Inland Revenue Commissioners v Desoutter Brothers Ltd

 Inland Revenue Commissioners v Desoutter Brothers Ltd

BANKING AND FINANCE: INTELLECTUAL PROPERTY; Patents: TAXATION; Profits

COURT OF APPEAL

LORD GREENE MR, MACKINNON AND TUCKER LJJ

22, 23 NOVEMBER 1945

Revenue – Excess Profits Tax – Royalities received from licences of patented inventions – “Income received from investments” – Finance (No 2) Act, 1939 (c

109), s 12(1), (4), Sched 7, Pt I, para 6(2), (9).

The appellant, a British company manufacturing electrical and pneumatic tools, was the registered proprietor of British patents covering improvements in

electrically operated hand tools. It also owned patents taken out in the United States of America covering the same subject-matter. By two agreements, dated

3 June 1937, and 1 August 1940, respectively, the appellants granted to an American company an exclusive licence to manufacture and sell, within a defined

territory, drills made in accordance with the patents mentioned in the agreements. A royalty was reserved to the appellant company in respect of the tools

manufactured or sold by the American company. On the question whether those royalties ought to be included in the computation of the appellant company’s

profits for the purpose of assessment to excess profits tax with regard to the chargeable accounting period for the twelve months ended on 31 December 1940,

it was contended for the appellant company (i) that on a true construction of the Finance (No 2) Act, 1939, s 12, this particular income was, as a matter of law,

excluded from the profits of which account was to be taken; (ii) that, as a matter of fact, this income was not profits of the trade or business, and, since the

Commissioners failed to come to any finding on it, the case should be remitted to them; (iii) that the royalties were income received from investments within

the meaning of the Finance (No 2) Act, 1939, Sched 7, Pt I, para 6, and ought, therefore, to be excluded from the computation of the profits for the purpose of

assessment to excess profits tax:—

Held – (i) On a true construction of the Finance (No 2) Act, 1939, s 12(1), (4) the profits derived from the royalties were liable to tax. Subsect (4) of the Act

did not restrict the application of subsect (1).

(ii) On the facts as found, the royalties were profits arising from the company’s trade or business, and, therefore, there was no case to be sent back to the

Commissioners.

(iii) The exploitation of a patent in the hands of a manufacturer differed from that of a mere passive owner, in that only in the latter case could the income

from the patent be properly described as income from an investment. In the circumstances of the case, therefore, the income received by the appellant

company under the agreements was not income derived from investments within the meaning of the Finance (No 2) Act, 1939, Sched 7, Pt I, para 6, but

income of the trade or business and, as such, liable to tax.

Decision of MacNaghten J ([1945] 2 All ER 532) affirmed.

Notes

The Court of Appeal affirm the court below upon a somewhat different ground. MacNaghten J, held that royalties received from licences of patented

inventions were not income received from “investments,” following his own decision in the Roll-Royce case, where he laid down the test that in order to have

an “investment” there must be a laying out of money in order to acquire it. Lord Greene MR, regards this test as fallacious, and lays stress upon the distinction

between a patent in the hands of a manufacturer engaged in exploiting his monopoly, and a patent in the hands of a mere passive owner. The profits received

by the latter would, he considers, be properly regarded as profits of an investment, whilst those received by the former are mere trading receipts. The quality

of the receipts appears, therefore, to be a question of fact in each case.

For the Finance (No 2) Act, 1939, see Halsbury’s Statutes, Vol 32, p 1180.

Case referred to in judgments

Inland Revenue Comrs v Rolls-Royce Ltd [1944] 2 All ER 340.

Appeal

Appeal by the taxpayer from a decision of MacNaghten J dated 27 July 1945, and reported ([1945] 2 All ER 532), where the facts are fully set out.

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F Grant KC and F N Bucher for the appellants.

D L Jenkins KC and Reginald P Hills for the respondents.

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23 November 1945. The following judgments were delivered.

