TMI Blog1982 (7) TMI 48X X X X Extracts X X X X X X X X Extracts X X X X ..... nce before 1933. In 1950 the sole agency of the Wolf company in India was taken over by Rallis India Ltd. (hereinafter referred to as " Rallis "). In 1954-55 the Wolf company's export to India amounted to 10% of its total exports by volume and a larger percentage by value. The volume of export business with India represented the Wolf company's largest export market outside the countries where it maintained its own branches. In 1954 Rallis informed the Wolf company that because of the Indian Government's policy of encouraging the setting up of local factories for making tools, unless the company undertook to manufacture in India, the whole of the Indian market would be lost. In 1956 there was an agreement between the Wolf company and Rallis for the assembly and partial or complete manufacture of certain tools in India under the name " Wolf " and this arrangement was to continue till a new company was promoted and commenced business. On 31st October, 1958, M/s. Ralliwolf Ltd., hereinafter referred to as the " Ralliwolf ", was incorporated in India on the condition that Rallis would be the majority shareholders. The issued capital of Ralliwolf was of 20,000 shares of Rs. 100 each. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lation to the selected tools and the benefit of all pending negotiations for acquisition of Indian patents; (b) the full benefit of all future inventions which shall be made by Wolfs in connection with the manufacture or working of the selected tools in India; (c) the exclusive right so far as Wolfs can confer the same to apply for and obtain Indian patents for the selected tools and any such future inventions as aforesaid and the benefit of all patents so obtained ; and (d) the benefit, of all extensions and prolongation of the terms and privileges granted by any such patents as aforesaid. This agreement was to remain in force for as long as the manufacturing and marketing agreement to be executed remained in force. This latter agreement was executed on 19th August, 1959. Under the agreement of 19th August, 1959, entered into between Wolf company and Ralliwolf, it was agreed that the tools assembled or manufactured in India would be marketed only in India and Nepal but the Wolf company would consider promoting exports by Ralliwolf when the possibility of exports arose. By this agreement, Ralliwolf had undertaken to keep secret and not to divulge to any persons save ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y of its assets as such but, instead of doing the business itself, it had sold its technique to an Indian concern and, therefore, the amount of Rs. 3,62,500 was received on revenue account. The AAC, however, held in favour of the assessee-company that no part of the sum of Rs. 3,62,500 accrued or arose or could be deemed to accrue or arise during the relevant accounting year in India because the presence of the technicians who served the Indian company as employees by itself would not spell out a business connection or an operation performed on behalf of the foreign concern. Having regard to this finding, the appeal filed by the assessee-company was allowed and the assessment order was set aside. The order of the AAC was challenged by the ITO by an appeal before the Income-tax Appellate Tribunal. It may be stated at this stage that the question as to whether the value of 3,625 shares in Ralliwolf issued to the assessee-company in consideration of supplying the drawings and information was of a capital nature or of an income nature had come up in the assessment proceedings of the assessee-company in London before the High Court of justice, Chancery Division, on a case submitted b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... One can illustrate that point, if illustration is necessary, by considering what would have been the position if, instead of Ralliwolf being owned as to 55 per cent. by Ralli and 45 per cent. by the company, the new Indian company had been a wholly-owned subsidiary of the company. In fact the transaction was not carried out in that simple manner. In three respects the transaction was different from a simple transaction of that kind. In the first place, the transaction was limited to the selected tools; in the second place, the transaction took the form of an exclusivity provision rather than of a transfer of goodwill ; and, in the third place, the consideration was attached, and attached exclusively, to the obligation to supply information. I do not think that any of those features makes any difference in principle. " Pennycuick J. held that it was plainly open to a trader to transfer his connection, either generally or in a limited area, quoad only some limited range of the goods manufactured by him and if the subject-matter of the transfer was a capital asset, then the transfer was none the less the transfer of a capital asset, and the consideration a capital receipt, by reaso ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... efore the Tribunal. It may be mentioned that the assessee-company had also filed cross-objection and both the appeal and cross-objection were decided by the Tribunal by the common order dated 4th September, 1971. The Tribunal in its order referred to the finding recorded by Pennycuick J., and reproduced the relevant parts of the order and found itself in agreement with the view that " transaction in question was in substance a parting by the non-resident company with part of its property for a purchase price, the property being its connection or goodwill in India and its fund of confidential material and the transaction was not of the nature of technique for exploiting the Indian market to provide trading income ". The transaction was thus held to be of a wholly capital nature and the value of the shares was treated as capital receipt. On the question as to whether any operation of business was carried out in India by the assessee-company, the Tribunal took the view that apart from the deputation of two technicians to India, there was no evidence of any other operation of the non-resident's activities in India, that the nature of the services contemplated under cl. 5 of the