No — paying the employee is precisely the thing that breaks the one provision that would otherwise let her sign without a tax cost.
Short answer
Income Tax Act s.56.4(2) taxes any amount received for a restrictive covenant as ordinary income. Subsection (6) protects an employee’s covenant from that result only if all six conditions hold, and two of them fail the moment the employee is paid directly: “no proceeds are received or receivable by the individual for granting the restrictive covenant” and consideration must be “received or receivable only by the vendors.” A non-shareholder employee is not disposing of any business asset, so the disposition-based exceptions in s.56.4(3) never reach her either.
Subsection 56.4(5) turns off the rule that would otherwise let the CRA deem part of a purchase price to have been paid to whoever gave a valuable covenant, whether or not any cheque was actually written to them. Subsection (6) makes that protection available only where nothing was paid to the covenantor and all consideration ran to the vendors instead. The instant a term sheet frames a payment as being “for entering into” the covenant, condition (e) is already broken, no matter how the cheque is later cut — and once s.56.4(2) applies, there is no capital-gains route open to an employee, because that exemption belongs to a vendor disposing of shares, not to someone disposing of nothing.
Folding the retention incentive into ordinary post-closing compensation — a retention bonus tied to continued service rather than to signing a covenant — sits squarely inside sections 5 and 6 on its own terms and never touches s.56.4 at all. What is left genuinely open on a standalone covenant payment is the buyer’s own deduction: s.56.4(4)(a) treats an amount as deductible wages only if it is already employment income under sections 5 or 6, which is a separate, fact-specific question a covenant-shaped payment does not automatically satisfy.
The full mechanic played out in a buyer that offered a key employee $75,000 to sign a non-compete, and broke the one rule that would have let her sign for free.
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