Purchaser of a company's operations and assets paid the previous owner and manager of the acquired company for his undertaking to refrain for 3 years from performing activities competing with the acquiring company's operations.
The Court held that this constitutes labor income, as it does not eliminate the recipient's ability to resume earning a living in the same field. The classification of a consideration in respect of a non-compete clause shall be carried out using a two-stage test: first, whether it is an authentic clause or a guise for another payment, and second, the substance of the payment will be examined for its classification as labor or capital. To examine the substance of the consideration, the nature of the 'void' it comes to fill will be examined. If the non-compete agreement amounts to 'cutting down the tree', i.e., preventing the use of his "personal capital" without the ability to return and yield fruits, and the consideration is intended to compensate for harm to the source of income, it will be classified as capital; but if it is intended to compensate for harm to the fruits of the income, it will be classified as labor income, whereas when an employer-employee relationship exists, there is a presumption that it is labor income. Here, non-competition clause is authentic as it stemmed from the purchaser's genuine concern of competition by the manager. However, the restriction on occupation relates only to the specific field of electron microscopes and not to any use of his "personal capital", furthermore, this restriction was limited to a 3 years period. Hence, the non-compete clause does not constitute 'cutting down the tree' but rather a temporary restriction on the production of fruits, hence it will be classified as labor income.