a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... goodwill which the assessee had in India. It was sought to be argued by Mr. Joshi on behalf of the Revenue that the statement of the case submitted for opinion of the High Court by the Special Commissioners in England showed that oral and documentary evidence Was given in those proceedings and that as no such evidence has been given in the proceedings out of which the present appeal arises. The matter will have to be decided merely on the reading of the relevant agreements. Both the learned counsel appearing on behalf of the Revenue and the assessee have extensively argued the question as to whether on facts in the present case the value of the shares acquired by the assessee must be treated as a capital receipt or a receipt on revenue account. Extensive reference was made to the three decisions of the House of Lords, viz., (1) Evans Medical Supplies Ltd. v. Moriarty [1957] 37 TC 540 at p. 573 [1959] 35 ITR 707, (2) IRC v. Rolls-Royce Ltd. [1962] 40 TC 443 at p. 490 ; [1965] 56 ITR 580 and (3) IRC v. English Electric Co. Ltd. [1964] 41 TC 556 at p. 585. Apart from the decision in Evans Medical Supplies' case referred to above, two other decisions in which the earlier decisions ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h an agency. However, when in 1953 the Burmese Govt. itself established an industry in Burma for the production of pharmaceutical and other products and the company itself secured a contract from the Burma Govt. to assist the Government in setting up this industry, the company had undertaken to disclose secret processes to the Burma Govt. and to provide other information in consideration of the payment of a capital sum of pounds I 00,000. The company also had undertaken to provide certain services 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 foreigner.. The claim of the company was that pounds 100,000 was a capital sum received either for the sale of fixed capital or for granting to the Burma Govt. an exclusive licence and that, in any event, it did not arise in the course of trade. The Special Commissioners construed the agreement as one for the provision of services and held that pounds 100,000 were properly included in computing the company's profits for income-tax purposes. The Chancery Division ([1957] 31 ITR 466), held that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion of their products, especially having regard to the importance of such matters in tropical countries. " These observations were made with reference to the terms of the agreement between the Govt. of Burma and Evans Medical Supplies Ltd.. The finding recorded by Upjohn J. was that the company was not exploiting its business in the only sense in which that word is relevant, that is, of carrying on its trade of wholesale druggists in Burma, but in and by the agreement it entered into the entirely new activity of acting as adviser of the Burmese Govt. by assisting to set up a completely new industry there which involved the disclosure to the Government of secrets never disclosed to any one before, and also involved the gradual cessation of its own wholesale trading activities there, for it was found as a fact that the company's Burmese agency will become progressively less important as the Government factory in Burma comes into production. Upjohn J., observed that the secret processes bore a marked analogy to patent rights and copyright. The learned judge also took the view that the industry in Burma, established by the skill and know-how of the company could embark on an export ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... trading in know-how consisting of a secret process and any other kind of know-how. Dealing with different situations in which a trader may decide to sell the secret process, he observed as follows (35 ITR at p. 724): " A person in trade or business who has a secret process which he decides to sell may do so in various situations. He may be retiring from business and selling his business to a purchaser. Obviously this is a capital transaction that attracts no tax. Again, he may remain in business, but being unable from lack of capital or otherwise to develop his secret process he may sell it outright to another trader. That again would be the sale of a capital asset which would not attract tax. A third type of case would be where the trader imparts his secret knowledge to some other trader, but retains the right to use it in his own business and, it may be, to share it further with other traders. In such a case it may be said that the secret knowledge is no longer secret knowledge. But that is not perhaps strictly accurate. It is not so secret as it was, but it may still retain a value. And if a trader, having developed some secret process, made practice of turning it to profit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ter avail himself of the special knowledge with which he has parted : see Trego v. Hunt [1896] AC 7, at pp. 24-5 (HL) ; and it may then rightly be regarded as the sale of a capital asset: see Handley Page v. Butterworth [1935] 19 TC 328 (HL). But the supplier of 'know-how' always remains entitled to use it himself, as was the case here." Lord Denning thus declined to treat know-how as capital asset. The result of the decision of the House of Lords in Evans Medical Supplies' case [1957] 37 TC 540; [1959] 35 ITR 707, thus was that there was no final determination of the question as to whether know-how could be treated as capital asset. The question again cropped up in Rolls-Royce case [1962] 40 TC 443 [1965] 56 ITR 580 (HL). In Rolls-Royce case the Rolls-Royce company, as result of research and development of engineering techniques, acquired fund of technical knowledge commonly called " know-how ", and during the period 1946 to 1953 it had entered into a number of agreements with foreign governments and companies under which it agreed to supply information necessary to construct certain engines which it had developed and to license the other party to manufacture these engines. