April 19, 2004
Non-Compete Agreements
The proposed amendments include a new set of rules dealing with restrictive covenants, also known as non-compete agreements. These rules will implement the changes announced by the Department of Finance on October 7, 2003. The amendments are a direct response to the Federal Court of Appeal's decision in Manrell v. R., [2003] 3 C.T.C. 50, which held that certain payments for a non-compete agreement were not taxable. Perhaps not surprisingly, these payments would now be taxable.
The new rules dealing with restrictive covenants are primarily contained in proposed section 56.4 of the Income Tax Act. Notably, the proposed definition of "restrictive covenant" is extremely broad in scope. It includes any agreement entered into by a taxpayer, regardless of whether it is legally enforceable, that affects, in any way whatever, the acquisition or provision of services or property by the taxpayer or by another taxpayer that does not deal at arm's length with that taxpayer. The default tax treatment for payments in respect of restrictive covenants under the proposed amendments is full taxation, but there are exceptions available in certain circumstances that provide capital gains treatment for payments to a shareholder or partner. An election may be made, to add the amount of the restrictive covenant payment to the proceeds of disposition of the shares or partnership interests.
Amendments addressing restrictive covenants have also been introduced to the provisions of the Income Tax Act dealing with employment income, non-resident withholding tax and the allocation of consideration for property, services or restrictive covenants.
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