Q: Torres and Baker ran a dog washing business together in Mosman, NSW, called Pets R. Torres decided to leave the partnership and start his own dog washing business alone. In May 2017, Baker paid Torres $50,000 to make sure he wouldn't start a similar business within a 10 km radius of Mosman. This payment was to protect Pets R's reputation.
How should Baker handle the $50,000 payment to Torres for tax purposes?
A: When someone pays to stop a former partner from competing, it's called a "restrictive covenant." Normally, you can deduct business expenses from your taxable income. But if the expense is more about protecting the business's future profits, it's considered a capital expense, not a regular business cost.
In Baker's case, the $50,000 payment is about protecting Pets R's reputation, so it's a capital expense. This means it's not fully deductible right away. Instead, it becomes part of the cost base for calculating capital gains tax (CGT) if Baker sells the business in the future.
However, since the payment is specifically to preserve Pets R's reputation, it can't be counted as part of the cost base for the business's goodwill. But it can be counted as part of the cost base for another CGT asset, like the right to stop Torres from starting a competing business.
This means Baker can spread out the $50,000 expense over five years, deducting $10,000 from his taxable income each year, starting from the 2016/17 tax year.
If you have any questions, feel free to contact Tax Ideas Accountants & Advisers. You can also book an appointment through our live calendar.
