Restrictive Covenants In M&A Deals: A Timely Refresher On Tax Rules

There are many issues to address in a merger and acquisition transaction. In most purchase and sale transactions the purchaser, after paying the seller consideration to acquire the business, wants to ensure it is protected from the seller competing with the sold business. A common mechanism to provide this protection is a restrictive covenant.

Restrictive covenants are varied and often heavily negotiated. While it is important to ensure the commercial terms and conditions of the restrictive covenant are acceptable to the parties, the tax implications of granting a restrictive covenant should not be overlooked.

What is a restrictive covenant?

For starters, it is important to understand that the Income Tax Act (Canada) (the "Act") contains an extremely broad definition of a restrictive covenant. Section 56.4 of the Act defines a restrictive covenant as an agreement entered into, an undertaking made, or a waiver of an advantage or right by the taxpayer, whether