A company and its owner entered into an agreement for the sale of the company's activities. As part of the transaction, the owner signed a separate agreement, the main part of which was a commitment of non-competition, and received a separate financial consideration against this commitment, which was reported to the tax authorities as income revenue.
The Court held that the payment for the non-compete obligation was part of the transaction and therefore needed to be reported and taxed as part of the transaction. In order to establish the taxable nature of non-compete payments it is necessary to examine whether the stipulation is an authentic stipulation and not a fictitious stipulation that is a cover for other payments as part of an attempt to avoid paying tax. One of the indications of a true non-compete stipulation, is a reasoned and calculated division of the consideration between the main receipt and the receipt for the non-compete obligation. Once it is determined that the obligation is a true non-compete condition, it must be examined whether it is a capital gain or an income revenue, while, in the case of a payment given to the employee by his employer, the assumption is that the payment is part of income revenue. Here, the commitment to non-compete was an integral part of the transaction with the company, as the original transaction agreement expressly stated, and it does not appear that a real attempt was made to assess the economic value of each of the consideration components, which raises the concern that the split was done for reasons of at attempt to reduce the tax burden. Therefore the company must be required to pay tax for the consideration in full, including the non-compete amount, as part of the sale transaction, and the owner must pay tax for receiving the amount from the company as dividend.