Commentary on October 24, 2012 Notice of Ways and Means Motion Relating to Tax Matters - Restrictive Covenants
Nov 1, 2012
Rules relating to restrictive covenants have been subject to an initial announcement on October 7, 2003 and were followed by a more complete set of rules initially released on February 27, 2004 (See Osler Update, March 9 2004). They have since been modified on numerous occasions prior to the Notice of Ways and Means Motion (“NWMM”).
The NWMM reintroduces some of the rules previously announced in respect of restrictive covenant. Consistent with prior announcements, the NWMM defines a restrictive covenant of a taxpayer very broadly to mean, in general terms, an agreement or undertaking (other than for the disposition of the taxpayer’s property and in satisfaction of some obligations described in section 49.1) or a waiver of an advantage or right that affects (or is intended to affect) the acquisition or provision of property or services by the taxpayer (or by a non arm’s length person), whether legally enforceable or not. As defined, a restrictive covenant is not limited to a non competition covenant given by a vendor in connection with the sale of a property or business.
As previously announced under the previous rules, payments for a restrictive covenant of a taxpayer that are received or receivable by the taxpayer (or by a person not dealing at arm’s length with the taxpayer) will be required to be included in the taxpayer’s income. However, if the taxpayer and purchaser deal with each other at arm’s length (or is a non-minor individual that is related to the taxpayer), there are important exceptions to the income inclusion rule:
- The amount is required to be included (or would be included if it were received in the year) in the taxpayer’s employment income for the year.
- The taxpayer disposes of goodwill of a business and the taxpayer elects (or the taxpayer and the purchaser jointly elect if the amount is payable in respect of a business carried on in Canada by the purchaser) to treat any payment for a restrictive covenant relating to that business as part of the proceeds of disposition of the goodwill.
- The restrictive covenant is a non-competition covenant given by the taxpayer and is directly related to the disposition by the taxpayer of a capital property that is a partnership interest or a share of a corporation, the amount received for the restrictive covenant is included in the taxpayer’s proceeds of disposition of the capital property, the partnership or corporation carries on a business (directly or in some circumstances indirectly though another corporation), the restrictive covenant has been granted to preserve the value of the interest disposed by the taxpayers and the taxpayer and the purchaser elect to have this exception apply. However, this election is not available on the redemption, acquisition or cancellation of shares by a corporation resident in Canada.
The NWMM also reintroduces saving provisions which precludes an amount received as consideration for property or services to be allocated to a restrictive covenant in certain circumstances. New subsection 56.4(7) under the NWMM includes similar saving provisions that were previously announced and includes slight changes thereto. Under the NWMM these saving provisions continue to apply only to non-competition covenant where no consideration has been allocated thereto. However, the saving provisions under the NWMM now provides that they could apply where the disposition of property to which the restrictive covenant relate was made on a rollover basis pursuant to section 85 or 97 of the Act, contrary to what was previously announced and expand the application of the saving provisions in situation where a non-competition covenant is granted to a non-arm’s length individual.
As previously announced, an election would be required to be made to benefit from these saving provisions in certain circumstances. The NWMM provides however that no such election would be required in respect of restrictive covenants that were granted prior to October 24, 2012.
Generally, rules pertaining to restrictive covenant are applicable to amount received or receivable after September 7, 2003.
The NWMM also reintroduces amendments to section 68 that are similar to those previously announced on February 27, 2004. Section 68 is being amended to include a rule which could allocate a portion of the consideration of services or for the disposition of property to a restrictive covenant, irrespective of the form and legal effect of the contract or agreement.
Amendments to section 68 of the Act are deemed to have come into force on February 27, 2004, except for restrictive covenants made in writing prior to such date between persons dealing at arm’s length.
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