Pangaea One Acquisition Holdings XII S.À.R.L. v. The Queen, 2020 FCA 21

The Federal Court of Appeal has upheld the decision of the Tax Court of Canada (2018 TCC 158, Smith J.), confirming that a payment made to induce a party to sign a share purchase agreement was subject to withholding tax under Part XIII of the Income Tax Act (Canada). If structured differently, the payment might have escaped the Canadian tax net.


Pangaea was one of three shareholders of Public Mobile Holdings Inc. ("Public") and party to a unanimous shareholders' agreement that prohibited the other Public shareholders from selling their shares without Pangaea's consent.

Telus Communications offered to buy Public in 2013 and Thomvest, one of the other Public shareholders paid Pangaea $3 million pursuant to a letter agreement under which Pangaea agreed to execute a share purchase agreement with Telus.

Thomvest withheld Part XIII tax on the payment to Pangaea and Pangaea sought a refund of that tax, which was denied by the Canada Revenue Agency.


The Canada Revenue Agency assessed withholding tax on the basis that the $3-million payment was in respect of a "restrictive covenant".

Subsection 56.4(1), defines a "restrictive covenant" of a taxpayer to mean, inter alia, "an agreement entered into… that affects, or is intended to affect, in any way whatever, the acquisition or provision of property by the taxpayer" (subject to certain exceptions that were inapplicable in this case).

Section 56.4 was enacted in response to case law which held that, in some circumstances, non-compete payments were not taxable. The "restrictive covenant" definition is both vague and broadly-worded and there is little authority on its scope.


Pangaea argued that the payment related to the waiver of its veto right under the unanimous shareholders' agreement and did not "affect" the provision of property by Pangaea. The Court rejected this argument, noting that the letter agreement provided for Pangaea's execution of the share purchase agreement and that the letter agreement did not refer to the veto right. The word "affect" means "to act upon, influence". It seems clear from the terms of the letter agreement that it did influence Pangaea to sell its shares of Public to Telus, as Pangaea was required under the letter agreement to enter into the share sale agreement with Telus. The Tax Court found that there was an obvious nexus between the letter agreement and the disposition by Pangaea of its Public shares to Telus, and this was sufficient to establish that the letter agreement affected or was intended to affect the provision of property, being the sale of Public shares to Telus. This conclusion is based on a solid factual foundation.

Perhaps the result would have been different, had the letter agreement been drafted to provide for the waiver of the veto right or the assignment of that right to Thomvest. Alternatively, the $3 million might have been paid as additional consideration payable by Telus to Pangaea for its Public shares, with an offsetting reduction in the consideration paid to Thomvest. Such a structure may have more accurately reflected the commercial intention of Thomvest; being to get Pangaea to agree to permit Thomvest to sell its Public shares to Telus. Unless Telus was only prepared to purchase 100 percent of the Public shares (and not a lesser percentage), which may have been the case, Thomvest should have been indifferent as to whether Pangaea sold its Public shares to Telus. The decisions are silent on this point.

Pangaea also argued that a textual, contextual and purposive interpretation of the restrictive covenant definition supported the conclusion that it was only intended to apply to non-compete agreements. The Court disagreed, concluding that the broad language in the definition clearly indicated that it was intended to apply to more than non-compete agreements. It is hard to disagree with this conclusion. Of note, the Court was not required to make a broader finding to dispose of this appeal, so it should not be surprising that there is not a broader discussion of the proper scope of the "restrictive covenant" definition. This is left for a future decision.

It is worth noting that the Canada Revenue Agency has previously said that payments received for granting rights under a product distribution agreement were taxable under subsection 56.2(4). This view is consistent with the Court's interpretation of the "restrictive covenant" definition in Pangaea.

This case reinforces the importance of carefully considering the potential tax characterization of payments when structuring unusual transactions. Unfortunately, it does not provide much guidance on the scope of the "restrictive covenant" definition, other than to confirm that it is not limited to non-compete payments.