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... can easily merge its character of a fixed asset into that of trading asset. The secret knowledge is the more transient since it becomes more quickly obsolete. That which is not secret is the valuable practical experience of years, but such knowledge partakes less of the nature of fixed asset. It consists in the power to communicate the knowledge possessed by a well trained, efficient and experienced staff. It could find no place in any balance-sheet. So far as part of the lump sums are paid in respect of the imparting of knowledge, they are sums regularly received as an ingredient in the company's policy of making manufacturing agreements to secure royalty revenue. To such agreements the disclosing of technical knowledge is a necessary adjunct, but it is a means rather than an end. None of these considerations is conclusive in itself, but they have cumulative weight." In our view, this would be the correct nature of know-how, which is but knowledge and which is evergrowing and everchanging and which is really in the nature of a trading asset. These observations were concurred with by Lord justice Upjohn, and Lord justice Donovan also rejected the argument that know-how is a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ar that the Evans Medical Supplies' case [1957] 37 TC 540; [1959] 35 ITR 707, cannot be treated as an authority for the proposition that whenever know-how is communicated to a third party, lump sum received therefor should be treated as a capital receipt. The House of Lords unanimously decided that the appeal of the Revenue should be dismissed. Lord Radcliffe declined to treat know-how as fixed capital asset. Pointing out that it was fundamental to the company's case that knowhow should be categorised as part of its fixed capital, he found that know-how was an asset ; it was intangible but that it would be difficult to identify with any precision the sources of expenditure which have gradually created it. Referring to the nature of know-how as an asset he observed : " An asset of this kind is-I am afraid that I must use the phrase-sui generis. It is not easily compared with factory or office buildings, warehouses, plant and machinery, or such independent legal rights as patents, copyright or trade marks, or even with goodwill. 'Know-how' is an ambience that pervades a highly specialised production organisation, and, although I think it correct to describe it as fixed capital ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ure by a limited number of companies in the United Kingdom, Australia and Canada. Later, the company entered into agreements with the Governments of Australia and an American aircraft manufacturing corporation under which it licensed them to manufacture the Canberra bombers which it had designed and developed. All the three agreements, inter alia, provided for the imparting of " manufacturing technique " to the licensees and in consideration of this, the company received specified lump sum payments. The question was whether these payments should be treated as trading receipts. They were in fact assessed as trading receipts, but in appeal the Special Commissioners held that the sums received were of a capital nature. On a case stated, Pennycuick J. held in favour of the Crown and the matter was taken to the Court of Appeal. In the Court of Appeal, Lord Denning held that while making the agreements in question, the company was able to exploit its capital asset, that is, its know-how by receiving large sums from its licensees for the use of it and upheld the decision of Pennycuick J. holding that the case was covered by the decision in Rolls-Royce's case [1965] 56 ITR 580 (HL). Danckw ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , 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 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 conte ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ffect the disposal by degrees of the company's branch business in Burma. The legal position on these authorities, therefore, is that know-how is not strictly a fixed asset and the nature of receipts from the know-how would essentially depend upon the transactions out of which the receipts arise and the context in which the receipts are received. If the imparting of know-how is really in the nature of services rendered without anything more, the receipt must be treated as a revenue receipt. But when consideration is received for imparting know-how in association with the disposal of a capital asset, then the receipt will have to be treated as capital receipt. The position, in our view, is admirably summed up by Walton J. in John E. Sturge Ltd. v. Hessel [1975] 51 TC 183 at 206 (CA), in the following words: " Accordingly, there is no ground for treating it (know-how) in any way differently from the rendering of any other service by the trader who imparts it : if imparted for consideration, the receipt is a trading receipt. However, the disposal is capable of wearing an entirely different aspect if it is found, not as a disclosure of 'know-how' on its own, but combined with so ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... case of the assessee-company, Woolf Electric Tools Ltd. v. Wilson [1968] 45 TC 326 (Ch D), that the assessee-company was parting with part of its property for a purchase price. Pennycuick J., who had considered the effect of the agreements in question, had observed as follows (p. 337): " The effect of that transaction as regards the company was simply, it seems to me, to alter the company's capital profit-making structure : that is to say, instead of having its own goodwill in India as regards the selected tools, the company acquired a 45 per cent. interest in the new company and thenceforward derived its profit through those shares. If the transaction had embraced the entire Indian connection of the company, and if the share consideration had been expressed to be attached to a transfer of that connection-i.e., in effect, goodwill-it is perfectly clear that no element of taxable profit would have been involved." Later, the effect of the agreements was again set out as follows (p. 340) : " In a case such as the present, the effect of the whole arrangement-and I must look at the whole arrangement-is that the trader receives new capital asset, namely, the shares in the forei ..... X X X X Extracts X X X X X X X X Extracts X X X X
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