Income Tax Case No 11220
08 April 2005
Posted by: TaxFind™
President: The Honourable Ms Justice K Satchwell
Accountant Member: Mr W B Cronje
Commercial Member: Mr V A Jiyane
ITC CASE NO: 11220
The taxpayer entered into three agreements with his employer which he identified as restraint of trade agreements.He received consideration in the amount of over R4,5 million in respect of the three agreements.In the relevant tax assessments, the Commissioner determined that the agreements were not true restraint agreements, and that the payments received by the taxpayer were of an income nature and taxable.The appeal by the taxpayer raised questions concerned the purpose, nature, and import of restraint of trade agreements.
Held that the issue before the court was whether or not the amounts in issue were of a capital nature.Restraints of trade entered into between employer and employee are devices to protect an employer's proprietary interests from misuse by an employee during employment or afterwards. They consist of restrictions on the freedom to trade or to practice a profession. As such, they are strictly interpreted. They will be carefully scrutinised to identify the existence and nature of the proprietary interest which is deserving of protection as also the existence and nature of the prejudice alleged to be suffered by reason of offending behaviour.
An amount received as consideration for a restraint of trade undertaking is of a capital nature.Prior to the enactment of the Taxation Laws Amendment Act 30 of 2000, such payments were excluded from "gross income".The reason for such exclusion is found in the nature and effect of the restraint undertaking itself.The subject matter of the undertakings given by the employee constitutes an asset in his hands. That asset is the unfettered ability to earn a living or engage in entrepreneurial activity. This right to trade freely is an incorporeal asset. When a person undertakes not to exercise a trade in a specified area for a defined period of time in return for some compensation, he is surrendering or sterilising, in whole or in part, such asset. Payment received for such a restriction would, if intended to compensate for the loss of part of a person's income-producing capacity or opportunities, therefore be a capital receipt.
Accordingly, the question was whether for the purposes of "gross income" the amount paid was a receipt or accrual of a capital nature, in other words, whether it was intended to compensate for the temporary loss of part of appellant's income-producing structure.The court found that only one of the three payments received by the appellant accrued to him as a result of a restraint of trade agreement.
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