Non-competition agreements can be a valuable tool for purchasers
who want to protect their investments in new businesses. However,
non-competition agreements can have unintended and unexpected tax
consequences, particularly to sellers who grant non-competition
agreements to purchasers.
The Income Tax Act (Canada) (the Act)
contains specific provisions regarding the taxation of
"restrictive covenants", a broadly defined term that
includes, among other things, non-competition agreements,
regardless of whether such agreements are legally enforceable.
Under section 56.4 of the Act, the portion of the purchase price
allocated to the granting of a restrictive covenant (whether by the
parties or as a result of a deemed allocation, as discussed below)
will generally be taxable to the seller as regular income, as
opposed to a capital gain. This treatment is significantly less
favourable for the seller because regular income is subject to tax
at the seller's normal tax rate,
