A-237-77
Canadian Industries Limited (Appellant)
v.
The Queen (Respondent)
Court of Appeal, Pratte and Le Dain JJ. and Hyde
D.J.—Montreal, January 16; Ottawa, March 28,
1980.
Income tax — Income calculation — Contract granting
licences to incorporate and use data, inventions and know-how
— Whether contract of services or contract of sale — Whether
consideration paid is taxable as profit from appellant's busi
ness — Income Tax Act, R.S.C. 1952, c. 148, s. 4.
This is an appeal from a judgment of the Trial Division
dismissing the appellant's appeal from a decision of the Tax
Review Board which had dismissed an appeal from an income
tax re-assessment in respect of the 1967 taxation year. The
appellant received $378,000 from the Government of the
United States of America under a contract licensing the latter
to incorporate and use the appellant's data, inventions and
know-how for the manufacture, according to a new process, of
trinitrotoluene (TNT). No part of this sum was allotted to any
particular item, but the appellant claims that the contract was
a contract of sale and not of services and the income received
was therefore not profit from the appellant's business taxable
under section 4 of the Income Tax Act.
Held, the appeal is dismissed. What emerges from an anal
ysis of the jurisprudence on this subject is that it is not
sufficient that there be the stipulation of a lump sum payment
unrelated to the extent of the anticipated use of the patent in
order for such payment to be capital in nature; the licence for
which it is consideration must amount to a disposition or sale of
part of the patent rights. The fact that the lump sum payment
was given for a licence to use patents as well as for "know-how"
does not add any significant force to appellant's contention that
the sum must be considered to be capital. While the United
States patents are clearly capital assets, the licence which is
non-exclusive, for a limited purpose (to the United States
Government for military of non-commercial purposes) and for
a limited term cannot be considered to be a parting with or
disposition of the patent rights. In so far as the licence to use
"background data" or "know-how" it is quite clear from a
study of the cases that the fact a lump sum payment for such
"know-how" is unrelated to the extent of use is not sufficient by
itself to make a capital receipt. As to the evidence that the
Licence Agreement was the only one of its kind that appellant
had entered into, there is this important distinction: while it
may have been obliged to enter into this agreement by the
position of the United States Government, agreements of this
kind were contemplated by the agreement made between the
appellant and inventor as a form of business to be shared in by
the parties. The essential question to consider is: does the
evidence show that appellant lost its business for military TNT
with the United States Government as a direct and necessary
result of entering into the Licence Agreement? It does not. The
evidence shows that the United States Government eventually
ceased to purchase TNT from appellant, although precisely
when that occurred is not clear. What it does not show is that
the loss of this business was inherent in the licensing arrange
ments that were made.
Evans Medical Supplies, Ltd. v. Moriarty (H.M. Inspec
tor of Taxes) 37 T.C. 540, distinguished. Wolf Electric
Tools Ltd. v. Wilson (H.M. Inspector of Taxes) 45 T.C.
326, distinguished. Jeffrey (H.M. Inspector of Taxes) v.
Rolls-Royce, Ltd. 40 T.C. 443, applied. Musker (H.M.
Inspector of Taxes) v. English Electric Co., Ltd. 41 T.C.
556, applied. Commissioners of Inland Revenue v. Rust
proof Metal Window Co., Ltd. 29 T.C. 243, applied.
APPEAL.
COUNSEL:
P. F. Vineberg, Q.C. for appellant.
W. Lefebvre and J. Côté for respondent.
SOLICITORS:
Phillips & Vineberg, Montreal, for appellant.
Deputy Attorney General of Canada for
respondent.
The following are the reasons for judgment
rendered in English by
LE DAIN J.: This is an appeal from a judgment
of the Trial Division [[1977] 2 F.C. 644] dismiss
ing the appellant's appeal from a decision of the
Tax Review Board which had dismissed an appeal
from an income tax re-assessment in respect of the
1967 taxation year.
What is in issue is the character of a sum of
$378,000 which the appellant received pursuant to
an agreement between it and the Government of
the United States of America respecting a licence
to use certain patents and "background data" or
"know-how" for the manufacture, according to a
new process, of trinitrotoluene ("TNT").
The appellant (hereinafter referred to as
"CIL") had been manufacturing TNT for many
years by what is called the "batch process". That
process is vulnerable to fire, and after its plant at
McMasterville, Quebec, burned down in 1958,
CIL began research efforts to discover a safer
method of producing TNT. It found that an engi
neering firm in Sweden (hereinafter referred to as
"Chematur") held the right to a new process for
manufacturing TNT called the "continuous proc
ess", but had not developed a plant for the applica
tion of the process. CIL and Chematur entered
into a letter agreement dated June 27, 1960 (here-
inafter referred to as the "CIL-Chematur agree
ment") which licensed CIL to use the continuous
process, contemplated that it would build the first
continuous process plant, and provided that the
parties would share in the proceeds of any licence
arrangements by which others might be permitted
to build such plants. Its provisions are as follows:
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
ing 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).
3. Chematur shall grant to C-I-L non-exclusive, irrevocable
licences under any patent rights in Canada, and any know-how,
relating to the continuous TNT nitration and purification
process. Such licences 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 licences to C-I-L pursuant to paragraph 3
above shall be royalty-free.
