Why Buyers Pay Sellers for a Non-Compete: The Tax Angle in an Ontario Business Sale

A buyer who just paid for a business doesn't want the seller opening a competing shop down the street six months later. That's why many Ontario business sale agreements include a restrictive covenant — commonly a non-compete or non-solicitation clause — from the seller, sometimes with a specific portion of the purchase price allocated to it. What often surprises sellers is that this allocation isn't just a drafting formality; it can carry its own, separate tax treatment.

This article explains why buyers ask for non-competes, the employment law wrinkle that limits when they're enforceable at all, and the general tax principle behind allocating part of the price to one.

The specific tax mechanics of restrictive covenant payments are technical federal tax law — this is the general shape of the issue, not a substitute for advice from your accountant on the actual numbers.

Why Buyers Want a Non-Compete From the Seller

A buyer who has just paid for a business's goodwill — its customer relationships, reputation, and ongoing revenue — has a real interest in making sure the seller doesn't immediately compete for the same customers. A non-compete, often with a companion non-solicitation clause protecting customers and employees, is the buyer's main legal tool for protecting that goodwill after closing.

The Employment Standards Act Wrinkle

Since October 25, 2021, Ontario's Employment Standards Act, 2000 has generally prohibited employers from entering non-compete agreements with employees. There are two recognized exceptions relevant here:

• The business-sale exception — where the seller becomes an employee of the purchaser as part of the sale.
• The executive exception — limited to defined, senior executive-style roles.

This means a non-compete signed with a departing owner who is not becoming an employee of the purchaser, or with someone who doesn't fit the narrow executive definition, may fall outside either exception and risk being unenforceable. Non-solicitation and confidentiality agreements are treated differently under the ESA and generally remain enforceable subject to ordinary reasonableness limits, so they're often used even where a formal non-compete is legally shakier.

The Tax Side: Why It's Not Just "More Purchase Price"

Here's the part that catches sellers off guard: an amount allocated specifically to a restrictive covenant isn't automatically taxed the same way as proceeds allocated to goodwill or shares. Canadian income tax law has specific rules addressing payments for restrictive covenants, and depending on how the payment is structured and allocated, it can end up taxed differently, and potentially less favourably, than a simple increase to the purchase price would be. The specific outcome depends on the details of the transaction and needs a tax professional's input; this article isn't the place to predict which treatment applies to your deal.

How This Plays Out in Negotiations

Because the tax treatment of a non-compete payment can differ from the treatment of the rest of the purchase price, allocation becomes its own negotiating point:

• Sellers often prefer to minimize, or avoid entirely, a specific dollar allocation to the non-compete, and instead fold that value into the general purchase price.
• Buyers sometimes want an explicit allocation, both to have clear, separately enforceable consideration for the covenant and for their own tax reasons.
• Both sides need their accountants involved in the allocation conversation before it's locked into the purchase agreement — this isn't something to leave to boilerplate drafting.

Getting the Restrictive Covenant Itself Right

Separately from the tax question, the covenant needs to actually be enforceable and useful:

• [ ] Confirm which ESA exception, if either, applies to the specific individual signing the non-compete.
• [ ] Keep the scope, geography, and duration reasonable — an overly broad covenant risks being unenforceable regardless of the tax treatment behind it.
• [ ] Address non-solicitation and confidentiality separately, since they survive under different rules than a non-compete.
• [ ] Decide, with your accountant, whether any specific amount will be allocated to the covenant before the purchase agreement is finalized.

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