Canada: From Loophole To Black Hole


1. The Loophole

Darren Sukonick, a partner in the Corporate/Technology department of Torys LLP in Toronto, represented CanWest Global Communications Corp. in its purchase of Hollinger International Inc. ("HII") in 2000. He testified before a US. District Court in 2007 that the $80-million non-competition payments made to Conrad Black and other HII senior executives personally and which ultimately resulted in their fraud convictions, were intentionally structured as non-compete payments because "non-compete payments were not taxable in Canada at the time."2

That loophole is closing: on October 7, 2003, the Department of Finance proposed amendments to the Income Tax Act3whereby all payments received or receivable in respect of restrictive covenants (including non-competition agreements) from the sale of a business are taxable as income, subject only to limited exceptions4. The current draft of the proposed legislation is the Income Tax Amendments Act, 20105that was published by the Minister of Finance on July 16, 2010 (the "Income Tax Amendments Act", the "proposed section 56.4 amendments" or the "proposed amendments").

The proposed amendments are the legislative fall-out from the Federal Court of Appeal's decisions in Fortino6 and Manrell7 which, by 2003, had fully invalidated the Canada Revenue Agency's8 traditional approach of treating non-competition payments as proceeds from the disposition of capital property. The proposed amendments have not yet been implemented but if they do receive Royal Assent, the legislation will have retroactive effect to amounts received or receivable from October 7, 20039. The amending provisions apply to all restrictive covenants granted upon the sale of a business, not merely to non-competition covenants. "Restrictive covenant" is defined in the draft subsection 56.4(1) as follows:

"[R]estrictive covenant", of a taxpayer, means an agreement entered into, an undertaking made, or a waiver of an advantage or right by the taxpayer (other than an agreement or undertaking for the disposition of the taxpayer's property or — except where the obligation being satisfied is in respect of a right to property or services that the taxpayer acquired for less than its fair market value — for the satisfaction of an obligation described in section 49.1 that is not a disposition), whether legally enforceable or not, that affects, or is intended to affect, in any way whatever, the acquisition or provision of property or services by the taxpayer or by another taxpayer that does not deal at arm's length with the taxpayer.10

This paper is a commentary on the draft legislation as published on July 16, 2010. The author traces the evolution of the jurisprudence and the statutory lacunae that was the impetus behind the amendments, and then summarizes the draft legislation, underscoring its complexity. In the final analysis, the author challenges the kind of 'judicial innovation'11 ironically engaged in by the Federal Court of Appeal in Manrell12 that led to the proposed section 56.4. The Manrell decision, as this paper seeks to show, is so characterized by the author because of its fundamental departure from the "object and spirit" of the Act and the general intent of Parliament "to reach conduct of the taxpayer" that the legislation was designed to apply to13. The author further intends to underscore the point that in Justice Sharlow's enthusiasm to avoid judicial activism, her decision manifests an almost surreal degree of strict constructionism that was itself a radical departure from the history of the law and practice conventions in this area.14

2. Untethering the Income Tax Act

The immediate and overriding concern among practitioners is the complexity of the proposed amendments - they are expected to have stifling effects on papering otherwise commonplace commercial transactions. Though also noteworthy is the fact the proposed amendments suggest a continued trending by Canadian tax legislators towards the U.S. tax regime (which generally treats proceeds of non-competition agreements as ordinary income)15, it is more their complexity coupled with further uncertainty created by their delayed implementation that is causing alarm. Blair Dwyer asserts this situation raises questions about the effect on "the rule of law [in this country]... because practitioners are being forced to comply with an unenacted piece of draft legislation that changes form more frequently than the shapeshifter Odo (of Star Trek Deep Space Nine fame)".16 Indeed, the most strident of criticisms point to the delays and complexity of the proposed amendments as defeating the principal policy objectives behind statutory reforms: those of "certainty, consistency, predictability and fairness" under the Income Tax Act.17

It is the opinion of the author that the difficulties with the proposed s. 56.4 amendments are their lack of any pragmatic underpinnings: the tax treatment of non-compete payments are to be de-coupled from the very core of their raison d'être, the purchase and sale of a business; a capital transaction. Full income inclusion for non-competition payments under the proposed amendments - in order to attribute fair value to the restrictive covenant - results in a very "metaphysical exercise"18 of differentiating between such proximate intangibles as a person's goodwill in the marketplace and his right to carry on a competitive business.

Before the Fortino and Manrell decisions, the CRA had customarily treated the proceeds from non-competition covenants in the sale of a business as a capital gain, which fit in easily with the tax treatment of the larger transaction: both had been treated as a disposition of "property" thereby facilitating the purchase price allocations that are often heavily negotiated in large business acquisitions. With these proposed amendments, however, the legislature rejected the CRA's approach19, ignored the pragmatic realities of the business transaction itself and created (particularly with the many exceptions that need be superimposed on the income inclusion provisions to avoid undesired tax consequences) a labyrinthine structure which some tax commentators have described as "horrifically complex"20 causing "brain overload"21; ... a black hole.

