Licence fees are trading income

The taxpayer invented a product that his company UKCO sold to the United States Government Department of Defence. He was the beneficial owner of all the intellectual rights in the invention; in December 1997 the rights were transferred to UKCO under a licence agreement so that the company could begin producing and selling the invention.

The taxpayer received licence fees on all sales generated by the company. When the licence ended all patent rights would revert to the taxpayer. A condition of supplying a US government department was that a US agent be appointed; an American company USCO was formed.

This company collected the payments and deducted marketing fees licence fees and US government levy before remitting the payment to UKCO which claimed a deduction for payments of licence fees in its corporation tax returns for 1999/2000 to 2001/02.

HMRC raised...