SARS Interpretation Note 7: Restraint of trade payments (source: https://www.sars.gov.za/lapd-intr-in-2012-07-restraint-trade-payments/)
SOUTH AFRICAN REVENUE SERVICE
INCOME TAX INTERPRETATION NOTE NO. 7
DATE: 27 March 2002
ACT : INCOME TAX ACT, 1962 (“the Act”)
SECTION : SECTIONS 1, 11(cA) and 23(l )
SUBJECT : RESTRAINT OF TRADE PAYMENTS
1. Introduction
In the Budget Speech on 23 February 2000 the Minister of Finance
announced that payments in respect of a restraint of trade (i.e.
sterilisation of a person’s income earning capacity) made to natural
persons or employment companies should be included as income in the
hands of the recipient and deducted in the hands of the payer over the
period of the restraint or three years, whichever period is longer.
To give effect to the announcement, a new paragraph (cA) was inserted
in the definition of “gross income” in section 1 of the Act. Sections
11(cA) and 23(l) were introduced to regulate the deductibility of these
payments.
The above provisions came into operation on 23 February 2000, and
apply to all restraint of trade payments received or accrued, or incurred
on or after that date. [Sections 13(1)(f) and 22(2)(a) of the Taxation Laws
Amendment Act, No. 30 of 2000]
2. The Law and its Application
2.1 Gross income
On the income side, section 1 of the Act was amended by the insertion
of the following paragraph in the definition of “gross income”:
“(cA) any amount received by or accrued to any person who-
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(i) is a natural person;
(ii) is or was a labour broker as defined in the Fourth Schedule
(other than a labour broker in respect of which a certificate of
exemption has been issued in terms of that Schedule);
(iii) is or was a personal service company as defined in the
Fourth Schedule; or
(iv) is or was a personal service trust as defined in the Fourth
Schedule,
as compensation for any restraint of trade imposed on such
person;”
The effect of the amendment is to specifically include restraint of trade
payments received or accrued in “gross income” as defined, irrespective
of whether it is a receipt or accrual of a capital nature or not. The
payment will be taxable in full in the year of receipt or accrual,
irrespective of the fact that the deduction may be spread over a period.
Where a payment received or accrued in respect of a restraint of trade is
of a capital nature, it will be taxable in full if it was received by or accrued
to a natural person, a labour broker not in possession of a certificate of
exemption, a personal service company or a personal service trust. A
company includes a close corporation.
If a sole proprietor sold his business on condition that he may, for
example, not open a new business within three years in a radius of 50
kilometres, and he received compensation in respect of the restriction,
the amount so accrued will be fully subject to income tax in the hands of
the recipient.
Amounts paid to companies and trusts that are not defined as personal
service companies or trusts do not form part of “gross income”, provided
the receipt or accrual is of a capital nature.
Inevitably the new provision dealing with restraint payments could be
susceptible to abuse. The provision “any amount received by or accrued
to” should be interpreted according to the general principles pertaining to
“accrued to”; viz. that accrual takes place when the taxpayer becomes
unconditionally entitled to the receipt. Cases where taxpayers allege that
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the accrual took place prior to the effective date should be carefully
considered.
Both the payer and the receiver of the restraint of trade payment may be
prosecuted where the date of accrual is recorded incorrectly.
2.2 Deduction
On the deduction side, section 23(l) provides for a general prohibition of
deductions in respect of a restraint of trade payment. However, provision
has been made for a deduction in terms of section 11(cA) in certain
specific circumstances. These provisions are discussed below.
The new section 11(cA) provides that:
“an allowance in respect of any amount actually incurred by such
person in the course of the carrying on of his trade, as compensation
in respect of any restraint of trade imposed on any other person who-
(i) is a natural person;
(ii) is or was a labour broker as defined in the Fourth Schedule
(other than a labour broker in respect of which a certificate
of exemption has been issued in terms of such Schedule);
(iii) is or was a personal service company as defined in the
Fourth Schedule; or
(iv) is or was a personal service trust as defined in the Fourth
Schedule,
to the extent that such amount constitutes or will constitute income of
the person to whom it is paid: Provided that the amount allowed to be
deducted under this paragraph shall not exceed for any one year the
lesser of-
(aa) so much of such amount so incurred as is equal to such
amount divided by the number of years, or part thereof,
during which the restraint of trade shall apply; or
(bb) one-third of such amount so incurred;”
Section 23 provides:
“No deductions shall in any case be made in respect of the
following matters, namely-
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(a) --- (k)
(l) any expense incurred in respect of the payment of any
restraint of trade, except as provided for in section 11(cA).”
The effect of the amendment is that restraint of trade payments
incurred in carrying on a trade will be deductible from the income
derived from such trade on the following conditions:
• The amount constitutes or will constitute income in the hands
of the person to whom it is paid.
• The qualifying amount will be deductible in equal instalments
over the longer of-
- three years; or
- the period of the agreement.
For example, if a restraint is to endure for one year, the taxpayer may
only deduct a third of the amount in the first year of assessment and a
third in each of the next two succeeding years. The recipient of the
amount will be taxable in full in the year of receipt or accrual.
2.3 Employees’ tax
A further amendment was also inserted into the Act to subject restraint of
trade payments to the deduction of employees’ tax with effect from 6
December 2000. All such payments received or accrued on or after this
date are, therefore, subject to employees’ tax deductions. Paragraph (a)
of the definition of “remuneration” in paragraph one of the Fourth
Schedule to the Act was, therefore, amended to include amounts
referred to in paragraph (cA) of the definition of “gross income”. [Section
53(1)(b) and (2) of the Revenue Laws Amendment Act, No. 59 of 2000]
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