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

Diversify your investments

It takes so much capital to start, maintain and expand an auto dealership that there usually isn’t much cash left for other investments. I have heard many auto dealership owners tell me their retirement will be funded by the ultimate sale of their dealership business and property. “I make the best return on my money through my dealership business; therefore why invest in anything else?” While I like the passion and confidence these dealers express, I must admit that I am worried for their futures.

In light of the changes in the auto industry over the last ten years, I would recommend that every dealership owner have some of their money held outside their business. Many of the dealers that had their dealerships cancelled or retired over the past couple of years lost their current source of income and the nest egg they had been banking on for many, many years. Just as you wouldn’t put all your extra cash in a single stock, you shouldn’t have all your cash tied up in a single business venture.

It doesn’t take much to have a diversified portfolio. Contributing to your Registered Retirement Savings Plan as well as the Tax Free Savings Account and investing in stocks, bonds, mutual funds or other securities that are unrelated to the auto industry will give you a degree of diversification and lower risk in your investments.

With maximum annual RRSP contributions capped at $22,000 for 2011 and $5,000 per year for the TFSA’s you can easily see that your investments in these types of vehicles can grow substantially over time. Make the commitment to fund these types of investments annually, and more importantly work with someone who understands your concerns and risk tolerance so you’ll feel comfortable with the investing process.