Tax Topics: Restrictive Covenants — The Final Chapter (For Now)— Part I


This article discusses proposed legislation dealing with the taxation of restrictive covenants. Due to its length, it is divided into two parts. Part I addresses the history, basic inclusion rules, tax treatment to the purchaser, elections to avoid subsection 56.4(2), Ministerial reallocation of proceeds, and the arm’s length employee exception. Part II addresses the realization of goodwill and disposition of property exceptions, special provisions, anti-avoidance rules, and transitional provisions. Part II will be published in a subsequent edition of Tax Topics.

The decisions of the Federal Court of Appeal in Fortino and Manrell held that payments received by a taxpayer for entering into a non-competition agreement were not income from a source and, therefore, were not taxable. The federal government was not pleased with these decisions, presumably because they did not want to see increasingly larger amounts of otherwise taxable consideration being allocated in an exempt manner. On October 7, 2003, the Department of Finance issued News Release 2003-049, advising that payments received or receivable by a taxpayer after that date for agreeing not to compete would be taxable as ordinary income, subject to certain exceptions.

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