LORD GREENE MR. In this case the question is whether or not certain income—and I use a neutral word for the moment—is to be brought into account in

ascertaining the profits arising from the appellants’ trade or business in the year in question for the purposes of the excess profits tax.

The appellants have raised three arguments. The first argument is that, on the true construction of the relevant sections of the legislation, this particular

income is, as a matter of law, excluded from the profits of which account is to be taken. The second argument is that, of that be not right as a matter of law,

then, as a matter of fact, this income is not profits of the trade or business. That is a question of fact, and it was said that, as the Commissioners did not come

to any finding upon it, the case must accordingly go back to them. The third argument is that, within the meaning of the Finance (No 2) Act, 1939, Sched 7, Pt

I, para 6, the income in question is income received from investments, and is expressly excluded from being brought into account for the purposes of this

legislation by that paragraph.

The first argument is based on the language of the Finance (No 2) Act, 1939, s 12(4), which deals with excess profits tax. The first subsection speaks of:

‘… the profits arising in any chargeable accounting period from any trade or business to which this section applies …’

It is in respect of those profits that the tax is exigible. It will be observed that the language only extends to the profits arising from “any trade or business.”

Subsect (4) says:

‘Where the functions of a company or society incorporated by or under any enactment consist wholly or mainly in the holding of investments or

other property, the holding of the investments or property shall be deemed for the purpose of this section to be a business carried on by the company or

society.’

I should have thought that the objects of that subsection were manifest. In my view, it was intended, and quite clearly intended, to bring into the net a

type of corporation which otherwise would or might have escaped it. The commonest type of corporation with which the subsection is dealing is what may be

called a trust investment company, whose business is the holding of investments and deriving income from them. Such a corporation would not be said to be

carrying on a “trade or business” within the meaning of subsect (1). Anyhow, if it were not absolutely clear, subsect (4) makes it quite certain that that type of

corporation is to be included, and its operations are to be regarded as the carrying on of a trade or business. That seems to me to be the real and sole object of

subsect (4). The argument really amounted to this: by implication the profits from investments or property held by any other type of corporation are

excluded. I cannot begin to see the shadow of a foundation for any such argument. In my opinion, it breaks down completely, once the real significance of

subsect (4) is appreciated.

The second argument was that the income here in question was not in fact a profit arising from the company’s trade or business. I am not at all sure

whether that argument was put before the Commissioners. It is, if not impossible, extremely difficult to discover it in the contention as set out in the case, and

the Commissioners do not appear to have been invited to make the findings of fact which would be necessary to carry the argument to success. I do not

propose at this moment to go into the details why I think that that argument also breaks down; but I may say, concisely, that, on the facts as found, and the

documents, there is only one conclusion to be drawn, in my opinion, namely, that the income in question is a profit of the trade or business. That being so,

even if the argument were acceptable in other respects, there would be no case to send back to the Commissioners at all. My reasons for thinking that the

income is the profit of the trade or business will, I think, sufficiently appear from a brief—I hope it will be brief—analysis which I propose to make in

reference to the third argument.

The third argument was the one that was dealt with by the Commissioners. The situation was this. In a somewhat similar case, Inland Revenue Comrs v

Rolls-Royce Ltd, a question relating to income derived from patent licences came up for decision. MacNaghten J, there held that the particular 􀂭 59􀀉 income

in that case was not income from an investment within the meaning of para 6 of the Schedule.

I should, perhaps, at this stage, to make what I am saying more intelligible, read the relevant words of Sched 7, Pt I, para 6, of the 1939 Act. Sub-para (1)

is as follows:

‘Income received from investments shall be [observe, it does not say “investments and property,” but simply “investments”] included in the profits

in the cases and to the extent provided in sub-para. (2) of this paragraph and not otherwise.’

Sub-para (2) says:

‘In the case of the business of a building society, or of a banking business, assurance business or business consisting wholly or mainly in the dealing

in or holding of investments, the profits shall include all income received from investments, being income to which the persons carrying on the business

are beneficially entitled.’

