Principal Issues: [TaxInterpretations translation] 1. Does the Canada Revenue Agency ("CRA") intend to issue guidance on the method to be used to determine the value of a restrictive covenant or, at a minimum, provide information on the benchmarks to be applied?
2. In the case of a sale of 100% of the shares of a private corporation by an executive shareholder to an arm's length purchaser, what criteria will the CRA use to determine the value of a covenant not to solicit the corporation's clients and the value of a covenant not to solicit the corporation's employees?
Position: 1. No.
2. That determination depends on several subjective factors.
Reasons: No comments.
FEDERAL TAX ROUNDTABLE
APFF CONFERENCE 2010
Question 15 - Evaluation of a restrictive covenant
When selling the shares of a private corporation, the norm is for the seller to undertake to not solicit the customers of the corporation being sold nor its employees to change employment. These undertakings of the vendor are essential terms and conditions for the purchaser. Such covenants are intended to protect all or part of the value attributable to the goodwill. In practice, the value of a restrictive covenant as defined in section 56.4 and the value of the goodwill are closely related and may form a whole that can be difficult to divide into two distinct values.
Questions to the CRA
(a) Does the CRA plan to issue guidance on the method it intends to use to determine the value of a restrictive covenant?
(b) In the absence of a methodology, does the CRA plan to provide information on the benchmarks it intends to use for this purpose?
(c) In the context of a sale of 100% of the shares of a private corporation by an executive shareholder to an arm's length purchaser, can the CRA provide us with the criteria it intends to use to determine:
- the value of the covenant not to solicit the corporation's clients; and
- the value of the covenant to not solicit employees of the corporation to change employment?
CRA Response to Question 15(a)
No. The Valuations Section of the Compliance Programs Branch does not plan to issue guidance on the method it intends to use to determine the value of a restrictive covenant since each situation must be assessed independently and a blanket method may not be appropriate for all situations that may arise. In order to determine which method should be followed for a given situation, it is necessary to analyze all relevant facts specific to that situation.
CRA Response to Question 15(b)
No. Since each situation is different and the approach taken in a given situation will depend on the facts of that situation, the Valuations Section does not intend to issue information on the benchmarks it intends to apply in determining the value of a restrictive covenant.
CRA Response to Question 15(c)
As stated in the preamble to the questions posed to the CRA, "These undertakings of the vendor are essential terms and conditions for the purchaser." Thus, the conditions that are provided for in a commercial transaction must generally be satisfied in order for the transaction to proceed. Where some of those conditions are not satisfied, it is possible that the purchaser may withdraw from the purchase process. If a restrictive covenant had a value, that value would normally be measured by the reduction in the income of the business sold if the vendor did not comply with the terms of the covenant.
The reasons underlying the negotiation of a restrictive covenant and the possibility that the vendor may solicit the corporation’s clients are subjective elements that require an assessment of the facts, the judgment of a recognized valuations expert, an evaluation of the industry and the corporation, a determination of the relationship between the corporation’s clients and the corporation’s owners or key persons and the impact on the corporation’s income level.
As indicated above, keeping in mind that what is being valued are conditions of a sale that are essential to the closing of the sale, the various elements that would have an impact on the income of the business sold must be evaluated in light of each individual situation.
Lucie Allaire
(613) 957-2046
October 8, 2010
2010-037335.