Restrictive covenant tax rules (s. 56.4)

A seller who signs a non-compete in a sale meets these rules. Subsection 56.4(1) defines a restrictive covenant as an agreement, undertaking or waiver of an advantage or right, whether legally enforceable or not, that affects, or is intended to affect, the acquisition or provision of property or services by the taxpayer or by a taxpayer not dealing at arm’s length with them, other than what the definition excludes. Subsection 56.4(2) includes amounts for it in income.

Exceptions and allocation

Subsection 56.4(3) lists conditions under which subsection (2) does not apply to a covenant granted to an arm’s-length purchaser. Some paths need an election, and some tie the amount to a disposition of an eligible interest in a corporation or partnership. Section 68 deems the part of an amount that can reasonably be regarded as consideration for the covenant to be received for it, irrespective of the form or legal effect of the agreement, except where subsection 56.4(5) switches section 68 off for that covenant. CRA’s covenant page says it is under review.

What to check or ask

• Who receives the payment? The rule reaches amounts received by the taxpayer or by a taxpayer not at arm’s length with them.
• Is the covenant priced separately, and does the allocation reasonably reflect what it covers?
• Does an exception apply, and does it need an election, and by whom?

See paying for a non-compete without a tax problem and non-compete.