On July 28, 2014, our firm published a
blog that discussed a recent Canada Revenue Agency
("CRA") announcement at the 2014 Society of Trust and
Estate Practitioners ("STEP") Roundtable. The
announcement involved the taxation of restrictive covenants under
subsection 56.4(2) of the Income Tax Act (the "Act").
Specifically, the issue revolved around whether or not certain
exceptions to the broad application of the taxation of restrictive
covenant receipts could be avoided because of the strict
application of the legislative requirement that no proceeds are
received or receivable by the vendor for the granting of the
restrictive covenant" (see paragraphs 56.4(6)(e) and
56.4(7)(d) of the Act).
As most commercial lawyers know, consideration is usually needed
in order to make a contract valid and therefore there is usually a
nominal amount of consideration granted in order to make the
restrictive covenant grant – like a non-competition agreement
– valid. The question posed was whether or not the nominal
consideration granted would make the exceptions (under paragraphs
56.4(6)(e) and 56.4(7)(d) of the Act referred to above) to the
"deemed receipt" rule under paragraph 68(c) applicable.
The CRA announced and subsequently published in Technical
Interpretation 2014-0522961C6, the following:
While we understand that a nominal amount of consideration
may be given by the parties in a contract relating to a restrictive
covenant to ensure that the contract is legally binding, it is the
CRA's view that this would still constitute an amount of
proceeds received or receivable by the particular party for
granting the restrictive covenant. As such, the exceptions set out
in subsections 56.4(6) and (7) could not apply because the
respective conditions in paragraph 56.4(6)(e) and paragraph
56.4(7)(d) would not technically be met. In such cases, the amount
of proceeds (or any additional amount deemed by paragraph 68(c))
received or receivable by the taxpayer for the RC would be taxable
as ordinary income under subsection 56.4(2) unless one of the three
exceptions in subsection 56.4(3) otherwise applies.
As such, taxpayers seeking relief in these circumstances may
want to contact the Department of Finance Canada to outline their
concerns on this issue.
As mentioned in our July 28, 2014 blog, we were disappointed
with the answer and made the following suggestions for
Seek specialized tax advice on section 56.4 early on in the
Ensure that restrictive covenant contracts are done under seal;
Keep their ears to the ground to see if the CRA changes their
administrative position at some point in the future.
Well, great news! At the CRA Roundtable table of the
66th Annual Tax Conference of the Canadian Tax
Foundation held today, the CRA was posed the following
Would the CRA consider amending the position set out in
document number 2014-0522961C6 (June 2014) to the effect that the
allocation in an agreement of $1 of consideration to a restrictive
covenant, merely to ensure that the agreement constitutes a legally
binding contract, does not constitute proceeds for the purpose of
paragraphs 56.4(6)(d) and (7)(e)?
The CRA responded by saying that they would administratively
accept that $1 of consideration (but not a dollar more) to make the
contract legally valid would not constitute proceeds for purposes
of paragraphs 56.4(6)(e) and paragraphs 56.4(7)(d). Again, great
news and kudos to the CRA for reconsidering its earlier
administrative position. Practitioners and taxpayers should
carefully plan for this new position when dealing with the granting
of restrictive covenants and the resulting tax implications under
Moodys Gartner Tax Law is only about tax. It is
not an add-on service, it is our singular focus. Our Canadian and
US lawyers and Chartered Accountants work together to develop
effective tax strategies that get results, for individuals and
corporate clients with interests in Canada, the US or both. Our
strengths lie in Canadian and US cross-border tax advisory
services, estateplanning, and tax litigation/dispute resolution. We
identify areas of risk and opportunity, and create plans that yield
the right balance of protection, optimization and compliance for
each of our clients' special circumstances.
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 Mondaq.com.
Click to Login as an existing user or Register so you can print this article.
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).