Rules
Vendor take-back financing in Canada: tax and security registration
Vendor take-back financing in Canada runs on two rulebooks: CRA tax rules under the Income Tax Act and provincial Personal Property Security Act registration.
What to take away
- Two authorities govern a vendor take-back note in Canadathe Canada Revenue Agency for tax, and the province for security.
- Section 16.1 of the Income Tax Act taxes interest as it accrues when a note defers or makes it contingent, so tax can fall due before cash arrives.
- A compliant note states the principal, the rate and the payment schedule. It also names the maturity, the security, the default remedies and the governing law.
- Security never registered at the provincial personal property registry ranks behind a trustee in bankruptcy.
- Quebec files security in a different registry under civil law, so an Ontario template does not travel.
Who has jurisdiction over a vendor take-back note
A vendor take-back note answers to two regulators at once. The Canada Revenue Agency decides how interest and capital gain are reported. The province where the debtor sits decides whether the seller's security binds anyone else.
For most business sales the debt is personal property, so the governing statute is the province's Personal Property Security Act — R.S.O. 1990, c. P.10 in Ontario, R.S.B.C. 1996, c. 359 in British Columbia and R.S.A. 2000, c. P-7 in Alberta. Each province runs its own registry under its own Act, with separate filing rules and separate priority rules.
One tax rule sits behind the paperwork. Where the buyer is a corporation and the seller is a shareholder, an uncharged or below-market loan can be treated as a benefit. Sections 15(2) and 80.4 apply, priced at a prescribed rate CRA republishes each quarter.
The buyer's side of the same borrowing is worked through in acquisition financing.
What a compliant note and disclosure must contain
What a compliant note must contain
| Term | What the note must state | Why the file depends on it |
|---|---|---|
| Principal and currency | Amount advanced, in Canadian dollars | Fixes the debt for the registry and the buyer's basis |
| Interest and accrual | Rate, and whether interest is paid yearly | Section 16.1 applies when interest is not paid annually |
| Schedule and maturity | Dates, amounts, and the final date | Sets the receipt each year and when the gain closes |
| Security | Property charged and where it sits | Drives the financing statement and any land charge |
| Default and remedies | Notice periods and available remedies | A remedy the note omits may not be available |
| Governing law | Province and forum for disputes | Decides the registry and the court |
Section 16.1 imposes accrual treatment, so a note written as a lump sum with interest rolling up is taxed year by year. Income Tax Act section 16.1 sets out the wording.
Note and Disclosure Terms
- Principal and currencyamount advanced in Canadian dollars
- Interest and accrualrate and whether paid yearly
- Schedule and maturitydates, amounts, final date
- Securityproperty charged and where it sits
- Default and remediesnotice periods and available remedies
- Governing lawprovince and forum for disputes
Disclosure to the counterparty is the narrower test. Before signing, the buyer needs the rate, the schedule, the security position and the default triggers. A broker running the sale carries separate duties, and broker requirements sets out where those collide with the seller's.
Records to keep, and the registration steps
- Sign the promissory note and the security agreement on closing, and date both.
- File a financing statement at the registry where the debtor is located: the Personal Property Security Registration (PPSR) system in Ontario, or the Personal Property Registry in British Columbia or Alberta.
- Register a mortgage, charge or hypothec at the land titles office if real property secures the note.
- Keep the verification statement and registration number with the signed note.
- Diarize the expiry, because a lapsed registration loses priority from the lapse date.
Keep the annual payment record, the interest received and any amending agreement. A corporation that receives the interest reports it on its T2 Corporation Income Tax Return, the same return where a capital gains reserve is claimed. Providers assemble that file differently, and a seller preparation comparison shows what each delivers.
What happens if the seller does not perfect or report
An unperfected security interest is not a paperwork gap. Under every provincial Personal Property Security Act it is subordinate to a trustee in bankruptcy and to a later registered secured party.
Registration decides whether the seller ranks as a secured creditor or as a name on a list of unsecured creditors.
Unreported interest invites reassessment with arrears interest, and a reserve claimed on unreasonable terms can be denied. The capital gains reserve is Income Tax Act section 40(1)(a)(iii), which spreads the gain as the note is paid but caps the reserve at five years. For an individual selling qualified shares, the timing affects the lifetime capital gains exemption under Income Tax Act section 110.6.
Where the rules differ by province
Quebec is the clearest break. Security there is taken under the Civil Code of Quebec and filed in the Register of personal and movable real rights. Land security is a hypothec, not a mortgage.
Quebec vs Common Law Provinces
Quebec
- Governing law
- Civil Code of Quebec
- Registry
- RDPRM
- Land security
- Hypothec
- Filing window
- Varies
- Debtor location test
- Varies
Common Law Provinces
- Governing law
- Provincial PPSA
- Registry
- Personal property registry
- Land security
- Mortgage or charge
- Filing window
- Varies by province
- Debtor location test
- Varies by province
Common law provinces differ among themselves too. Ontario files in the Personal Property Security Registration system, British Columbia and Alberta file in a Personal Property Registry, and the filing window and the debtor location test vary as well. So does the treatment of a purchase-money security interest, which can lift a seller above an earlier registrant.
The earnings side of the file rests on assumptions that requirements for valuation methods sets out before any figure counts.
Example: an unregistered note meets a trustee
A seller in Ontario sold the shares of a fabrication company and took back a note secured by the equipment and inventory. Both documents were signed at closing. No financing statement was filed.
Fourteen months later the trustee in bankruptcy sold the equipment. The seller's interest was unperfected, so it ranked behind the trustee and behind a bank that had registered earlier. The note stayed valid, but the assets behind it were gone.
