Tax Planning Opportunity Closed: Proposed Amendments To The Income Tax Act (Canada) Will Tax Non-Competition Payments

Article by John Unger and Catrina Card

On October 7, 2003, the Department of Finance announced proposed amendments to the Income Tax Act (Canada) that will legislatively overturn the tax planning opportunity reopened by the Federal Court of Appeal decision in Manrell v. the Queen.¹ In Manrell, the Court found that an amount received by a vendor of shares of a corporation (or received by any other person who is not an employee of the corporation) as compensation for the person’s agreement not to compete with the business of the purchaser or the corporation, is non-taxable.

The proposed amendments treat any amount receivable or received in respect of a noncompetition agreement as income to the recipient, making the amount fully taxable. There is only one exception to this tax treatment. To the extent that the non-competition agreement increases the fair market value of the shares of the corporation that are being sold, the recipient of the payment may treat the amount receivable or received as being part of the proceeds for the shares. In such a case, the noncompetition payment will be taxable to the recipient as a capital gain, as opposed to income. Similar rules will apply in respect of the sale of partnership interests.

This new tax treatment of non-competition payments will apply to amounts receivable or received after October 7, 2003, unless the payment is made pursuant to a written agreement entered into on or before that date.

1 The Manrell decision was discussed in our client memo no. 2003-13T (May 29, 2003), which stated that "it is reasonable to expect the Department of Finance to propose amendments to the Income Tax Act (Canada) to legislatively overturn the effect of the decision."

The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.