Restrictive covenant


The topic, Restrictive covenant, is under review and the present content on this page may not reflect the accurate revised legislation.

Any amount received or receivable for a restrictive covenant will be treated as ordinary income for income tax purposes. This applies to amounts received or receivable by a taxpayer after October 7, 2003, other than to amounts received before 2005 under a grant of a restrictive covenant made in writing on or before October 7, 2003, between the taxpayer and a person with whom the taxpayer deals at arm's length.

A restrictive covenant affects or is intended to affect, in any way, the acquisition or provision of property or services by the taxpayer or by another taxpayer that does not deal at arm's length with the taxpayer. It can take the form of either:

  • an arrangement between the parties
  • an undertaking or a waiver of an advantage or right

Restrictive covenants may frequently be found in the terms of an agreement dealing with the sale or acquisition of a business, corporate shares, or a partnership interest. Such covenants usually last for a specified period of time and may apply to a specific geographic area.


There are three exceptions to the proposed general income inclusion rule. The exceptions, listed below, only apply to the seller (grantor) of a restrictive covenant who deals at arm's length with the person to whom the covenant was granted (sold):

  • Employment income – The general inclusion rule will not apply if the amount is required to be included in the calculation of the grantor's employment income or would be so required if the amount had been received in the tax year.
  • Eligible capital property – Sometimes an agreement to sell a business and its underlying assets includes a non-competition agreement by the seller (grantor). An amount received under a restrictive covenant that is the proceeds of disposition of eligible capital property (an eligible capital amount) is income under the general rule unless the grantor and buyer jointly elect, in prescribed form with their return of income for the tax year that includes the date of the covenant. In this case, the amount is an eligible capital expenditure to the buyer and an eligible capital amount to the grantor.
  • Shares and partnership interests – In cases where the consideration for certain types of restrictive covenants directly relates to the grantor's disposition of an eligible interest and where five additional requirements are satisfied and the grantor and buyer elect in prescribed form. An eligible interest means capital property of the grantor that is a partnership interest in a partnership that carries on a business, or a share of the capital stock of a corporation that carries on a business. In these cases, part of the amount receivable for the covenant may be treated as part of the proceeds for the disposition of the eligible interest, to the extent that the covenant increases the fair market value (FMV) of the grantor's eligible interest. The remaining part of the amount receivable for the covenant (that is in excess of the part treated as proceeds of disposition of the eligible interest) will be taxable as ordinary income. For an illustration of the treatment of a restrictive covenant when this exception applies, go to Treatment of a restrictive covenant.


For the second or third exception to apply, the payor and grantor must each make an election and include it in their income tax return for the tax year in which the restrictive covenant was agreed upon.

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