(b) Chematur will grant non-exclusive royalty-free licences
under the process and any relevant patents to Imperial
Chemical Industries Limited, Great Britain, African Explo
sives 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 licence fees for any
future plants using this process to be built on the North
American continent by others than C-I-L. Each licence fee
will be set by mutual agreement between Chematur and
C-I-L, taking into consideration the demonstrated advan
tages of the process. C-I-L will negotiate all such licence
agreements itself and will supply the licensee with complete
design and operating information on its own plant (exclud-
ing, however, the NITROPEL operation). The licensee will
have the right of either engineering 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 overhead. 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, how
ever, 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
licences pursuant to paragraph 3 above, a lump sum, non-recur
ring licence 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.
After a further period of research and develop
ment, based on the ideas obtained from Chematur,
CIL succeeded in building the first continuous
process plant for the manufacture of TNT at
McMasterville, Quebec, in 1962. A second contin
uous process plant was built by CIL at Valleyfield,
Quebec, in 1965. Almost the entire production of
the Valleyfield plant was of TNT for military
purposes. The United States Government was vir
tually CIL's sole customer for such purposes. CIL
sold an insignificant amount of TNT for military
purposes to the Canadian Government. The
United States Government had several batch pro
cess plants which had been built around 1940, but
it was encountering certain difficulties with their
operation. CIL was the only company from which
it bought additional requirements of TNT. About
1966, or a year or so after the Valleyfield plant
was built, the United States Government
approached CIL with a view to obtaining the right
to use the continuous process to build plants of its
own. It had for some time been looking for a better
way of manufacturing TNT. The testimony of Mr.
A. S. Donohoe, sales manager for CIL, implied
that CIL had no choice but to agree. As he put it,
"You cannot fight Uncle Sam."
In 1967 CIL entered into agreements to permit
the United States Government, with the assistance
of CIL, to build continuous process plants for the
manufacture of TNT. There were two agreements.
The one that is of concern in this appeal was
entitled "Patent and Data Sub-License Agree
ment" (hereinafter referred to as the "Licence
Agreement") and was entered into by CIL and the
United States Government as of June 30, 1967. Its
purpose was to give the United States Government
the right to use certain United States Patents
concerning the continuous process, which were
controlled by Chematur, and the "know-how" con
cerning the process that had been developed by
CIL, and which it claimed as its property. The
second agreement (hereinafter referred to as the
"Services Agreement") was entered into as of the
same date between CIL and the prime contractor
of the United States Government, a company
which may be referred to as "Hercules". It pro
vided for the assistance to be furnished by CIL to
Hercules, in the form of information and services,
to permit the construction of the first continuous
process plants for the United States Government.
The Services Agreement is referred to in the
Licence Agreement as "Sub-Contract No. 397".
The amount paid to CIL under the Services
Agreement was treated as income for tax purposes
and is not in issue in the present appeal. It is the
amount that was paid under the Licence Agree
ment that is in issue. CIL's undertaking to impart
"know-how" is, however, covered to some extent
by both agreements. CIL is referred to in the
Licence Agreement as the "Contractor" and the
United States of America as the "Government".
Article 1 of the Licence Agreement reads in part
as follows:
ARTICLE I. LICENSE GRANT
(a) Contractor agrees to and does hereby grant and convey
to the Government, and to its officers, agents, and employees
acting within the scope of their official duties, an irrevocable,
nonexclusive 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 developed
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 construct 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 process
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 Contractor'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 anticipated
by Contractor, critical special relationships of equipment, con
trol 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 or material
concentrations and quantities.
PROVIDED, that nothing contained in this Article 1(a) or
elsewhere 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.
(b) Contractor further agrees to and does hereby grant and
convey to the Government, as represented by the Secretary of
the Army, an irrevocable, nonexclusive, nontransferable license
under any and all United States patents and applications for
patent of Contractor, based on inventions now owned or con
trolled 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 subject matter of the
aforesaid Contract No. 397 as said process exists at the effec
tive date of this and said Contract No. 397 and as it may 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,
said patents and applications for patent to include the
following:
(1) U. S. Patent No. 3,034,867 for Continuous Trinitrotol-
uene Manufacture issued to Erik Samuelson on 15 May 1962;
(2) U. S. Patent No. 3,087,971, for Method for Trinitrotol-
uene Manufacture issued to Erik Samuelson on 30 April 1963;
(3) U. S. Patent No. 3,087,973 for Continuous Trinitrotol-
uene Manufacture issued to Erik Samuelson on 30 April 1963;
(4) U. S. Patent No. 3,204,000 for Manufacture of Nitrotol-
uene issued to Erik Samuelson on 31 August 1965;
(c) Contractor further agrees to provide the Government
with copies of applications for U. S. patent based upon inven
tions or improvements owned or controlled by Contractor per
taining to the continuous manufacture of TNT for a period of
ten (10) years from the effective date of the aforesaid Contract
No. 397.
(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.
(e) The Government shall have the right to examine by an
authorized representative or representatives at any time and
from time to time during regular business hours, those plants of
the Contractor manufacturing TNT by the continuous process
for the purpose of identifying operating improvements in said
process, and the contractor agrees at this time to disclose those
improvements incorporated. Contractor further agrees to make
such data available with the right to use same in the operation
of Government plants. The Government in like manner agrees
to make available to Contractor Government owned or con
trolled data relating to similar improvements made in Govern
ment plants. The foregoing arrangement shall exist for a period
of ten (10) years from the effective date of this agreement.
