Jeffrey (HM Inspector of Taxes) v Rolls-Royce, Ltd

(1) Jeffrey (H.M. Inspector of Taxes) v. Rolls-Royce, Ltd.

CASE

Stated under the Income Tax Act, 1952, Section 64, by the Commissioners for the Special Purposes of the Income Tax Acts for the opinion of the High Court of Justice.

1. At a meeting of the Commissioners for the Special Purposes of the Income Tax Acts held on 18th June, 1956, and thence adjourned to 19th, 20th, 21st and 22nd June, 1956, and 29th January, 1958, Rolls-Royce, Ltd. (hereinafter called "the Respondent"), appealed against assessments to Income Tax made under Schedule D as follows:

The grounds of the appeal were that, in computing the profits or gains of the Respondent for the period relative to the assessments under appeal, lump sums paid to and received by the Respondent by virtue of certain licensing agreements as hereinafter appeareth had been included contrary to law, such lump sum payments being of a capital nature.

2. Evidence was given by James Denning Pearson (hereinafter called "Mr. Pearson"), a director of the Respondent and managing director of the Respondent's aero engine division; William Tait Gill (hereinafter called "Mr. Gill"), a director of the Respondent; and James Walter Jeffrey, H.M. Inspector of Taxes for Derby 3rd District. The following documents were produced and admitted or proved at the hearing of the appeal:

1. (i) A bundle comprising notices of assessments made on the Respondent under Schedule D for the years 1948-49 to 1954-55 inclusive.

2. (ii) A chronological list of agreements entered into by the Respondent.

3. (iii) A comparative list of countries covered by licensing agreements and ordinary sales of the Respondent.

4. (iv) Two bundles comprising the agreements listed in document (ii) above.

5. (v) An abstract of the agreements comprised in document (iv).

6. (vi) A statement in writing entitled "Brief History of Rolls-Royce Limited".

7. (vii) A schedule showing the total turnover of the Respondent on engine sales and receipts from licence agreements for the years 1946 to 1955 inclusive.

8. (viii) A bundle comprising statements of accounts and directors' reports for the years ended 31st December, 1946, to 31st December, 1954, inclusive.

9. (ix) A copy of a schedule entitled "Annexure R.-R."

10. (x) A schedule showing a calculation of notional sales of the Respondent's aero engines based on receipts from licence agreements.

11. (xi) A copy of the memorandum and articles of association of the Respondent.

Such of the above documents as are not attached to and do not form part of this Case are available for the use of the High Court if required.

1. (2) The Respondent was incorporated in 1906 with an authorized capital of £200,000 divided into shares of £1 each. The share capital was increased subsequently, and on 16th October, 1947, amounted to £2,500,000 divided into 2355,000 ordinary shares of £1 each and 145,000 workers' shares of £1 each. On 24th July, 1951, the share capital of the Respondent was again increased to £4,000,000 divided into 3855,000 ordinary shares of £1 each and 145,000 workers' shares of £1 each. The object for which the Respondent was established was, inter alia:

   1. 3(1) To manufacture, sell, or let on hire, or in any manner dispose of or turn to account, motor vehicles for use on land or water or in the air, and any parts of or accessories to the same, and internal combustion engines for stationary use, and to carry on all or any businesses directly or indirectly relating to or connected with any object or thing which the Company is authorised to manufacture.

   2. (5) To carry on any other business, whether manufacturing or otherwise, which may seem to the Company capable of being conveniently carried on in connection with any of the above objects, or calculated, directly or indirectly, to advance any of the above objects, or add to the value of any of the Company's property or rights.

   3. (8) To purchase, acquire, or apply for letters patent, or patent rights, which the Company may deem it advisable to hold in connection with its business, and to sell or otherwise deal with such patents, or patent rights, and grant licences in respect thereof.

1. (3) The business of the Respondent in its early years was confined to the manufacture and sale of motor cars. During the first world war, the Respondent began to manufacture aircraft engines; and with the development of the aircraft industry the manufacture of aircraft engines became the larger and more important part of the Respondent's business.

2. (4) For the purposes of its business as a manufacturer of motor cars and aircraft engines the Respondent has throughout its life been engaged in metallurgical research and in the discovery and development of engineering techniques and secret processes. As a result, it acquired in the course of the years a fund of technical knowledge (commonly called "know-how"), of which only a comparatively small part was capable of forming the subject-matter of patent rights.

3. (5) In the years immediately following the first world war, the aero engine side of the Respondent's business existed, without government support, on the proceeds of contracts for overhauls and supply of spare parts of obsolete types of engines. In 1925, in the absence of government support, the Respondent embarked on the private venture of producing a new aircraft engine, and it designed the "Kestrel", deriving directly from its wartime engines, but with a different construction of cylinders. The Respondent made use of its "know-how", particularly in the field of lightness and strength of materials, which it had by now acquired. The "Kestrel" engine was very successful, and orders were received from the United Kingdom Government and from a number of foreign governments. This led to an engine of increased power called the "Buzzard", which in turn was the foundation of other engines and led directly to the design of the "Merlin", the first test type being produced in 1934. In order to continue the development of the "Merlin" engine, including testing in flight, the Respondent acquired its own aircraft and aerodrome; and in 1935 and 1936 this engine was used in various aircraft, including the prototype "Hurricane", the prototype "Spitfire" and the prototype Fairey "Battle". In the years immediately preceding the second world war a great strain was put on the Respondent owing to the rearmament of the United Kingdom. In order to cope with the demand, the Respondent rented from the Government a factory at Crewe and undertook the management of a government shadow factory at Glasgow. After the war ended the Respondent leased from the Government parts of both of these factories, and has thenceforward carried on aero engine production at Glasgow and the manufacture of motor cars at Crewe.

4. (6) During the immediate pre-war period the Respondent embarked on the task of designing "power eggs". Troubles were often experienced due to faulty installation of an engine in an aircraft, and, in order to ensure that the best use was made of its engines, the Respondent designed...