A restraint of trade agreement can have tax advantages for you as an employee, but don't make one up just to avoid tax: the taxman isn't so easily fooled.
A restraint of trade is an agreement between employer and employee where the employee agrees not to compete with the employer in a specified line of business, in return for compensation. Because the money paid is regarded as a capital payment, the employer cannot deduct it from taxable income and it is tax free to the employee.
But Boris Pelegrin, a KPMG tax consultant, warns that it is not a good idea to try to hide a payments for services rendered under the cover of a restraint of trade agreement in an attempt to avoid tax, because the tax authorities are wise to this ploy.
Usually a restraint of trade applies to an employee leaving a job. Pelegrin says although common law principles protect an employer from an employee who tries to compete against the business while still employed, restraints of trade are increasingly being used while the employee is still working in the company.
Usually the restraint is of limited duration although under some circumstances it can be indefinite.
Amounts paid in restraint of trade agreements vary according to the seniority of the employee and the amount of damage he or she could do the business.
A restraint of trade should only be used to shield the business from competition from a former employee, Pelegrin says.
An employer must stand to suffer a loss if the employee competes against the business, and there must be a risk the employee will leave, otherwise the taxman will regard the money as income and will taxthe employee on it.
Pelegrin says the tax authorities will take into account the age and seniority of the employee, his or her access to company secrets, the size of the compensation relative to the potential harm he or she can do the company and the size of his or her salary. And if the taxman thinks the company has set up a restraint of trade agreement just to save the employee tax, he is likely to take action.
Cape Town lawyer Jacques Louw, of Lionel Murray, says restraints of trade are often added to the purchase price when a business is sold to make sure that the previous owner does not start the same business in the same area. These normally pass the scrutiny of the taxman, he says.
More open to debate are the restraints used, for instance, when companies list on the Johannesburg Stock Exchange as a sort of "listing bonus" for senior executives. Sums of up to R10 million are not uncommon. "These are carefully scrutinised by the Receiver of Revenue," Louw says.