(g) Contractor further agrees that after ten (10) years from
the effective date of this contract the Government shall have
the right, at any time, to dispose of any plant or facility
constructed in accordance with the design and process data
furnished by contractor pursuant to the aforesaid Contract No.
397, and to disseminate to any person, including purchasers of
such plants or facilities, all such data. In the event that the
Government decides to dispose of any such plant or facility
within said ten (10) year period, the Contractor shall be given
the first opportunity to purchase said plant or facility. If such
plant or facility is sold to anyone other than Contractor, the
purchaser shall be contractually obligated to restrict his use of
data embodied in the plant or facility to the purchased premises
for Governmental (non-commercial) purposes only and not to
divulge said data to anyone, for the remainder of said ten (10)
year period, provided, however, that Contractor agrees to make
available, on fair and reasonable terms, a license to operate the
same plant for commercial purposes.
(h) Contractor agrees to mark with a restrictive legend all
that data relating to apparatus, processes or components devel
oped at private expense and provided pursuant to the aforesaid
Contract No. 397. The Government and its selected contractor
agree to observe the restrictions for the period of ten (10) years
from the effective date of this and the aforesaid Contract No.
397, PROVIDED, that such restrictions shall not apply to that
data in the public domain or otherwise available to the Govern
ment without limitations.
Article 4 of the agreement provides for payment
as follows:
ARTICLE 4. PAYMENT
The Government in consideration of this license, subject to
the availability of funds, shall be obligated to pay the Contrac
tor 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 Govern
ment 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 ( 1 / 2 ) on the
effective date of Contract No. 397; and the remaining one-half
( 1 / 2 ) 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 pay
ment on the part of the Government.
The sum payable was later increased by agree
ment to $650,000. By letter dated August 9, 1967
CIL and Chematur agreed concerning the distri
bution of this sum as follows:
We wish to refer to the agreement between our companies,
dated 27th June, 1960, concerning our purchase of rights under
your continuous TNT process, and our recent correspondence
in connection with our sale of rights under such process to the
United States Government.
This letter will serve to confirm that in consideration of the
nature of the know-how to be supplied to the U.S. Government,
and notwithstanding the terms of Clause 4(c) of our agreement
of June 27th, 1960, it has been agreed by our two companies
that the price received from the U.S. Government would be
shared between us on the basis of Chematur receiving $300,000
and C-I-L keeping $350,000 of the capital sum of $650,000.
Mr. Harley Prime, manager of an engineering
group and explosive research for CIL, testified
that the relative importance of the research and
development contributed by CIL and Chematur to
the construction of the first continuous process
plant was CIL -80%; Chematur-20%.
Pursuant to the Licence Agreement and the
Services Agreement the United States Govern
ment immediately constructed three continuous
process plants with the assistance of CIL. Eventu
ally it constructed twenty such plants, fourteen of
which were operating and six of which were in the
process of completion at the time of the hearing
before the Tax Review Board in 1974.
Eventually the United States Government
ceased to purchase TNT from CIL. Precisely when
this occurred is not clear from the evidence. CIL
had definitely ceased to sell TNT to the United
States Government by' the time of the hearing
before the Tax Review Board. At that time the
Valleyfield plant was manufacturing a variety of
products. Its production of TNT for military pur
poses was confined to small quantities for the
Canadian Government, which placed restrictions
on sale by CIL of TNT for such purposes to
others. It is possible to conclude from the evidence,
however, that CIL continued to sell TNT for
military purposes to the United States Govern
ment for some time after the Licence Agreement.
It is the contention of CIL that as a direct result of
entering into the Licence Agreement and perform
ing its obligations thereunder it lost its entire
market for TNT with the United States Govern
ment.
Up to the time of the trial the agreement with
the United States Government was the only one
that CIL had entered into of the kind contemplat
ed by the CIL-Chematur agreement for the estab
lishment of continuous process plants.
The issue in the appeal is whether the sum of
$378,000 (the Canadian equivalent of $350,000
(U.S.)) which CIL received as its share of the
payment under the Licence Agreement was an
income receipt or a capital receipt. The Tax
Review Board and the Trial Division held that it
was income.
The appellant contends that the sum received
was a capital receipt on the ground that it was
consideration for giving up a part of the capital
assets of the company. It is argued that the pay
ment under the Licence Agreement was a once-
for-all lump sum payment unrelated to the actual
use of the patents and the so-called proprietary
"background data" or "know-how", and, further,
that as a direct result of entering into the Licence
Agreement CIL lost its entire business for the sale
of TNT for military purposes to the United States
Government. The respondent contends that the
agreement between CIL and Chematur contem
plated the kind of transaction that was entered
into as part of a business from which revenue
would be derived, that the licence to use the
patents and the "know-how" was of a non-exclu
sive nature which left the appellant free to make
other such arrangements in the United States, and
that there is no evidence that the appellant lost its
business with the United States Government as a
direct result of entering into the Licence
Agreement.
Reference was made in argument to several
cases, but the argument focused particularly on
the application of four of them: Evans Medical
Supplies, Ltd. v. Moriarty (H.M. Inspector of
Taxes) 37 T.C. 540; Jeffrey (H.M. Inspector of
Taxes) v. Rolls-Royce, Ltd. 40 T.C. 443; Musker
(H.M. Inspector of Taxes) v. English Electric Co.,
Ltd. 41 T.C. 556; and Wolf Electric Tools Ltd. v.
