31 May 2006 Internal T.I. 2006-0177961I7 - Non-Competition Payments

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Whether a non-competition payment is taxable to the recipient in the particular situation.

Position: It appears the payment may be considered an "eligible capital amount" for the purposes of section 14 of the Act.

Reasons: Legislation at the time of the payment and jurisprudence.

 							May 31, 2006

	XXXXXXXXXX  Tax Services Office 	HEADQUARTERS
	XXXXXXXXXX 	Shaun Harkin, CMA 

							2006-017796

Technical Interpretation Request: Non-Competition Payment

We are writing in response to your email of March 27, 2006, wherein you asked for our opinion on whether a non-competition payment ("NCP") is taxable to the recipient. Our understanding of the facts is as follows:

• XXXXXXXXXX. ("XXXXXXXXXX Corp") carries on the business (hereinafter referred to as the "Business") of a retirement home under the name "XXXXXXXXXX".
• XXXXXXXXXX (the "Trust") is the beneficial owner of all of the shares of XXXXXXXXXX Corp.
• XXXXXXXXXX the trustee of the Trust, performed an integral part in the operation of the Business as the manager and had numerous contacts in the industry and an excellent rapport with clients.
• XXXXXXXXXX was compensated by XXXXXXXXXX Corp in the form of management fees, which XXXXXXXXXX reported as self-employed business income.
• Pursuant to a Share Purchase Agreement ("SPA"), dated XXXXXXXXXX, and a Non-Competition Agreement ("NCA"), effective XXXXXXXXXX, a purchaser paid, on the closing date of XXXXXXXXXX, a NCP directly to XXXXXXXXXX.
• As provided in the NCA, the purchaser paid the NCP so that for a period of XXXXXXXXXX years commencing on the closing date (the "Non-Compete Period") XXXXXXXXXX will not, among other things, ".... XXXXXXXXXX...".
• XXXXXXXXXX did not remain as the manager of the Business upon the closing of the Share Purchase Agreement.
• XXXXXXXXXX considered the NCP a non-taxable receipt and did not include the NCP in her income tax return.

Your View

In your view, since XXXXXXXXXX is not the vendor you presume the NCP is taxable income for her. You do not state under which section of the Income Tax Act (the "Act") she should be taxed.

Representative's View

In his letter of April 24, 2006, XXXXXXXXXX, is of the view that the NCP should be treated as a non-taxable receipt consistent with jurisprudence at the time. We assume XXXXXXXXXX is referring to the Federal Court of Appeal decisions in The Queen v Fortino et al dated December 14, 1999, and Manrell v The Queen dated March 11, 2003.

We have reviewed the SPA and the NCA. Our comments are as follows.

Our Comments

As a result of the decision of the FCA in Manrell, where a taxpayer receives an amount as the consideration for granting a covenant not to compete, the amount received will not be considered the "proceeds of disposition" of any "property" for purposes of the Act (subject to the proposed amendments to the Act, i.e., section 56.4, Restrictive Covenants, announced by the Department of Finance on October 7, 2003, which are not applicable in this case because the proposed amendments apply after the time of the payment of the NCP). While the FCA decision in this case and the earlier decision in Fortino support the proposition that an amount received for granting a covenant not to compete must be considered a receipt on account of capital, we are of the view that such amount may still be taxable if it falls within specific provisions of the Act, such as subsection 6(3) or section 14 of the Act, among others.

If it can be established that the NCP received by XXXXXXXXXX was paid by the Trust or its subsidiary, XXXXXXXXXX Corp, during a period while XXXXXXXXXX was an officer or employee of the Trust or XXXXXXXXXX Corp, it would be our opinion that such amounts may be caught by subsection 6(3) of the Act, and deemed to be remuneration for the purposes of section 5 of the Act. However, in the situation described, it appears that pursuant to the SPA and the NCA made in connection with the sale of the Business, XXXXXXXXXX received the NCP from an arm's length purchaser as consideration for granting a covenant not to compete. Also, XXXXXXXXXX reported the compensation from XXXXXXXXXX Corp as self-employed income. Accordingly, it is our opinion that such amount should not be included in calculating XXXXXXXXXX income pursuant to subsection 6(3) of the Act.

With respect to section 14 of the Act, where the grantor of a covenant does not carry on (or did not formerly carry on) a business to which the activities described in the covenant relate, the amounts received cannot be considered "eligible capital amounts"for the purposes of section 14 of the Act. In our opinion, a respectable argument can be made that the business of providing management services to XXXXXXXXXX Corp that XXXXXXXXXX is carrying on is a business to which the activities described in the NCA relate. Accordingly, it would appear that the NCP should be included in income as an "eligible capital amount" for the purposes of section 14 of the Act. Please refer to IT-123R6, Transactions Involving Eligible Capital Property, for further assistance on the application of section 14 of the Act.

We trust the above comments are of assistance.

Randy Hewlett
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
legislative Policy and Regulatory Affairs Branch