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HMRC internal manual

Capital Gains Manual

Goodwill: restrictive covenants, exclusivity agreements, non- competition agreements etc

This part of the guidance deals with the treatment of sums received in consideration for an agreement that restricts the way in which a person can carry on a business or enter into an employment. This type of agreement can take the form of restrictive covenants, exclusivity agreements, non-competition agreements, golden handcuff agreements and the like.

A common feature will be that in return for consideration which may take the form of money or money’s worth the person concerned will restrict their business, trade, professional or employment activities in some way.

You will need to consider firstly whether all or any part of the receipt is chargeable to tax as an income receipt or whether it falls to be taken into account in computing the income profits, gains or losses of the recipient. To the extent that it is chargeable as income or is taken into account in calculating income profits, gains or losses it must be excluded from the consideration to be taken into account for CG purposes in accordance with TCGA92/S37(1).

The tax treatment of the receipt will depend on the precise facts of the case in question and in particular the purpose for which the payment was made. It is essential, therefore, to consider the precise terms of the agreement between the parties and all of the surrounding circumstances. It may be necessary to apportion the sum received under a composite agreement between capital and revenue receipts and between various capital assets. Any apportionment under TCGA92/S52 (4) should be “just and reasonable”, see CG14771+.

For example, a sum received for entering into a restrictive covenant that leads to the complete cessation of a trade is likely to be a capital receipt. A sum received for entering into a restrictive covenant that leads to the cessation of part only of a trade or a temporary interference in a trade is more likely to be a revenue receipt. The capital/revenue quality of a payment, however, depends upon the precise facts, see BIM35600.

A person ceasing to hold an office or employment may be required to enter into an agreement which restricts his freedom to engage in similar activities. Alternatively, an employee may agree to remain in an employment for a fixed period and to refrain from competing with the employer after his employment ceases. Any sums received in connection with such agreements may be chargeable to income tax as employment income, see EIM03600+.

To the extent that a payment received in return for entering into a restrictive covenant or similar agreement is not chargeable to income tax you should consider whether it is chargeable to capital gains tax or corporation tax on chargeable gains.

In Kirby v Thorn EMI plc, 60TC519, Nicholls L J characterised a restrictive covenant as:

the means by which, amongst other matters, the vendor, for the benefit of the purchaser, precludes himself from exploiting the reputation he has regarding the trade in question.
The reputation of a business is an element of its goodwill, see CG68010. If the terms of the restrictive covenant agreement impose restrictions that affect the proprietor’s freedom to exploit the goodwill of his business we consider that the capital sum was derived from goodwill. The receipt will normally be treated as a capital sum derived from goodwill within TCGA92/S22, see CG68050. Where, however, the restrictive covenant is entered into as part of a transaction in which the business is disposed of as a going concern the receipt should be treated as part of the consideration for the disposal of goodwill.

A claim may be made that a sum received in return for a restrictive covenant or similar agreement is not a chargeable gain. The argument for this is usually founded on comments in Kirby v Thorn EMI plc where it was held that a person’s freedom to trade is not an asset.

Under the terms of the sale of three of its subsidiaries Thorn EMI plc entered into a covenant with the purchaser in which it agreed that it would not, during the next five years, engage in the UK in the types of businesses carried on by those companies. It was found as fact that the purchaser had required Thorn EMI plc to enter into a restrictive covenant because of its established reputation in the type of trades carried on by the subsidiaries. Although the subsidiaries did not bear the “Thorn” name they were known to be part of the Thorn EMI Group and sold some of their products under that name. The Court of Appeal held that in restricting its ability to turn its reputation to account, Thorn had derived a capital sum from its goodwill. Nicholls LJ said at page 453 that in such a case:

…the covenant is the means by which all the advantages that the purchaser was intended to have by taking over the goodwill of the business are secured to him.
A recipient may argue that, in whole or in part, a restrictive covenant payment was derived from his freedom to trade rather than the goodwill of his business. Our view is that a requirement to enter into such an agreement is, prima facie, evidence of the existence of goodwill in the covenantor’s business that will be affected by the terms of the restrictive covenant. In such circumstances it would be for the covenantor to show that he did not own any goodwill in the business if he wished to displace the proposition.