Wilson (H.M. Inspector of Taxes) 45 T.C. 326.
The appellant contended that the sum received
under the Licence Agreement was of the same
character as the lump sum payments that had been
held to be capital in the Evans Medical Supplies
and Wolf Electric cases. The respondent argued
that it fell within the principles applied in the
Rolls-Royce and English Electric cases, where the
lump sum payments were held to be income. It is
necessary to consider, then, what these cases
appear to stand for in relation to the issue in the
appeal.
Evans Medical Supplies and Wolf Electric
involved agreements whereby companies under
took to disclose secret processes and other "know-
how" and otherwise to provide the necessary
assistance to enable other companies to become
established in their kind of business, and as a
direct result of which they lost their entire business
in the countries in question. This result is the
feature of the cases that is stressed by the appel
lant. It would also appear to be the feature of
Evans Medical Supplies that was emphasized by
the House of Lords in Rolls-Royce and English
Electric as distinguishing it. In these cases there
were agreements by which companies undertook to
impart their "know-how" to governments and
other companies for lump sum payments unrelated
to the extent of use, but it was held that they had
not lost any business by doing so. On the contrary
they had been enabled by these agreements to
carry on their business in countries in which they
would not otherwise have been able to do so.
Because of the appellant's reliance on Evans
Medical Supplies it is necessary to take a more
detailed look at the facts of that case and the
variety of opinion expressed in the House of Lords.
The Burmese Government had decided that
Burma should have its own pharmaceutical indus
try and sought to obtain the assistance of some
well-established pharmaceutical company to
enable it to do so. Evans Medical Supplies, Ltd.
was such a Company with a world-wide business,
including a business in Burma which it carried on
through an agency. Encouraged by its own govern
ment, and desiring to make the best of the situa
tion, the Company entered into the necessary
agreement with the Burmese Government by
which it agreed to disclose its secret processes and
otherwise to assist the Government to establish a,
pharmaceutical industry. As consideration the
Company received what the agreement described
as a "capital sum" of £100,000. As a result of
entering into the agreement the Company lost its
entire business in Burma. This was the only case in
which the Company made a disclosure of its secret
processes to enable another company to enter into
business in competition with it. Opinion was divid
ed in the House of Lords. Two of the members,
Viscount Simonds and Lord Tucker, held that the
sum was wholly capital. Two, Lord Denning and
Lord Keith of Avonholme, held it was income. The
fifth member, Lord Morton of Henryton, held that
it was capital in so far as it was attributable to
disclosure of the secret processes, and that the case
should be sent back for the determination of that
proportion. The Company's appeal succeeded for
the whole of the amount because Lord Denning,
while considering the sum to be income, held that
it had not been received in the course of the
Company's existing trade and could therefore not
be brought into the assessment of that trade for
the taxation year in question. Thus, it must be
observed that there was not a majority in the
House of Lords for the conclusion that the whole
of the sum was capital.
Viscount Simonds, with whom Lord Tucker con
curred, adopted the test expressed by Bankes L.J.
in British Dyestuffs Corporation (Blackley), Ltd.
v. The Commissioners of Inland Revenue 12 T.C.
586, at page 596 as follows:
... looking at this matter, is the transaction in substance a
parting by the Company with part of its property for a pur
chase price, or is it a method of trading by which it acquires
this particular sum of money as part of the profits and gains of
that trade?
Viscount Simonds likened the secret processes to
a patent, held that they were a capital asset, and
that the Company had "parted with its property
for a purchase price." As to the character of a
secret process, he referred to the decision of the
Court of Appeal in Handley Page v. Butterworth
(H.M. Inspector of Taxes) 19 T.C. 328, where in a
case involving compensation by the Government
after the war for the use of secret processes which
the inventor had been obliged to disclose, Romer
L.J. said at pages 359-360, after describing the
position of a patentee:
The owner of a secret process, such as was possessed by Mr.
Handley Page, stands in a very analogous position; he has not a
monopoly at law, but he has a monopoly in fact—a monopoly
in fact arising from the possession by him of the secret knowl
edge of the process that he is carrying on. That secret knowl
edge is as much his capital asset as is the patent monopoly the
capital asset of the patentee, and, like the patent, he can use
that capital asset in either or both of the following ways: he can
himself carry on the secret process or he may—it is very seldom
done owing to the obvious danger involved—grant a licence to a
third person to carry on the secret process, securing himself
against his secret process being divulged by that third party to
others. In both these cases the profits he derives from carrying
on the secret process himself and the royalty he might derive
from the licensee would be annual profits or gains within the
meaning of Schedule D. But, supposing he sells his secret
process, or supposing, as here, he surrenders his quasi monopo
ly by making it public to the world, then I say that, if he gets
paid for doing either one or the other of those things, the money
he receives in payment is a capital asset. Here, at the invitation
of the Government, he surrendered to the world his secret
knowledge, and his capital asset thereupon ceased to exist. The
payment in question, in my opinion, was made to him for the
surrender of his capital asset and, in his hands, is capital money
not taxable under Schedule D or any other Schedule.
