Friday, February 8, 2013

Watch Out for the Taxman and Restrictive Covenants


What do you get when you use an elephant gun to kill a mosquito? You get the Canada Revenue Agency attempting to close what they perceive as a loophole and catching a lot of other innocent taxpayers.

Let’s bring some context to my statement. A number of years ago, 2003 to be precise, tax legislation was proposed to close the perceived abuse that might transpire as a result of the Fortino and Manrell cases.

The Fortino case involved the sale of Fortinos Supermarket Ltd. to a competing grocery store chain. The transaction involved the sale of shares and a non-competition agreement. An amount was allocated to the share sale as well as the non-competition agreement. The non-competition agreement stipulated that the vendors would not compete with the purchaser for a certain number of years.

The taxpayers reported the share sale in their respective tax returns but did not report the proceeds from the non-competition agreement. They argued the amount received represented personal goodwill, not income from a source, and constituted a windfall. The Minister of National Revenue disagreed and first reallocated the non-competition as additional proceeds on the sale of shares then later as just income. The Fortinos objected and won their case at the Federal Court of Appeal.

To close this loophole, the CRA recently drafted legislation that states the taxation of amounts received pursuant to non-competition agreements are taxed as income, not capital, and stipulates that an election must be filed to recharacterize the amounts as proceeds from the sale if certain conditions are met.

The draft legislation is extremely complex and burdensome. Needless to say, if you are contemplating selling your dealership in the near future, you should contact a tax advisor to ensure you don’t fall into any tax traps as a result of this proposed legislation.

- Jeff