To read this article in full, please click here.


1. Tax practitioners in Canada have extensively criticized the draft legislation for lacking transparency (see Blair Dwyer, "Proposed Section 56.4 Still Draft After All these Years" 2011 British Columbia Tax Conference, Vancouver, Canada, online at: Manon Thivierge, a partner at Heenan Blaikie Montréal, entitled her presentation on the proposed s. 56.4 amendments to the Income Tax Act at the Canadian Tax Foundation conference in November 2011 as "Restrictive Covenants and s. 56.4: Traps for the Wary" intending to convey the unintended risks to practitioners resulting from the complexity of the proposed legislation. I chose an analogy to a black hole in respect of the proposed s. 56.4 amendments because, in the words of Dr. G.H. George, "[t]he concepts associated with a black hole provide perhaps the most extreme departure which present day physics can provide from the "common sense" of our every day experience here on Earth." Presentation to a meeting of the St. John's (Newfoundland) centre of the Royal Astronomical Society of Canada, 1989 March 15, internet:

2. Heritage Institute, "Conrad Black Trial: Non-Compete Payments & the Role of Torys LLP Lawyers", April 16, 2007, online at

3. Income Tax Act, R.S.C., 1985, c. 1 (5th Supp.), as amended, (the "ITA", the "Income Tax Act" or the "Act").

4. Exceptions include covenants given by employees; covenants given in the context of an asset sale which requires that the taxpayer granting the restrictive covenant be carrying on the business being conveyed; and covenants given upon the sale of shares provided there is no multi-tiered corporate structure but which is subject to various additional requirements. A critical analysis of these exceptions is provided by David Louis in "Restrictive Covenant Rules, Restrictive Covenants: Last of the Unholy Trinity" CCH Tax Notes Issue No. 571, August 2010. A more detailed discussion of the exceptions is provided below in section 8 (The Exceptions).

5. Proposals to Amend the Income Tax Act and Related Legislation to Effect Technical Changes and to Provide for Bijural Expression in that Act.

6. Fortino v. The Queen (2000) DTC 6060 (F.C.A.), aff'g 97 DTC 55 (TCC) ("Fortino").

7. Manrell v. The Queen (2003) DTC 5225 (F.C.A.), rev'g 2002 DTC 1222 (TCC) ("Manrell").

8. Hereafter referred to as the "CRA".

9. Amounts paid by arm's-length parties under an agreement made prior to October 7, 2003 are excepted, provided that the amounts are received before 2005. See D. Jeffrey Harder "Valuation and Tax Issues" 2004 BCC p. 20:1 at p. 22.

10. Online at:

11. See Justice Iacobucci's decision in Ludmer v. Minister of Revenue, [2001] 2 S.C.R. 1082 (S.C.C.), at paragraph 38.

12. Justice Sharlow, who wrote the court's decision in Manrell, was concerned about judicial "innovation" when he determined that non-competition payments were not to be treated as 'property' under section 248(1) and thereby radically changed the judicial landscape in this area.

13. See Justice Estey comments in Stubart Investments Ltd. v R., [1984] 1 S.C.R. 536, [1984] C.T.C. 294 , 84 D.T.C 6305, at paragraph 56.

14. The consequences of the Manrell decision include the difficulty in legislating amendments to the ITA that will close the loophole Justice Sharlow created; amendments which have been more than eight years in the making, and still counting.

15. See Muskat v. United States, 2009 WL 211067 (1st Circ. 2009).

16. Blair Dwyer, "Proposed Section 56.4 Still Draft After All these Years" 2011 British Columbia Tax Conference, Vancouver, Canada, online at:

17. The stated policy objectives set forth by the Supreme Court in respect of interpreting the ITA are to seek certainty, consistency, predictability and fairness under the Act for taxpayers in the organization of their affairs. See The Queen v. Canada Trustco Mortgage Co., [2005] 5 C.T.C. 215 (S.C.C.), at paragraphs 1, 12, 31, 42, 50 and 61.

18. Justice Lamarre describing section 14 of the ITA in Fortino v. R., 1996 CarswellNat 2269, 97 D.T.C. 55, [1997] 2 C.T.C. 2184, at paragraph 67.

19. The CRA, depending on the specific facts, had treated the proceeds of a restrictive covenant as either a disposition of eligible capital property or amounts received as consideration for contingent or conditional obligations in respect of such disposition of property.

20. Moody, Clark and Baass "The Restrictive Covenant Proposals: Brain Overload," Report of Proceedings of Sixtieth Tax Conference, 2008 Tax Conference (Toronto: Canadian Tax Foundation, 2009), 36:1-54, p. 51.

21. Moody, Clark and Baass "The Restrictive Covenant Proposals: Brain Overload," Report of Proceedings of Sixtieth Tax Conference, 2008 Tax Conference (Toronto: Canadian Tax Foundation, 2009), 36:1-54, p. 1.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.