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HMRC internal manual

Business Income Manual

HM Revenue & Customs
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Capital/revenue divide: intellectual property: lump sums for ‘know-how’

Payments for sharing knowledge

In determining whether the sum in question is capital or revenue, you should approach payments or receipts for intellectual property in the same way as any other payment or receipt. Capital allowances in respect of the cost of know-how, which is not otherwise deductible, are governed by S451-S463 Capital Allowance Act 2001. See CA70000 onwards. See also BIM35501 for the Corporation Tax intangible fixed assets legislation, which may require the accounting entries in respect of know-how to be followed in computations of income for Corporation Tax, even if those entries are of a capital nature. Capital allowances are not available for know-how within the intangible assets regime.

The annual sums that a UK company received (before the introduction of the intangible assets rules) under a ten-year agreement with an American company were held to be income in the case of British Dyestuffs Corporation (Blackley) Ltd v CIR [1924] 12TC586. The UK company carried on the business of manufacturing dyes. The UK company and the American company entered into an agreement under which they undertook to communicate to each other all particulars of patents and secret processes and other information relating to the manufacture of dyes that they owned at the time or might acquire during a certain period. The agreement specified the particular territories in which each company had the right to exploit such patents and secret processes. The UK company was entitled to receive annually a sum of £25,000 for ten years, provided that sufficient information in regard to existing patents, etc, had been given from time to time to the American company to enable a satisfactory product to be manufactured. The UK company contended that the annual receipts of £25,000 were instalments of a capital sum representing the sale price of an asset. Rowlatt J found that the receipt was not derived from an outright sale of the rights but was income and so taxable.

Bankes LJ in the Court of Appeal (on page 596) agreed, again distinguishing exploitation of the asset from outright sale:

‘It is really using this property, if you like, and taking an annual return for it roughly corresponding probably to its average life and not a sale once and for all of a capital asset, a light in which certainly it is not put by any words which are in the agreement.’

Bankes LJ went on to say that the test to apply was to identify if the taxpayer was parting with any of its property for a purchase price or was this simply a method by which the taxpayer carried on their trade:

‘…looking at this matter, is the transaction in substance a parting by the company with part of its property for a purchase 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?’

By way of contrast and to emphasise that at the margin these can be difficult cases to resolve, a lump sum received by a UK company for disclosing certain secret processes and other information to the Burmese Government was held to be a capital receipt in Evans Medical Supplies Ltd v Moriarty [1957] 37TC540.

The UK company, which manufactured pharmaceutical products and had a world-wide trade, carried on business in Burma through an agency. In 1953 the Burmese government wished itself to establish an industry there for the production of pharmaceutical and other products, and the UK company secured a contract from the Burmese government to assist in setting up this industry. The UK company undertook to disclose secret processes to the Burmese government and to provide other information in consideration of the payment of a ‘capital sum of £100,000’. The UK company also undertook to provide certain services and to manage the proposed factory in return for an annual fee, which was admitted to be subject to tax. No similar agreement had been entered into by the company with any other foreign government or any other party.

The Special Commissioners and the Court of Appeal held the £100,000 was income. The High Court and a majority in the House of Lords did not agree, finding instead that the £100,000 was a capital receipt.

Lords Simonds, Tucker and Denning held that, the case having been stated by the Commissioners and the appeal argued throughout on the footing that the sum of £100,000 was indivisible, it was not open to the Court of Appeal to direct apportionment between consideration for the disclosure of secret processes and consideration for other matters.

Lords Simonds and Tucker were of opinion that the company had parted with a capital asset for a purchase price. Lord Denning considered that there was nothing wrong in the Commissioners’ finding that the amount in question was a payment for services, but that it was not received in the course of the UK company’s existing trade of wholesale druggists, etc, and therefore could not be brought into the assessment of the company’s existing trade.

Lord Morton of Henryton, dissenting as to the cross-appeal, agreed with the judgements in the Court of Appeal.

Lord Keith of Avonholm, dissenting, was of opinion that there was ample evidence that the company was trading in ’know-how’ and that it was no more than a legitimate extension of their existing trade.

The range of judicial opinion as to the ‘correct’ answer shows that even experienced judges well-acquainted with the law and fully appraised as to the facts can and do come to different conclusions in cases that are on the margin.