The restrictive covenant draft legislation (in proposed section 56.4) has still not been proclaimed into law but, if passed, will generally have retroactive effect to October 7, 2003. There are numerous problems with the impact of these rules, including a deemed reallocation of proceeds from the disposition of other property (such as shares) to a restrictive covenant. Such proceeds would be fully taxable as opposed to only half taxable (as a disposition of capital property would normally be).
An additional problem arises as any amounts allocated to a restrictive covenant are fully taxable whether the amounts are received or receivable.
This is problematic given that dispositions of capital property that create a capital gain (but all the proceeds are not yet due) can often result in a deferral of the realized capital gain. This can provide for significant tax deferral planning when dealing with vendor take back consideration, for example.
However, to the extent that proceeds are deemed to be received and thus taxable on a restrictive covenant, no reserve is available. This problem can cause accelerated taxation in a situation where the consideration includes vendor take back indebtedness.
Finally, the proposed restrictive covenant rules contain numerous elections that can be helpful. Some of the elections must be joint but may not be beneficial to both parties. It may be wise to ensure that purchase and sale agreements contain provisions to compel both parties to sign the joint elections, where relevant.
The restrictive covenant draft legislation is full of traps and professional advice should be obtained at all times.
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