Is restraint of trade payment debited to legal expense a s11(c) expense. Mrs X previously worked for company ABC and signed restraint of trade papers with company ABC. Mrs X left company ABC and joined the opposition company Y. Company ABC sude Mrs X and
Important:
This answer is based on tax law for the year ending 28 February 2017.
Answer:
From the facts provided the legal expenses were incurred in respect of a claim, dispute or action at law. ITC 1419 (49 SATC 45) ... the word 'dispute' covers 'any disagreement as a result of which parties require legal assistance'. On the face of it section 11(c) will then apply.
Deductions may however only be made (against income) if the income was derived from a trade. Section 11(c) expands on this by requiring that the claim, dispute or action at law must have arisen “in the course of or by reason of the ordinary operations undertaken by him in the carrying on of his trade”. Judge van Reenen, in ITC 1837, said:
“The prevailing view of authors on the subject (See eg: D Meyerowitz: Meyerowitz on Income Tax (2007-2008) p12-6; De Koker & Urquhart: Income Tax in South Africa, p11-8) appears to be that legal expenses are so deductible if the existence of a causal connection between the ordinary operations undertaken by a taxpayer in the carrying on of his trade, on the one hand, and the claim, dispute or action in respect of which such expenses have been incurred, on the other hand, has been established.
That view is consonant with the view that when the concept ‘by reason of’ is used elsewhere in the Act (eg s 7(3)) it has been interpreted by our courts as signifying ‘some causal relationship’ and would be met not only if a taxpayers’ ordinary operations are the proximate cause of the institution of an action in respect of which the legal expenses have been incurred but also where it is the efficient cause thereof…”
With regard to the capital in nature of the expenses (proviso (i) to section 11(c)) the following is relevant. In Smith v CIR Judge Hiemstra said the following in relation the word capital in the context of legal expenses:
“In the absence of any indications to the contrary - and I have found none – the word 'capital' has to be given its ordinary meaning. Broadly speaking and for present purposes, it may be said to connote money and every form of property used or capable of being used in the production of income or wealth. Such a commercial or business sense is the sense in which one expects it to be used in the context here in question, and it is to capital in that sense that, for the purposes of sec. 11 (2) (b) bis at any rate, expenditure is to be related in order to determine whether or not it is expenditure of a capital nature.”
Judge Ponnan’s decision in BPSA (Pty) Ltd v CSARS may also be of assistance in determining this issue:
“The purpose of expenditure is important and often decisive in assessing whether it is of a capital or revenue nature. Expenditure incurred for purposes of acquiring a capital asset of the business is capital expenditure whereas expenditure which is part of the cost incidental to the performance of the income-producing operations as distinct from the equipment of the income-producing machinery is revenue in nature. A distinction is thus drawn between expenditure made to acquire an income-producing concern (in respect of which the outlay is usually non-recurrent) and money spent '... in working the concern for the present production of profit'…”
It is also not a loss or expense, the deduction of which would otherwise be allowable, which it is recoverable under any contract of insurance, guarantee, security or indemnity.
We didn’t read the case itself, but it doesn’t appear to be any payment or claim involved. The restraint of trade payment would in any event have qualified for a deduction under section 11(cA) of the Income Tax Act itself.