In order, therefore, that income from an investment is to be treated as a profit, it must be an investment which falls within the language of sub-para (2).

In the Rolls-Royce case, MacNaghten J held that an income derived from the patent licences in that case was not income from an investment within the

meaning of para 6. When the present case was before the Commissioners, that decision of MacNaghten J, had not been given. The Commissioners, not being

bound by that decision, came to this conclusion:

‘We, the Commissioners who heard the appeal, were of opinion that the word ‘investment’ in the said para. 6 was apt to include patents which had

been licensed and which were yielding a royalty income and that the said royalties were income from investments.’

MacNaghten J, reversed that decision, following, without further comment, his own decision, in the Rolls-Royce case.

Attempts have been made by counsel on both sides to suggest some comprehensive test or definition which would enable the court to discover whether a

particular piece of income is income received from an investment or not. MacNaghten J, in the Rolls-Royce case applied a test which was, put shortly, this:

that before you can have anything properly called an investment, you must have the placing of money into it in order to acquire it or bring it into existence.

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Applying that test, MacNaghten J, came to the conclusion that the patents in that case were not investments because they had come into existence not by

putting money into them but by making the invention which the patent protected.

Speaking for myself, I am always disinclined to accept any general definition or test for the purpose of solving this type of question. The question

whether or not a particular piece of income is income received from an investment must in my view, be decided on the facts of the case. The facts must be

ascertained, and then the question has to be answered. For the court to find itself fettered by some apparently comprehensive attempt at a definition directed to

the solution of the problem in relation to one type of property, I cannot help thinking is unfortunate. It may well be that a definition or test, when applied to

one type of property, is a useful method of approaching the particular problem in the particular case; but to take it as a guide in other cases is apt to be

extremely dangerous, and certainly, in the present case, I do not propose to do it.

As I view this case, it falls to be decided in rather a different way. The facts of the case, for the present purpose, are shortly these. Here is a

manufacturing company carrying on a manufacturing business in this country. It makes and sells certain specialities protected by patents here, and in the

United States of America. A patent is a peculiar type of property. In considering what it is and what is the nature of the income from it, it seems to me to be

only confusing to attempt to find analogies and comparisons with war loan, real property, and other types of property. One has to remember exactly what a

patent is. I am not concerned to dispute the proposition that in some cases, and in some sets of circumstances, a patent may fall within the description of

investment within the meaning of para 6. But the question in the present case, whether the income derived from these patents is or is not an investment, must

be determined by the true character of that income, and the true nature of the source of the income which is derived by this particular company in this

particular way.

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Before these agreements were made—and they are only temporary agreements—the American patents conferred upon the appellants—and I must assume

that the patent law to this extent is the same in the United States as in this country—the right to exclude others from manufacturing in the United States, and

from selling in the United States, the specialities of the appellant company. The appellants were in a position, if they so wished, to manufacture in the United

States; but, if they did not wish to manufacture in the United States, their United States patents gave them the exclusive right to sell in the United States

articles manufactured in this country under the English patents. It is merely, in effect, a shield against competition. It is the right to exclude competitors from

all operations, whether manufacturing, or vending, or using the patented article in the territory covered by the patents. That is all a patent is. The advantage to

the patentee, if he manufactures and sells but does not grant licences, is merely this: he has reflected in the price of his article the benefits of the monopoly

which the patent confers upon him. The benefits of that monopoly he can secure either by manufacturing and selling himself, in which case he gets the benefit

in the price of the article, or, if he chooses, he can grant a licence which will, in principle, affect the price that he gets because the licensee immediately

becomes a competitor. The patent licence may, and frequently does, specify the prices, or the minimum prices, at which the patented article may be sold; but,

in effect, the grant of a licence is merely lifting in favour of the licensee the embargo which is the trade protection of the patentee’s speciality.

