Edited version of private advice

Authorisation Number: 1051639742776

Date of advice: 13 March 2020

Ruling

Subject: Income - restraint of trade payment

Question 1

Is the restraint payment made to you on the cessation of your employment assessable income?

Answer

Yes, it is assessable as a capital gain.

Question 2

Is the capital gain included in your assessable income for the income year in which the Deed of Release was entered into?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You were employed.

You provided your employment contract. Your employment contract contains Restraint provision.

It provides that within X days of the termination of your employment, your former employer may, at its sole and absolute discretion, by written notice to you (a Restraint Notice), elect to restrain your post-termination business activities.

The Restraint Notice must specify the Restraint Period and may specify a reduced Restraint Area and any specific Competing Business and Business. The Restraint Notice will be followed by the Restraint Payment paid to you either as a lump sum payment or paid to you on a monthly basis.

You resigned from your role.

You were placed on leave in lieu of notice.

You signed a Deed of Release with your former employer which restrains your ability to work until further date.

You receive Restraint Payment and the payment is paid to you on a monthly basis.

The former employer will not be required to pay any further Restraint Payments if you breach any of your obligations set out in the Deed of Release.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 160M(6)

Income Tax Assessment Act 1936 subsection 160M(7)

Income Tax Assessment Act 1936 subsection 160U(3)

Income Tax Assessment Act 1997 section 104-35

Income Tax Assessment Act 1997 section 104-25

Reasons for decision

Restraint of trade payments can be made on signing an employment contract as well as on the termination of a contract. Payments made on signing a contract have the character of income. Those that are made on termination have the character of capital.

This is outlined in paragraphs 128 - 130 of the Taxation Ruling TR 95/3 Income tax and capital gains: application of subsections 160M(6) and 160M(7) to restrictive covenants and trade ties.

Your restraint of trade payment will therefore be assessed as a capital gain.

Paragraph 35 of Taxation Ruling TR 95/3 states a contract of employment stipulating exclusive service by the employee during its term is an example of a restrictive covenant which is a contractual obligation.

The nature and CGT implications of restrictive covenants were most thoroughly explained in the Explanatory Memorandum ('EM') to the Taxation Laws Amendment Act (No. 4) 1992, where it was stated that rights under a contract of personal services are CGT assets.

In your case, your employment contract that stipulated exclusive service by you during its term was a restrictive covenant. Its creation was a CGT event D1 under section 104-35 of the ITAA 1997. Its termination was a CGT event C2 under section 104-25 of the ITAA 1997.

Paragraph 98 of the TR 95/3 provides that the timing for CGT purposes is not when the consideration is received but the time of entering into the covenant.

In your case, you resigned from your role on XX XXXX 20XX, you signed a Deed of Release with your former employer on XX XXXX 20XX; you are required to include the capital gain in your assessable income for the income year 20XX - 20XX.