have been disposed of by plaintiff.
In Jeffrey (H. M. Inspector of Taxes) v. Rolls-
Royce, Ltd. 10 , Donovan L.J., at pages 487-88, as
to the treatment for tax purposes of the reward,
says:
If these distinctions be borne in mind it does not matter a
great deal by what name knowledge, skill and experience be
called. They are clearly part of the capital equipment of a
company such as the Respondent, in much the same way as the
same attributes are the capital equipment of an individual
craftsman. They can be exploited in two ways. By their employ
ment, articles can be produced and sold. Alternatively or in
addition, the knowledge, skill and experience can be imparted
to others for reward. The great artist with his pupils is a
familiar example. Similarly with a company such as the
Respondent. It can and does use its great experience, and the
knowledge and skill which comes of it, to make and sell aero
engines. In addition it imparts these things to others for reward.
Admittedly, it does this in the course of its trade, and the sole
question here is whether that part of the reward consisting of a
9 (1967) 44 T.C. 175.
10 (1962) 40 T.C. 443.
lump sum is a receipt which should be included in the revenue
account when computing the Company's taxable profits, or
whether, on the other hand, the receipt should properly be
credited to some capital account.
As to the nature of "know-how", Lord Reid, at
page 492 ibid., referring to the Evans Medical
Supplies, Ltd. case (supra) says:
I cannot accept the contention that by each of these agree
ments the Company sold a part of that capital asset and
received a price for it. There is nothing in the Case to indicate
that that capital asset was in any way diminished by carrying
out these agreements. The whole of its knowledge and experi
ence remained available to the Company for manufacturing
and further research and development, and there is nothing to
show that its value was in any way diminished. The Company
had not even given up a market which had been open to it. It
could not sell its engines in these countries whether it made
these agreements or not. If it had not made these agreements, it
would have got nothing from these countries; by making them
it was able to exploit its capital asset by receiving large sums
for its use there. In essence, what it did was to teach the
"licensees" how to make use of the "licences" which it granted.
The Company founds on the decision of this House in Evans
Medical Supplies, Ltd. v. Moriarty (1957) 37 T.C. 540. In that
case it was held that the company parted with a capital asset
and received for it a capital sum. For one thing, it lost its
Burmese market. And, further, it was said to be obvious that
the capital value of the secret processes must have been greatly
diminished by their disclosure to the Burmese Government.
Every case of this kind must be decided on its own facts; and, at
least in these two respects, that case was very different from the
present case. There is also the difference that in that case there
was a single transaction, whereas in the present case there was
a series of similar transactions. That in itself might not count
for much, but it is, I think, important that these transactions
arose out of deliberate policy. Even in the first agreement there
was, in clause 23, a provision that certain further payments
should not be less favourable than the sums demanded from
other manufacturers for a similar licence.
Teaching the Government of the United States
of America through information, data and non-
exclusive licence is of the essence of the contract of
plaintiff.
The capital aspect of "know-how" is discussed
by Lord Radcliffe on pages 494-95:
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 commis
sion how the sum was described; on the other hand, it certainly
did not bind the Company, when it has received the money, to
apply it in any particular way in its 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 monies are to be paid
outright against complete delivery of the drawings and other
documents, regardless of 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 ascer
taining 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 Company's trading profits. It seems to me
that, so long as it kept its "know-how" to itself, it used it for the
manufacture of its own engines, and its value was expressed in
the successful sales which it achieved of those products. I
daresay that the Company would have preferred, ideally, to
reserve its "know-how" solely for the purpose of its 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 it saw that, having the "know-how", it could
derive profit from the manufacture of its engines, even by
others, in parts of the world where it either could not or would
not sell or manufacture them itself, provided only that it
equipped those others with the requisite expertise. So it 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.
The last sentence surely applies to plaintiff.
