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Posted on February 21st 2006 in Legal Articles

Tax Update

Tax Update

The Federal Court of Appeal recently handed down an interesting ruling involving taxable capital gains and non-competition covenants.

In 1995, three plastics companies, in which Tod Manrell had substantial interests, were sold. As part of the agreement of purchase and sale, Manrell delivered to the purchaser non-compete agreements. In return for signing the agreements, he was to be paid $4 million over a four-year period. When he initially filed his tax returns, Manrell included these monies as part of the proceeds of disposition of the shares sold to the purchaser.

In 1997 after hearing about a case similar to his own, he filed notices of objection to seek reassessment reducing to nil the taxable capital gains he had reported in relation to his non-competition payments. The minister and the Tax Court denied his request, so he turned to the Federal Court of Appeal.

In order to be a taxable capital gain, a person must sell, for profit, property that meets the Income Tax Act’s definition of property. According to the Income Tax Act, “property means property of any kind whatever…” The issue in this case was whether Manrell’s “right to compete” fell within the definition of property, specifically whether it was captured by “a right of any kind whatever”.

The government argued that the phrase “a right of any kind whatever” was sufficiently broad to include rights that did not necessarily have the usual characteristics of property. Manrell, on the other hand, argued that the “right to compete” was a personal liberty, not a right that is exclusive or that entails any claim against anyone else.

The appellate court agreed with Manrell, concluding that the payments he received under the non-competition agreements were not the proceeds of the disposition of property. Madam Justice Sharlow stated:

It is implicit in this notion of “property” that “property” must have or entail some exclusive right to make a claim against someone else. A general right to do something that anyone can do, or a right that belongs to everyone, is not the “property” of anyone. In this case, the only thing that Mr. Manrell had before he signed the non-competition agreement that he did not have afterward was the right he shares with everyone to carry on a business. Whatever it was that Mr. Manrell gave up when he signed that agreement, it was not “property” within the ordinary meaning of that word.

In light of this decision, Parliament may choose to amend the Income Tax Act in order to permit the taxing of these monies. However, if and until that occurs, those selling a business should consider how much compensation should be allocated to a non-competition agreement. Please contact Howard Steinberg or Stanley Landau for further information.