A special commissioner decided that royalty payments made pursuant to a deed of trust, based on sales of a product invented by the taxpayer, belonged to the taxpayer alone and not to him and his wife equally since the deed clearly stated that the payments were made for the taxpayer's services.

Facts

The taxpayer invented a dry powder inhaler. The intellectual property in the inhaler was vested in a company (T Ltd'). The taxpayer owned 25 per cent of the share capital of T Ltd and was entitled to 25 per cent of the net income derived from the commercial exploitation of the intellectual property in the inhaler.

In October 1991, T Ltd assigned the intellectual property in the inhaler to another company (IBL) pursuant to a deed to which the taxpayer was also party ('the 1991 deed'). Under the 1991 deed IBL was obliged to pay the taxpayer the greater of 25 per cent of the net income received by it from the commercial exploitation of the intellectual property in the inhaler and £6,000 per half year. Clause 3 was expressed to enure for the benefit of the taxpayer, his personal representatives and his assigns. In 1992 IBL licensed the intellectual property to B.

Between 1994 and 2003 the taxpayer was employed by IBL. For all tax years up to and including 1996–97, he returned the full amount of the payments made to him under cl. 3 of the 1991 deed as his income. By declaration of trust executed on 3 April 1997 the taxpayer declared that he would thenceforth hold all his rights and interests under the 1991 deed and the income therefrom on trust for himself and his wife in equal shares. On 10 July 1997, the taxpayer and IBL executed a deed ('the 1997 deed') under which IBL agreed to make certain payments to the taxpayer linked to the taxpayer discharging IBL from its obligations under the 1991 deed and to the development of the inhaler.

Those payments were returned as income by the taxpayer and his wife as to 50 per cent each for the relevant year of receipt. The Revenue assessed the taxpayer to tax in respect of the full amount of the payments on the basis that those payments belonged exclusively to the taxpayer for tax purposes. The taxpayer appealed against discovery assessments for 1998–99 to 2000–01 and an amendment to his self-assessment for 2001—02 attributing the income returned by his wife to the taxpayer.

Issue

Whether the royalty payments based on sales of the inhaler invented by the taxpayer made pursuant to the 1997 deed belonged to the taxpayer alone or to him and his wife equally.

Decision

The special commissioner (Dr John Avery Jones) (dismissing the appeal) said that the 1997 deed had to be construed in accordance with the principles set out by Lord Hoffmann in Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896.

In this case the factual matrix was that IBL already owned all the intellectual property (IP) rights in the inhaler under the 1991 deed subject to making the profit share payments to the taxpayer who had worked on developing the inhaler initially as a consultant until 1994 and then as a full-time employee of IBL. The commercial prospects had changed from being entirely speculative at the time of the 1991 deed to commercial exploitation being in prospect with product licences expected in the near future. The profit share in the 1991 deed only made sense if the IP rights were licensed by IBL, as they were originally to B, which paid £4m to IBL on termination of its licence, 25 per cent of which the taxpayer could expect to receive.

Once IBL was going to market the inhaler itself a royalty per unit sold was much more suitable than a profit share which would probably be impossible to calculate. Since in April 1997 the taxpayer declared that he held his rights under the 1991 deed on trust for himself and his wife, there was no apparent reason to terminate those rights in July 1997.

The problem was that, given that factual matrix, one would not have expected a reasonable person to have entered into the 1997 deed but merely to have varied the 1991 deed to substitute the 2.5p royalty for the profit share but with the taxpayer receiving 25 per cent of what B had paid to terminate its licence and receiving further payments on the grant of the product licences that were then envisaged (both of which would have been included in the profit share if the 1991 deed had continued). If that had been done there would have been no doubt that all the payments would continue to be caught by the declaration of trust. The form of the 1997 deed bore no relation to what one would have expected and it was hard to understand why either party should have wanted to enter into it.

However, speculation was not relevant to the task of interpreting the 1997 deed. One had to consider the meaning of the words used, not what one might guess to be the intention of the parties.

There was no difficulty in seeing what the deed would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties. They clearly stated that they wanted to terminate the 1991 deed on payment of a lump sum and to provide in its place for payments to the taxpayer for his services that had led to the successful development of the inhaler. The deed meant what it said. The payments were for the taxpayer's services. Whatever the likely intention of the parties, the fact was that they entered into the 1997 deed on legal advice and there was nothing unclear about what they said in that deed. The task was to determine what the deed would convey to a reasonable person, not to say that a reasonable person would not have entered such an arrangement.

On the evidence, if in 1997 the parties had applied for rectification they might well have been successful. However, it was now 2008 and in the course of construing the 1997 deed the taxpayer's intention was not relevant.

(2008) Sp C 674.
Decision released 1 April 2008.