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IN 6 (2) Income Tax acT: InTeRPReTaTIon noTes IN 7
De nitive rules cannot be laid down in determining the place of effective management and all relevant facts and circumstances must be examined on a case- by-case basis.
The place of effective management test is one of substance over form. It therefore requires a determination of those persons in a company who actually ‘call the shots’ and exercise ‘realistic positive management’.
Legal and Policy Division
SOUTH AFRICAN REVENUE SERVICE Date of 1st issue: 26 March 2002
Income Tax Interpretation Note 7 Restraint of Trade Payments
DATE: ACT: SECTION: SUBJECT:
1. Introduction
26 March 2002
INCOME TAX ACT, 1962 (the Act) Sections 1, 11 (cA) and 23 (l) Restraint of Trade Payments
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 de nition 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 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 de nition of ‘gross income’:
‘(cA) any amount received by or accrued to any person who—
(i) is a natural person;
(ii) is or was a labour broker as de ned in the Fourth Schedule (other than a labour broker in respect of which
a certi cate of exemption has been issued in terms of that Schedule);
(iii) is or was a personal service company as de ned in the Fourth Schedule; or (iv) is or was a personal service trust as de ned in the Fourth Schedule,
as compensation for any restraint of trade imposed on such person;’
The effect of the amendment is to speci cally include restraint of trade payments received or accrued in ‘gross income’ as de ned, 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 certi cate 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 de ned 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 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
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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 speci c 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 de ned in the Fourth Schedule (other than a labour broker in respect of which a
certi cate of exemption has been issued in terms of such Schedule);
saIT comPendIum oF Tax LegIsLaTIon VoLume 2