To my mind, it is obvious that a patent in the hands of a manufacturer is quite a different type of property, both in the business and in the practical sense,

to a patent in the hands of somebody who is a mere passive owner of the monopoly right. For instance, a member of the Bar, who was fortunate enough to

have bequeathed to him a patent, or who had purchased a patent, the validity of which had been established by the court, might continue, without any active

participation in manufacturing himself, merely to exploit that monopoly by granting licences. He would then be merely passive; he would be the passive

recipient of income from that particular piece of property. In such a case it might very well be, and I strongly suspect it would be, held, if members of the Bar

were subject to excess profits tax, that the income from that patent could properly be described as income from an investment. But directly the patent is held

by a manufacturer of the patented article, it seems to me that the situation is entirely changed. When you have a manufacturer who is exploiting his monopoly

right, not merely by excluding all competitors, but by letting one competitor in on terms, to say that the profits so derived are profits from an investment seems

to me to be a misuse of language. It is contrary to what one may call the popular conception of the word “investment,” which is not a word of art, but has to

be interpreted in a popular sense. The contrast, I venture to think, is brought out exactly in the two examples I have put. One is that of a private individual not

concerned with manufacture at all, but merely holding a patent, as he might hold a copyright in a book, and simply drawing the income from the royalties

payable under the copyright. He would merely be a passive person drawing the income which flows from that particular chose in action. That is one example.

The other example is the manufacturer who can, if he likes at any moment, exploit his monopoly in a number of different ways—either by manufacturing

himself, or by vending himself, or by allowing somebody else to manufacture and vend or manufacture but not vend, or to vend but not manufacture. The

mere granting of such licences does not seem to me to take the income out of the category of income of the business.

I have said that what I was proposing to say on this argument would dispose also of the second argument, namely, the question whether the income is

profits of the business. It will be seen that the considerations which I have mentioned, if they are right, answer that question just as much as they answer the

question whether or not it is to be regarded as income from an investment. If my view is right, it leads to a decision on a ground different to that adopted by

MacNaghten J, in the Rolls-Royce case. The decision in that case, if I may respectfully say so, was, in my opinion, perfectly correct, but the reasons on which

he based it do not satisfy me. The reasons were really founded on a definition of investment as involving the laying out of money. I think that a

unsatisfactory, because one can think of cases where, if that test were applied, 􀂭 61􀀉 it would not really satisfactorily describe the property in question. One

perfectly simple illustration is the case where a manufacturer had made an invention and obtained a patent which he bequeaths to his son, who is not a

manufacturer, but merely a professional man, and the son proceeds to derive income from it. Nobody in that case has put money into the invention, except the

expenditure on fees. No money has been invested in the popular sense. The father made the invention and he acquired the patent. The son has not put

anything into it because he has not bought it from his father. Nevertheless, I venture to think that the profits derived from the patent in the hands of the son

might properly be described as the profits of an investment, and the patent would be properly described in the hands of the son as an investment. I express no

concluded opinion upon that. I merely mention it to illustrate what I consider to be the dangers of the suggested definition.

I have dealt with this question so far without reference to the special argument which counsel for the respondents put forward in connection with the

particular agreements under which the income is derived in this case. Counsel for the appellants in reply vigorously disputed the right of the Crown in this

court to raise that point. He suggested the question would be one of fact, or, at any rate, would involve a finding of fact, and, therefore, it ought to have been

raised before the Commissioners. As I have said, on the face of the stated case, it is extremely doubtful whether some of the arguments of counsel for the

appellants were technically open to him, and it looks to me very much as if he were engaged in a form of activity which is sometimes engaged in by persons

who inhabit glass houses. But there is really nothing in the point because, in my opinion, no question of fact is involved. It is a question which arises on the

construction of the documents. The argument is this. The profits derived by the company in the present case cannot be said to be derived entirely from the

mere ownership of the patents, but are attributable also to certain other obligations which the company undertakes under these agreements.

The first agreement of 3 June 1937, recites the granting of a sole and exclusive licence, and goes on to say that:

‘… it is witnessed that in consideration of the royalties hereinafter reserved and of the mutual promises of the parties hereto, the owners agree … ’

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Preamble

The first paragraph of the undertakings given by the owners is:

‘To grant to the licensee sole and exclusive licence and authority to manufacture and sell [in a number of countries] the drills made in accordance

with the inventions of the patentees.’