Lord Morton of Henryton, who held that the
lump sum payment was a capital receipt in so far
as it was attributable to the disclosure of the secret
processes of the Company, adopted the reasoning
of the judges in the Court of Appeal, in which
reference was made to the characterization by
Romer L.J. of secret processes in Handley Page.
The judges in the Court of Appeal had held that
the fact the disclosure was not a disclosure to the
world, as in Handley Page, did not prevent it from
being a parting with a valuable part of the Compa-
ny's assets.
Lord Denning held that there had not been a
sale of secret processes, since the Company
retained the right to use the processes, and that
what the transaction amounted to was the supply
of "know-how". He said "know-how" could not be
sold as a capital asset for a capital sum, it could
only be used by a company or taught to others for
profit. Acknowledging that there might be a sale
of secret processes for a sum that would be a
capital receipt, he said at page 589: "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."
Lord Keith of Avonholme held that there was
ample evidence to support the conclusion of the
Commissioners that the Company was trading in
"know-how".
The subsequent commentary by the House of
Lords on the decision in Evans Medical Supplies
is significant as indicating what are to be con
sidered the distinguishing features of that case. In
Rolls-Royce, where the House of Lords held that
the lump sum payments received for the disclosure
of "know-how" were income receipts, Viscount
Simonds said at pages 490-491, with reference to
Evans Medical Supplies, that the inference had
been drawn in that case that the capital sum had
been paid for the communication of secret pro
cesses, "with a resulting total loss to the company
of its Burmese trade", that particular regard was
had to the fact that the transaction was an isolated
one, and that an analogy had been drawn between
secret processes and patents. He added: "The deci
sion did not establish, or purport to establish, a
principle that whenever, and however often, a com
pany communicates what is called `know-how' to a
third party and receives what is called a lump sum
for it, that sum is for tax purposes a capital
receipt. The circumstances may lead, as in my
opinion they lead in the present case, to the oppo
site conclusion." Lord Reid at page 492 said the
distinguishing features of Evans Medical Supplies
were that the Company had lost its Burmese
market, that the capital value of the secret pro
cesses had been greatly diminished by their disclo
sure to the Burmese Government, and that there
was a single transaction, in contrast to Rolls-
Royce, in which there had been a series of transac
tions arising out of a deliberate policy. Lord Rad-
cliffe said at page 495: "What weighed with the
majority judgments in that case was that the com
pany had sold to the Burmese Government a secret
process upon which the success of its business in
Burma had to depend and it had, in effect, dis
posed altogether of its Burmese trade. To do that
was to dispose finally of part of its fixed capital,
and monies received in return were not trading
receipts. The case was regarded as being an
equivalent to Handley Page v. Butterworth, 19
T.C. 328, in which the owner of a secret process
had destroyed his property by making it available
to the world." Lord Morris of Borth-y-Gest, refer
ring to Evans Medical Supplies at page 497,
stressed the fact that there had been an isolated
transaction and not the repetition of licensing
found in the Rolls-Royce case, and that the
imparting of knowledge had been to the detriment
of the Company's business in Burma. Lord Guest
said at page 498 that he regarded Evans Medical
Supplies as "a very special case decided upon its
own particular facts". He said that the disclosure
of the Company's secret processes, which had
never been disclosed to anyone before, "involved
the gradual cessation of the company's own whole
sale trading activities in Burma", and that the
Company "parted with an asset which was the
source, or one of the sources, of its profits." He
said there had been the realization of a consider
able part of the capital value of the secret pro
cesses in a "once for all" sale.
Evans Medical Supplies was also the subject of
commentary by the House of Lords in the English
Electric case, where once again it was unanimous
ly held that the Company had been trading in
"know-how" and the lump sum payments received
were income. The case was held to be governed by
Rolls-Royce. Lord Donovan, with whom Lord
Reid agreed, said with reference to Evans Medical
Supplies at page 588: "What distinguishes Evans
Medical Supplies, Ltd. v. Moriarty in this respect
is, I think, the circumstances of the transaction,
which was, in effect, the disposal by degrees of the
company's branch business in Burma. Where a
business is sold, or relinquished by degrees, and
part of the consideration is a lump sum for the
disclosure of secret processes which will enable the
purchaser of the business to carry it on, it may
well be that the lump sum should be regarded
simply as part of the entire consideration for the
sale, and thus as capital."
In Wolf Electric, on which the appellant also
relies, the Company, a manufacturer of power
tools in England with an extensive export trade,
was selling tools in India through an agency on a
principal to principal basis, when it was told for
reasons of governmental policy similar to those in
Evans Medical Supplies that it would have to
establish manufacturing facilities in India. A
Company was incorporated in India, and Wolf
Electric agreed to supply it with the necessary
confidential information to enable it to manufac
ture certain tools, and it further agreed that the
Indian Company should have the exclusive right in
India for a specified period to manufacture the
selected tools. In return for the supply of informa
tion Wolf Electric received 45% of the shares of
the Indian Company. The issue was whether the
value of these shares was a capital or income
receipt. Pennycuick J. in the Chancery Division of
the High Court held that it was capital. He said
that what had taken place was a change in the
profit-making structure of the Company whereby
it had exchanged its goodwill in India for the
shares in the Indian Company. He said the case
fell within Evans Medical Supplies rather than
Rolls-Royce or English Electric. Quoting from
what was said by Viscount Radcliffe in English
Electric, he said at page 340 that the obligation to
supply information was one element of "a compre
hensive arrangement by virtue of which, quoad the
selected tools, the Company effectively gave up its
business in India." In conclusion he observed that
in the Rolls-Royce and English Electric cases the
Companies had no pre-existing goodwill in the
countries in which they made agreements to
impart their "know-how", and that the pre-exist
ing goodwill in India in the Wolf Electric case was
the crucial factor in concluding that the transac
tion was of a capital nature.
