Capital versus income characterisation of exclusive patent licence payments determines whether tax deduction applies

Payments under an exclusive patent licence must be characterised by their true legal and commercial nature, not by labels alone. A licence that grants exclusivity and restrains the patentees may support capital treatment where the contractual arrangement shows a fixed lump-sum element payable by instalments rather than ordinary user-based consideration. The royalties and patent-user provisions were treated as machinery for tax collection, not as provisions that automatically convert every patent-related payment into income. On the facts, the payments were capital in nature and were not chargeable to tax deduction under rule 21.

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Issues: Whether sums payable under an exclusive patent licence agreement, including lump-sum instalments and yearly royalties, were capital payments not chargeable to deduction of tax under rule 21, or income payments paid in respect of the user of a patent.

Analysis: The payment provisions had to be construed according to their true legal and commercial character. The agreement was not a bare licence to use a patent, but also conferred exclusivity and restraints on the patentees, and the first class of payments was a fixed lump sum payable by instalments while the second class was expressed as annual royalty payments. The legislation concerning royalties and sums paid in respect of the user of a patent was treated as a machinery provision for collection of tax, not as one that automatically converted every payment connected with patent user into income. The earlier authorities were read as turning on their own facts, and the question whether a payment was capital or income remained one of fact to be determined from the contractual arrangement and surrounding circumstances.

Conclusion: The payments in question were correctly treated as capital in nature, so they were not chargeable to tax deduction under rule 21.

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