Can a buyer pay a key employee for a non-compete without a tax problem?

Buyers sometimes want a key manager or technician to promise not to compete after a sale, and may offer a payment for it. Two questions sit under this one. How does the Income Tax Act treat the payment, and can the promise be enforced at all? The first is about tax. The second is about employment law and decides whether you are paying for something that holds up.

How the Income Tax Act treats the payment

Section 56.4 includes in a person’s income an amount received or receivable for a restrictive covenant that the person gave, with listed exceptions. One exception covers a covenant given to an arm’s-length purchaser where sections 5 or 6 already include the amount as employment income. For a purchaser’s payment that must be included that way in an employee’s income, the Act considers it wages paid by the purchaser to the employee. Wages carry payroll obligations, so the payer’s accountant should be involved before the money moves, using the CRA’s guidance on remitting payroll deductions and contributions.

When the employee receives nothing

The Act has a rule for the case where an arm’s-length individual gives a non-compete connected with a purchaser’s acquisition of an interest in their employer, or in a business it carries on, and receives no proceeds for it, with the consideration going only to the sellers. In that case section 68 does not deem the individual to have received consideration for the covenant. The conditions are specific, and missing one changes the result.

Whether the promise can be enforced

In Ontario, the Employment Standards Act, 2000 says an employer shall not enter into an agreement with an employee that includes a non-compete, and a non-compete made in breach is void. It carves out executives, defined by title, and a seller who becomes the purchaser’s employee right after a sale. Other provinces have their own rules. Asking staff to sign after closing has the wider picture.