It is not clear how much significance Pen-
nycuick J. attached to the exclusivity provision in
the agreement, but the importance of the distinc-
tion between a non-exclusive and an exclusive
licence under a patent was stressed in Murray
(H.M. Inspector of Taxes) v. Imperial Chemical
Industries Ltd. 44 T.C. 175, where the issue was
the character for tax purposes of a lump sum
payment received as consideration for a "keep-
out" covenant that was held to be ancillary to
patent licences. It was held to be capital. The
licences were for the life of the patents, and to
gether with the "keep-out covenant", were held to
be the equivalent of an assignment of the patent
rights for a lump sum consideration unrelated to
use in the countries concerned. Lord Denning
M.R., in the Court of Appeal, discussed the sig
nificance of different kinds of licence transactions
involving a lump sum payment. The respondent
invokes this passage in support of his contention
that the non-exclusive character of the licence in
the present case prevents the transaction from
being a capital one. I quote only a part of the
passage in the reasons of Lord Denning M.R.
which begins at page 211. After pointing out the
distinctions in the rights granted by an ordinary or
non-exclusive licence, a "sole" licence, and an
exclusive licence, of which the licence with "keep-
out" covenant is a particular form, as well as the
various kinds of payment which the owner of
patent rights may receive, Lord Denning M.R.
said at page 212:
If and in so far as he disposes of the patent rights 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 Nethersole
v. Withers (1948) 28 T.C. 501, at page 512, approved by Lord
Simon in the House of Lords, at page 518). 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 £25,000 in the British Salmson case). It is
different when a man does not dispose of his patent rights, but
retains them and grants a non-exclusive licence. He does not
then dispose of a capital asset. He retains the asset and he uses
it to bring in money for him. A lump sum may in those cases be
a revenue receipt (see Commissioners of Inland Revenue v.
Rustproof Metal Window Co. Ltd. (1947) 29 T.C. 243, at
pages 270-1 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.
The lump sum in the present case is clearly one
that was fixed without reference to an anticipated
quantum of user. It was paid for a non-exclusive
licence to use an invention and for "know-how".
The appellant contended that it was well estab
lished by a long line of authorities that a payment
of this character was to be considered to be capi
tal. I do not think that the weight of authority
supports this unqualified contention, as appears
from the judgment of Lord Denning in the
Imperial Chemical case which I have quoted. In
Constantinesco v. Rex 11 T.C. 730, in which a
lump sum payment made after the use of a patent
was held to be income, Rowlatt J. said, "Suppos-
ing, before the user, it is said: 'Now pay
£25,000'—or whatever sum the parties agree to—
'and use it as much as you like, for a definite time
or for the whole length of the patent.' That will
clearly be a lump sum. It would not be parting
with the patent, because other people might use it,
but it would be clearly a capital sum, in my
judgment." In Desoutter Bros. Ltd. v. J. E.
Hanger & Co., Ltd. [1936] 1 All E.R. 535, Mac-
Kinnon J., relying on this statement, held that a
lump sum payment in advance for a licence to use
a patent, without regard to the extent of the
anticipated use, was capital. There was nothing to
indicate that the licence was an exclusive one, and
no reference was made to any distinction, in this
respect, between a non-exclusive and an exclusive
licence. These expressions of judicial opinion cer
tainly support the appellant's contention. In Brit-
ish Salmson Aero Engines, Ltd. v. Commissioners
of Inland Revenue 22 T.C. 29, the Court of
Appeal held that a lump sum payment, unrelated
to extent of use, for an exclusive licence under a
patent was capital. The Crown had argued, on the
basis of something said by Greer L.J. in Mills v.
Jones (H.M. Inspector of Taxes) 14 T.C. 769,
concerning a lump sum payment of royalties, that
any payment for a licence to use a patent, whether
lump sum or not, whether related to use or not,
was income. Finlay J. in the King's Bench Divi
sion, said that what Greer L.J. had said in Mills v.
Jones appeared to cast doubt on the dictum in
Constantinesco but that he felt bound by Desout-
ter. In the Court of Appeal, Sir William Greene
M.R. said that Finlay J. came to the right conclu
sion, but in his own reasons he drew particular
attention to the exclusive character of the licence
that had been granted and stressed the importance
in this respect of the distinction between a non-
exclusive and an exclusive licence: see pages 39-40
and 46-47. He said that Greer L.J. in his observa
tions in Mills v. Jones had expressly reserved the
case of an exclusive licence. It is, I think, a clear
implication of the reasons of the Court of Appeal
in British Salmson that the case was decided the
way it was because the licence was an exclusive
one. In Commissioners of Inland Revenue v.