As to the description of "know-how", Lord
Morris of Borth-y-Gest says at pages 496-97:
Whatever description is given to that which in this case has
been denoted by the words "know-how", the course of activity
embarked upon by the Company was to put its current "know-
how" to the most advantageous available use while it had its
maximum current value. The Company acted in the way in
which it considered that it could best carry on its trade as
manufacturers. This may have involved a development of the
method in which it had previously traded, but the fact that
many successive licensing agreements were made suggests to
my mind that, of set policy, the Company decided that its
methods of trading as manufacturers should include that de
velopment. I cannot regard the licensing agreements as involv
ing sales of successive portions of a fixed capital asset. So to
regard the licensing agreements seems to me to be quite unreal.
The Company did not part with, or get rid of, its "know-how".
Another description of "know-how" is given by
Lord Guest at page 499:
It is not doubtful that if the Crown had made a case that the
Company entered upon a new trade of dealing in "know-how",
it might have been assessed on the lump sums paid under the
agreements. The Crown, however, expressly disclaimed any
intention of alleging a new trade. The question is, therefore,
whether the licensing fees can be included as profits of the
Company as incidental to the manufacture of aero engines. I
have given my reasons for distinguishing this case from Evans
Medical Supplies ([37] T.C. 540). If the licensing fees are not
capital receipts on the basis of the decision in Evans Medical
Supplies, I do not see any other conclusion than that they are
trading receipts. The matter can be expressed in different ways.
I prefer to base my conclusion upon the view that tit licensing
agreements were a development of the general trade carried on
by the Company. The royalties are admittedly included among
the Company's profits of the trade as manufacturers of aero
engines. These could not have been earned so easily without the
licensing, which enabled the foreign governments to manufac
ture the aero engines. It was an integral trading activity and the
licensing agreements were incidental to the manufacture of
aero engines.
In Masker (H. M. Inspector of Taxes) v. Eng-
lish Electric Co., Ltd.", Lord Denning M.R.writes
about the use of "know-how" at page 582:
Now it seems to me that this is a typical case of "know-how".
"Manufacturing technique" is just "know-how". "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 use so as to produce
revenue in two ways. The manufacturer can use it himself to
make things for sale and make profit 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.
The nature of "know-how" is looked at by Vis
count Radcliffe at page 585:
In my opinion, there are two considerations which govern
cases of this kind and which go a long way towards 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. One is that in reality no
sale takes place. The Appellant had after the transaction what
" (1964) 41 T.C. 556.
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, trade
marks 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 use 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.
Imparting information, data and inventions for a
fee or reward is exactly what the plaintiff has done
and fee is the word it used when it referred to the
payment.
I cannot help not concluding that the amount of
three hundred and seventy-eight thousand dollars
($378,000) being three hundred and fifty thousand
dollars ($350,000) at exchange rate, was an
amount paid by the Government of the United
States of America as a fee; that fee was paid for
services then to be rendered by plaintiff; these
services consisted in having access to data, infor
mation and inventions; in common parlance, there
is no way that a fee can be a purchase price; fee is
defined inter alia, in dictionaries as "a reward for
services"; none of the three items being the object
of the contract could have been the object of a
contract for sale; indeed, plaintiff kept these rights
afterwards and consequently it is only their use
that could be conveyed by way of services, to be
paid for with a fee; plaintiff and its Swedish
partner Chematur used the word "fee" in the
agreement, not "payment" or "sale price", when
they referred to licences or other rights of the
same nature; nobody can say that Chematur and
plaintiff did not know what a fee was; they
referred to it in their agreement: services to be
rendered for fee; as far as that goes, the Govern-
ment of the United States of America knew
through the agreement that it is services that were
involved and that the consideration for the
performance of these services was a fee; there
cannot be a sale of services because services are
rendered and they are rendered for a fee; plaintiff
was not imparting anything at all when it entered
into that contract with the Government of the
United States of America and it was foreseen in
the contract with Chematur that services were to
be rendered; it follows that plaintiff, in my view,
by using that designation in its agreement with
Chematur, had decided then to enter into con
tracts with the same object in view: fees; I think
that in acting in such a way, plaintiff's business
could include entering into contracts like the one
with the Government of the United States of
America; that such contracts could be part of their
business; consequently, the fee is a profit from
their business under the provisions of section 4 of
the Act.
The appeal shall be dismissed with costs.
You are being directed to the most recent version of the statute which may not be the version considered at the time of the judgment.