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Restrictive Covenants (“RC”)

(CRA Views and Technical Interpretations)

“A restrictive covenant affects or is intended to affect, in any way, the acquisition or provision of property or services by the taxpayer or by another taxpayer that does not deal at arm’s length with the taxpayer. It can take the form of:

  • An arrangement between the parties; or
  • An undertaking or a waiver of an advantage or right.

Restrictive covenants may frequently be found in the terms of an agreement dealing with the sale or acquisition of a business, corporate shares, or a partnership interest. Such covenants usually last for a specified period of time and may apply to a specific geographic area.”

The basic rule under subsection 56.4(2) provides that any amount received or receivable for a Restrictive Covenant will be treated as ordinary income for tax purposes. The definition in subsection 56.4(1) is very broad and potentially encompasses non-disclosure and non-solicitation agreements as well as non-compete agreements. Care must be taken when payments are associated with such agreements.

There are a number of exception to the income-inclusion rule:

  • An Employment income exception;
  • An Eligible Capital Property (”ECP”) exception; and
  • An exception for shares and partnership interests.

In order to take advantage of the ECP exception or the share and partnership interest exception, the vendor and purchaser must jointly elect and file a prescribed form.

Additional exceptions are found in new Section 56.4:

  • Full income inclusion; and
  • “deemed receipt” rule.

One of the conditions that has to be met for the deemed receipt rule to operate is that “no proceeds are received or receivable by the vendor for granting the restrictive covenant”. Even nominal amounts of consideration would constitute an amount of proceeds received.

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pro-tip

Pro Tip

ACCESSING THE SMALL BUSINESS DEDUCTION IN YOUR BUSINESS

The Small Business Deduction gives businesses a tax deduction on the first $500,000 of income. This saves an eligible corporation around up to $50,000 in income taxes. There are a number of conditions that have to be met to be eligible for this deduction.