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HMRC internal manual

Business Income Manual

Capital/revenue divide: intellectual property: transfer of know-how: akin to a teacher instructing a pupil

Where a taxpayer sells part of their fixed assets the receipt will generally be on capital account. Where a taxpayer exploits their knowledge base by transferring know-how to others in exchange for payment (be that a lump sum, a series of regular payments, shares in the acquiring company or whatever) the receipt will generally be on revenue account. 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.

The case of Musker v English Electric Co Ltd [1964] 41TC556 was very similar to Jeffrey v Rolls-Royce Ltd [1962] 40TC443. English Electric, in the course of carrying on its trade of engineering manufacturers, acquired a fund of specialised information and technique in engineering processes. It had not been English Electric’s practice to turn this information and technique to account by imparting it to others. In 1949, however, at the request of the Admiralty, English Electric entered into an agreement to design and develop a marine turbine and to license its manufacture by a limited number of companies in the UK, Australia and Canada. Later, in 1950 and 1952, English Electric, at the request of the Ministry of Supply, entered into agreements with the government of Australia and an American aircraft manufacturing corporation, respectively, under which it licensed them to manufacture the Canberra bomber which it had designed and developed. All three agreements provided, amongst other things, for the imparting of ‘manufacturing technique’ to the licensees and in consideration of this the company received specified lump sum payments.

The courts found that the amounts received represented taxable income. Viscount Radcliffe in the House of Lords explained that when a company sells know-how for reward this does not involve a disposal on capital account any more than when a teacher imparts knowledge to a pupil (41TC 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 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, trademarks 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.

The other point is that “know-how”, though very naturally looked upon as part of the capital equipment of a trade, is a fixed asset only by analogy and, as it were, by metaphor. The nature of receipts from it depends essentially, I think, upon the transaction out of which they arise and the context in which they are received. Where, as in Evans Medical Supplies, Ltd v Moriarty, 37TC540 [see BIM35705],”know-how” is imparted as one element of a comprehensive arrangement by virtue of which a trader effectively gives up his business in a particular area, the moneys paid for the “know-how”, whether or not independently quantified, may properly rank as capital receipts. But the Rolls-Royce [see BIM35710] case provides a different context, in which the imparting is no more than a service, of however special a kind, attendant upon an activity that arises out of the appellant’s trading.’

In the case of Coalite & Chemical Products Ltd v Treeby [1971] 48TC171 Coalite was the parent company of a group whose products included chlorinated phenols for use in agriculture. Coalite concentrated primarily on administration and research, leaving manufacture, production and distribution mainly to its subsidiaries. By 1960 the group had become the leading manufacturers of chlorinated phenols in the UK and Western Europe and was beginning to break into Eastern Europe, where there was a growing demand for them. In and after 1964-65 over 5% of its exports of chlorinated products went to countries in Eastern Europe but none to East Germany. The group’s processes for manufacturing these products were not patented; its supremacy lay in ‘know-how’ as to the application of known chemical processes to large-scale production.

In 1964 Coalite joined a consortium to advise and assist in a project to install a plant for the large-scale production of herbicides in East Germany, where production already existed, but in insufficient quantities. In consideration for joining the consortium, Coalite received a fee of £100,000, apportioned as to £68,000 for the provision of ‘know-how’ and £32,000 for the provision of services, which was paid by instalments in the year to 31 March 1966 and subsequent years. There was no dispute as to the apportionment and it was accepted from the outset that the £32,000 was taxable.

Coalite argued that the £68,000 was capital. Goulding J held that the £68,000 was a taxable revenue receipt. Having reviewed the various authorities Goulding J felt that the case was very firmly on the Rolls-Royce side of the line and not Evans Medical because:

  1. of the permanent character of the ‘know-how’ possessed by Evans Medical, and
  2. because the Evans Medical transaction was an isolated one. The fact that the consideration for ‘know-how’ was clearly defined would not have been enough to give the receipt the quality of capital for tax purposes without the further element of the transfer or relinquishment of the existing Burma business.

These factors were not all present in Coalite.