Rustproof Metal Window Co., Ltd. 29 T.C. 243,
the Court of Appeal held that a lump sum unrelat
ed to extent of use given for a non-exclusive licence
was income. The Court stressed the fact that the
licence was non-exclusive, for a limited purpose
and for a limited time. In the King's Bench Divi
sion Atkinson J. had rejected the argument that
the payment was income because the licence was
non-exclusive. He pointed to Desoutter and to the
terms in which Lord Greene M.R. had expressed
himself in the Court of Appeal in Nethersole v.
Withers (H.M. Inspector of Taxes) 28 T.C. 501,
where, according to Atkinson J., he had expressed
approval of Desoutter and had said with reference
to British Salmson at page 512: "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. 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." In the Court
of Appeal in Rustproof Metal, Lord Greene M.R.
rejected the proposition that a lump sum paid
without reference to the extent of use for a licence
to use a patent is necessarily capital. He denied
that what was said in Nethersole was intended to
approve such a proposition, although he did make
the following observation concerning the conclud
ing sentence in the passage quoted above [at page
268]: "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'." At pages 270-271 he expressed what
appear to have been the essential considerations
for holding the payment to be income as follows:
"The licence is a non-exclusive licence and the
Company's right to exploit the patent by the grant
of other licences is therefore unimpaired. It is
granted for a specific purpose only, namely, to
enable the licensee to fulfil 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 no capital element in a receipt of this nature in
those circumstances." In the Nethersole case,
which was decided on the basis that what was
involved amounted to a sale or assignment of
copyright, Viscount Simon in the House of Lords
referred to Constantinesco, Mills v. Jones, De-
soutter, and British Salmson, and said he adopted
the statement by Lord Greene M.R. in Nethersole
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" and that
"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." I do not think that any
thing said by Viscount Simon in the Nethersole
case detracts from the significance of the distinc
tion, emphasized by Lord Greene in Rustproof
Metal, between an exclusive and a non-exclusive
licence. On the contrary, what was emphasized in
Nethersole was that there had been a disposition
of property. In Evans Medical Supplies there was
reference by Upjohn J. in the Chancery Division
and by Lord Evershed M.R. and Romer L.J. in the
Court of Appeal to what was said by Lord Greene
M.R. in Nethersole. Upjohn J rejected the dis
tinction between an exclusive and non-exclusive
licence as the basis for determining whether a
lump sum payment is capital or income. He said
such a proposition was in conflict with what was
said by Lord Greene M.R. in Nethersole and
approved by Viscount Simon in that case, and with
the decision in Desoutter. Lord Evershed M.R. in
the Court of Appeal said at page 562: "For it is
not, in my judgment, an answer to Mr. Senter's
argument in this respect that the Company did not
part with the information in the sense of making it
over wholly to the other party so as to exclude the
further use of it by the Company anywhere in the
world. The cases on patents, for example Margeri-
son v. Tyresoles, Ltd., 25 T.C. 59, show that it is
not a sufficient answer to a claim to treat money
received as capital that only limited and non-
exclusive rights were granted." The reference to
Tyresoles is difficult to understand because that
appears to have been a case in which a lump sum
payment was made for an undertaking by which
the Company agreed to limit its activity in the
area covered by the agreement. It was a form of
"keep-out" covenant. At page 68 of his reasons
Wrottesley J. said, "Prima facie here, therefore,
what the Company has done is to grant an exclu
sive right to the garage owner, which will be
enforced by the Courts of Law, and which will pro
tanto disentitle the Company from exercising the
patent rights it has under the law", and at page 70
he said with reference to what Lord Greene M.R.
had said in British Salmson, "He fastened upon
two elements which distinguish the Salmson case
. from those in which no more was granted than
the mere right to use a patent. The first was that
by the agreement the French company, the paten-
tees, undertook not to exercise its patent rights in
the British Empire. This was as the Master of the
Rolls pointed out something quite different from a
mere right of user. It entitled the English company
to restrain the French company from exercising its
rights in that territory. Pausing there, I find some
thing of the same kind in the case under debate.
The Company could be restrained by the garage
owner from exercising in the area specified in the
agreement its undoubted patent rights to the
extent set out in the agreement. The Company
parted with this amount of its corpus." Romer L.J.
in the Court of Appeal in Evans Medical Supplies
held that while the Company had not, strictly
speaking, sold or assigned any property, the value
of the secret processes to the Company had been
diminished by their disclosure to the Burmese
Government. He cited the statement of Lord
Greene M.R. in Nethersole that where the prop
erty "is permanently diminished or injuriously
affected, it means that the owner has to that extent
realised part of the capital of his property as
distinct from merely exploiting its income-produc
ing character." There was no reference in the
House of Lords in Evans Medical Supplies to the
distinction, in respect of a lump sum payment for a
licence under a patent, between a non-exclusive
and an exclusive licence. Nor was there any such
reference in the House of Lords in the Rolls-
Royce and English Electric cases. Finally there is
the statement with reference to this distinction by
Lord Denning M.R. in the Imperial Chemical
case, part of which has been quoted above. Davies
L.J. and Russell L.J. in the Court of Appeal held
that because of the nature of the licences in that
case, which were exclusive licences for the term of
the patents reinforced by "keep-out" covenants,
there had been a disposition of a part of the fixed
assets of the Company. All of the judges in the
Court of Appeal expressed agreement with Cross
J. in the Chancery Division who in the course of
his reasons said at page 205: "But the agreements
in question contained in substance dispositions of
the whole interest of I.C.I. in the patents in the
various countries, supported by the 'keep-out'
covenants."