Then comes this obligation of the owners:

‘To supply to the licensee drawings of the drills and of any tools used by them in the manufacture of drills or component parts thereof, and to give to

the licensee information of their manufacturing methods, and to permit a representative of the licensee to inspect the manufacture of the drills and their

component parts at their works at Hendon.’

That undertaking could only be given by a company which itself was manufacturing in accordance with this invention. No mere passive holder of the patent

could give an undertaking of that kind. Although it is a type of undertaking extremely common in patent licences, it is none the less an undertaking which the

owners of the patent are giving, and can only give, by virtue of the fact that they are manufacturing and can give to the licensee valuable manufacturing

information and experience which would otherwise not be available to them. That also brings out the difference between exploitation of a patent in the hands

of a mere passive owner and the exploitation of a patent in the hands of a manufacturer. Then come these undertakings by the company:

‘(3) After the date of this agreement they will not sell any of the said drills in the territories heretofore mentioned during the life of this agreement.

(4) To sell to the licensee as many drills of their ‘Mighty Atom1/4in.’ design as it may require at the following prices.’

The “Mighty Atom” we are informed, is one of the drills protected by these patents. Obviously there again that covenant could only be entered into by a

manufacturing company. It is another example of the way in which this manufacturing company is exploiting its manufacturing position and its manufacturing

experience and advantages in order to confer on the licensee the 􀂭 62􀀉 benefits of this agreement. Cl 5 says: “To sell to the licensee all the component parts

of the ‘Mighty Atom1/4in’ drill it may require” at certain prices. That is all I need refer to in the provisions of that agreement.

The second agreement, which is dated 1 August 1940, does not confer quite the same advantages on the licensees. It is a non-exclusive licence to

manufacture and sell in the territories stated. It contains precisely the same undertaking in respect of trading and giving information as to manufacturing

methods and allowing the representatives of the licensee to inspect the manufacture at Hendon. There is no undertaking to sell drills, the reason being, I

suppose, that, by that time, the American company had got going and did not require a supply of these drills any more. Nevertheless, it was apparently

contemplated that they might want to buy component parts, and they might want to buy drills, because cl 6 contains an undertaking by the licensee “to pay for

all component parts of drills purchased hereunder on terms as follows.” But, as I have said, there was precisely the same obligation which could only be given

by persons themselves manufacturing to provide drawings and give information and allow inspection.

The effect of these agreements in these respects is purely a matter of construction of the agreements. In my opinion, that circumstance alone, even if I

were wrong on the major proposition which I discussed a moment ago, would be sufficient to justify, and, indeed, compel, the court to say that the profits in

question are not income from investments, but they are the income of the trade or business, and are not excluded as being income from investments under para

6 of the Schedule. In the result, the appeal must be dismissed with costs.

MACKINNON LJ: I agree. I think that the word “investments” in the relevant sections of the statute is not a word capable of legal definition. Like so many

words in modern legislation, it is a word of current vernacular. On the facts of this case, I do not think that the income derived by the appellants under these

American agreements was income from investments within the meaning of that English word, for the reasons so aptly stated by Lord Greene MR.

TUCKER LJ. I agree. I agree that it is unnecessary and undesirable to attempt to define the word “investments.” I think, on the facts of this case, the

income in question was not income derived from an investment for reasons which I can express in two sentences. The company, whose business it is to invent,

manufacture, and supply tools cannot, in my view, be said to be making an investment when it takes out patents for the protection of its own products. Nor

can it be said to be making an investment when it enters into an agreement for the exploitation of the said patents taken out for that purpose. I agree that this

appeal fails.

Appeal dismissed with costs.

Solicitors: Alfred Cox & Son (for the appellants); Solicitor of Inland Revenue (for the respondents).

F Guttman Esq Barrister.

[1946] 1 All ER 63