Example 2: The facts are the same as in Example 1, except that T is a sub-chapter S Corporation and P and J accept an election under section 338(h)(10) which treats the transaction as a purchase and sale of assets. The sales contract provides that the parties agree on a purchase price allocation to be prepared by T and verified by P. Shortly after the closing of the transaction, a tax advisor was asked about how to deal with the Covenant and the corresponding value of $US 15 million attributed by the estimate for income tax purposes. Is the total fair value of $15 million for J taxable as compensation? Before concluding that J has a normal income of 15 million $US, the practitioner should review the case law in force that can tell him something else. In a 2010 Finanzgericht (T.C. Memo 2010-76 (pdf)) paid a former employee $400,000 for a one-year obligation not to compete. The Finanzgericht held that, although the agreement lasted one year, the non-competition agreement within the meaning of Section 197 of the Internal Income Code was not tangible and should be amortised over a period of one year. In Allison, despite the lack of agreement between the parties on the value of the Covenants, the Tribunal did not consider whether the Covenant could be separated from the purchase of the good, but rather whether the Covenant had an independent importance distinct from the acquisition of the good. The IRS and the U.S. Financial Court (in a separate proceeding against the buyer) previously said the deal constituted “a remission of [the taxpayer`s] future income and not the sale of goodwill.” On the basis of the purchaser`s testimony, the Court of First Instance agreed with the Finanzgericht and the IRS that the agreement was not a transfer of ownership; On the contrary, in addition to the purchase of business assets or companies, the agreement had an independent meaning and in reality constituted a tax on future income – that is, compensation for not competing during the term of the agreement. Competition bans are extremely popular, but extremely controversial. Supporters hail these provisions as a way to protect trade secrets and prevent customer theft.
Critics consider them anti-competitive and cumbersome. But whether you are for or against them is not really the point (they are in our life anyway). . . .