What emerges from this analysis is that it is not
sufficient that there be the stipulation of a lump
sum payment unrelated to the extent of the
anticipated use of the patent in order for such
payment to be capital in nature; the licence for
which it is consideration must amount to a disposi
tion or sale of part of the patent rights. This
concept of a disposition of or parting with a capital
asset is central to the test formulated by Bankes
L.J. in British Dyestuffs, which has been cited
with approval in several of the cases. It is central
to the view that is reflected in Rustproof Metal
and which appears from the judgment of Lord
Denning M.R. in Imperial Chemical Industries to
have prevailed in the Court of Appeal. It is admit
tedly contrary to the view expressed by Lord Ever-
shed M.R. in Evans Medical Supplies which
would appear to treat a non-exclusive licence as a
sufficient impairment of the capital asset to make
a lump sum payment unrelated to the extent of use
a capital receipt, but what was said by him and
Romer L.J. in that case cannot be divorced from
the particular facts of that case and in particular
from what was the ultimate effect of the agree
ment on the Company's business in Burma.
It is my opinion, therefore, based on this line of
authority, that the fact the lump sum payment in
the present case was given for a licence to use
patents as well as for "know-how" does not add
any significant force to the appellant's contention
that the sum must be considered to be capital.
While the United States patents are clearly capital
assets the licence, which is non-exclusive, for a
limited purpose (to the United States Government
for military of non-commercial purposes) and for a
limited term, cannot be considered, on the analysis
to be found in the cases, to be a parting with or
disposition of the patent rights. The right stipulat
ed in the Licence Agreement to sell any plant built
under the licence and to disseminate the design
and process data furnished under the Services
Agreement would not appear to have any bearing
on the nature of the licence to use the United
States patents. Moreover, I would observe that
these patent rights are in any event not, strictly
speaking, the property of the appellant. CIL was
given the right to grant licences under them by
those who control the patents in accordance with
the understanding in paragraph 4(c) of the CIL-
Chematur agreement that CIL would negotiate
the licence agreements for continuous process
plants on the North American continent. What
had been granted to CIL by that agreement was a
non-exclusive licence under any Canadian patents.
The record shows that Chematur owned or con
trolled the rights under the four United States
patents referred to in Article 1, paragraph (b) of
the Licence Agreement.
In so far as the licence to use the "background
data" or "know-how" is concerned, it is quite clear
on the authority of the Rolls-Royce and English
Electric cases that the fact a lump sum payment
for such "know-how" is unrelated to the extent of
use is not sufficient by itself to make it a capital
receipt. The appellant's case then comes down in
the final analysis to the contention that it reflects
the essential distinguishing features of Evans
Medical Supplies—namely, that the "know-how"
was of a secret or confidential character, that the
agreement under which it was imparted was a
single or isolated transaction, and that the impart
ing of it resulted in a loss to the appellant of a
substantial part of its business. I am prepared to
regard the appellant's "know-how" as the equiva
lent, for purposes of analysis, of the "secret pro
cesses" in Evans Medical Supplies and Wolf
Electric, but that does no more than give it the
character of a capital asset analogous to patent
rights. As to the evidence that the Licence Agree
ment was the only one of its kind that CIL had
entered into, I think there is this important distinc
tion: while it may have been obliged to enter into
this agreement by the position of the United States
Government, agreements of this kind were contem
plated by the CIL-Chematur agreement as a form
of business to be shared in by the parties. They
were contemplated as a deliberate policy, to use
the distinction that was emphasized in Rolls-
Royce and English Electric. It comes down then in
my opinion to the essential question: does the
evidence show that CIL lost its business for mili
tary TNT with the United States Government as a
direct and necessary result of entering into the
Licence Agreement? In my opinion it does not.
The evidence shows that the United States Gov
ernment eventually ceased to purchase TNT from
CIL, although precisely when that occurred is not
clear. What it does not show is that the loss of this
business was inherent in the licensing arrange
ments that were made. These arrangements did
not, as in the case of Evans Medical Supplies and
Wolf Electric, permit someone who had not been
manufacturing at all to engage in manufacturing.
The United States Government had been purchas
ing TNT from CIL when the Government had its
own "batch process" plants. There is nothing to
suggest that at some point it might not have
increased its own production and ceased to pur
chase from CIL. Conversely, there is nothing in
the evidence to suggest that it might not have
continued to purchase from CIL after the licensing
arrangements permitting it to build continuous
process plants. Nowhere in the evidence is it
indicated that it was part of the understanding
which led to the licensing arrangements and the
lump sum payment stipulated that the United
States Government would cease to purchase from
CIL. For these reasons, I do not think the case can
be brought within Evans Medical Supplies,
assuming that that case may still have some
application to a lump sum payment for "know-
how", despite the extent to which its significance
has been narrowed by subsequent judicial com
mentary. In effect, I can see no reason in the
circumstances of the present case not to apply the
principles affirmed in the Rolls-Royce and Eng-
lish Electric cases with respect to the nature of a
disclosure of "know-how" and to hold that the sum
received was an income rather than a capital
receipt. Accordingly, I would dismiss the appeal
with costs.
* * *
PRATTE J.: I agree.
* * *
HYDE D.J.: I agree.
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.